On-chain and off-chain transactions in digital currency and blockchain technology can significantly affect factors such as speed, cost, and privacy.
Join us in this guide as we take a closer look at the two main types of blockchain transactions—on-chain transactions and off-chain transactions—to better understand the differences and use cases.
An on-chain transaction is any transfer of value recorded directly on the blockchain, the distributed digital ledger underlying cryptocurrencies, and other decentralized applications. Miners or validators validate on-chain transactions before adding them to the permanent record after crypto mining.
In contrast, an off-chain transaction bypasses the primary blockchain by using alternative means for value transfer and record-keeping. Things like crypto exchanges, payment channels, and side chains fall into this category.
Rather than broadcasting transactions on the main network, they operate using separate solutions built on top of or alongside the core blockchain protocols. Let’s continue with the details of each blockchain transaction to understand them better!
The network verifies the movement of funds before finalizing the transfer of cryptocurrency from one crypto wallet address to another.
Miners race to solve the cryptographic puzzle required to add the new block, which bundles the transaction data along with others, to the chain. This is how on-chain transactions work.
For example, if I use my Ethereum wallet to pay a friend 1 ETH, the network sees this requested transfer and works to officially record it on Ethereum's blockchain.
When a block picks up crypto coins, it considers them truly sent. This provides a high level of security and transparency since any node can view and validate the updates to the digital ledger. On-chain KYC regulations also secure updates to the digital ledger.
For an example of an on-chain transaction, imagine Ricardo sending 2 ETH to Alexandre on the Ethereum blockchain. Here's what would happen:
This whole process may take several minutes as the network waits for transaction confirmation in a new block. Let's now discuss some key benefits of on-chain transactions!
Validated through crypto mining and consensus mechanisms, such as PoW, PoS, and PoA, transactions benefit from the security of the entire blockchain network.
The public blockchain permanently records all transaction data, including amounts, addresses, and balances.
Recording data in blocks prevents alteration, ensuring irreversible transactions.
There is no single point of failure and no need to trust intermediaries as blockchain validates transactions.
However, on-chain transactions also have limitations when it comes to scalability and transaction throughput due to block size constraints. This is where off-chain transaction solutions come in.
Rather than occurring directly on the blockchain, off-chain transactions take place through alternative protocols built on top of blockchains. Many people widely use the Lightning Network as an example of a layer-two scaling solution built on top of the Bitcoin blockchain.
Off-chain transactions operate by establishing crypto payment channels between two parties that allow for an unlimited number of transfers without using blockchain space. Both parties decide to close the channel and then settle the transactions on-chain periodically.
Parties deposit BTC into a multisignature address that both control to open a payment channel.
Once the channel is open, counterparties can send BTC back and forth via hash time locked contracts (HTLCs).
When the channel closes, it publishes the final balance on-chain in one transaction.
This process of off-chain transactions allows for near-instant, low-fee transactions without overloading the base-layer blockchain technology. Let's look at a specific example of an off-chain transaction!
Imagine Ricardo wants to buy coffee from Alexandre's shop every day using the Lightning Network. Here's what their process may look like:
This allows for unlimited coffee purchases without clogging the Bitcoin network and for negligible fees. Let's explore some key benefits of off-chain transactions!
Compared to on-chain transactions, off-chain transactions provide several advantages.
No waiting for block confirmations means crypto payments complete in seconds.
Micropayments and unlimited transactions between two parties using just one on-chain transaction when the channel closes.
Reduced fees per payment rather than high on-chain miner fees for each individual transaction.
Publishing only netted settlements kept the paths and amounts of individual payments private.
Off-chain assets like stablecoins can represent value across multiple blockchains.
Off-chain transactions enhance scalability and usability while retaining the security of settling periodically on-chain. Let’s summarize what we have learned about on-chain and off-chain transactions so far!
On-chain transactions occur directly on a blockchain, while off-chain transactions happen through second-layer protocols on top of blockchains.
On-chain awaits mining into blocks, while off-chain settles instantaneously without block times.
On-chain miners charge higher transaction fees, while off-chain can be ultra-low or free.
On-chain data like amounts and addresses is public, while off-chain data can better preserve users' financial privacy.
On-chain transactions face limitations at the base layer scale, while off-chain transactions boost scalability via state and payment channels.
On-chains are trustless and permissionless by design, while off-chains require parties to have some trust in each other and/or intermediaries like Lightning nodes.
By integrating both on-chain and off-chain transaction benefits, a 1:1 euro-backed EURK stablecoin, which is backed by real cash in trusted bank reserves and available on ERC20, can play a crucial role.
For example, cross-border payment remittance corridors could leverage EURK's low fees, speed, and reliability off-chain while periodically settling obligations on-chain with finality and security.
EURK is a euro stablecoin that empowers fast, secure, and easy payment solutions with the power of blockchain technology. It has multiple reserves that keep its stable value constant against fluctuations. Therefore, EURK is a secure stablecoin option for investing in stablecoins.
We've explored both on-chain and off-chain transactions in depth, including definitions, processing workflows, examples of off-chain transactions, and the pros and cons of each.
On-chain provides security, while off-chain enhances scalability. Both have important roles to play, but off-chain transactions aim to relieve pressure on base-layer blockchains.
The complementarity of on-chain and off-chain transaction solutions is important for fostering blockchain adoption globally. With a securely audited stablecoin like EURK fueling reliable transaction capability either on- or off-chain, real use cases can blossom across DeFi, payments, and beyond.
If you want to adopt EURK into your business, become a partner. Explore the secure euro stablecoin platform advantages with EURK. You can also find us on the reliable and secure crypto exchange platform, Coinstore!
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