The blockchain network is used to perform cryptocurrency transactions without the involvement of a third party. It facilitates the investors to perform a secure transaction with transparency and immutability as well as enhancing security requires much time and high transaction fees.
In the blockchain network, all the transactions are done by using two main types of transactions: the first one is an on-chain transaction and the other one is an off-chain transaction.
The on-chain transaction is always done in the main blockchain network and stored in the distributed ledger which is an immutable, transparent, and secure publicly available database and it requires more time to proceed and is expensive. On-chain transactions contrast with off-chain transactions, which are transactions that take place outside of the blockchain, such as through a centralized payment processor, while off-chain transactions can provide a faster and more convenient way to transfer value or information, they are not as secure or transparent as on-chain transactions.
In this article, we will discuss on-chain and off-chain transactions in detail so let’s get started and have a broad view of it!
What is On-Chain Transaction
An on-chain transaction refers to a transaction that is recorded directly on the blockchain's main network and is synonymous with the public blockchain, which means that the on-chain transaction would be made public. In this kind of transaction, the input (the previous transaction, signature, and more input), output (the output value, recipient address, and other output), and metadata (the transaction hash and housekeeping) are recorded in a block and added to the blockchain network after validation.
Miners perform mining by solving complicated mathematical problems in order to validate transactions. Mining is time-consuming and requires costly resources due to its complexity. After validation, a distributed ledger can be used to store each transaction, all parties have access to the same information, and the details of the valid transaction are recorded in an immutable ledger. On-chain transactions are the cornerstone of decentralized systems and are used to securely transfer value or information between parties without the need for middlemen like banks and governments.
Bitcoins (BTC) are the most common example of an on-chain transaction, as they use distributed ledgers to store data and proof of work (POW) for transaction validation.
Working Of On-Chain Transaction
The on-chain transaction is the process of adding new transactions in the distributed ledger after validation. Here are the step mentioned about the working of the on-chain transaction:
- Transaction Request: For instance, Alice wants to send cryptocurrency to Bob. The very first step is, Alice would initiate the transaction and send it to the network by specifying the details of the transaction such as the amount, the sender and recipient addresses, signature, and any other relevant information.
- Validation: The transaction would be broadcasted to each node in the network for validation, each node would be responsible to validate the following details if the sender has sufficient funds or other rules of the network.
- Consensus: After the transaction validation, it is added to a pool of unconfirmed transactions and this pool is called mempool or memory pool which is responsible to hold transactions until it is not a part of the blockchain.
- Mining: This is the process to validate the transaction and create a new block by solving the cryptographic puzzles and the node tries to solve this puzzle called miner. Firstly, the mining node will solve a mathematical problem then add the block to the chain, and at the last would be rewarded with the transaction fee and other bonuses.
- Confirmation: When a block is included in the blockchain, any transactions it contains are deemed secure. As more blocks are added afterward, the transaction is further reinforced, making it increasingly difficult to modify or reverse.
- Storage: After confirmation, the transaction would be stored in the distributed ledger, which is available on all computers in the whole system and cannot be changed.
Advantages Of On-Chain Transaction
Disadvantages Of On-Chain Transaction
- Low Speed
- Energy Consumption
What is Off-Chain Transaction
Transfers of assets between two parties that aren't recorded on the blockchain ledger are commonly referred to as off-chain transactions. This type of transaction is similar to a private blockchain, meaning that it would not be visible to everyone. For an off-chain transaction to take place, both parties must agree to the same terms and conditions by signing a smart contract, and often a third party is necessary for validating the transaction.
Off-chain transactions are generally faster and cheaper than those conducted on-chain, however, they are not as transparent or secure as those that take place on the blockchain. Payment channels and state channels in Ethereum are examples of off-chain transactions. Additionally, the Liquid Network is another off-chain transaction protocol.
Liquid Network: The Liquid Network Protocol operates in the Bitcoin layer 2 and is a side-chain protocol. This protocol runs independently and adopts different techniques to enable higher throughput and more discreet trades. The data is maintained on the Bitcoin blockchain and the transaction is processed in isolation, it also guarantees security and secrecy while increasing the speed of the transaction. The Liquid Network Protocol is not decentralized but operates with regulatory approval.
Working Of Off-Chain Transaction
Off-chain transactions are transactions that occur outside of the blockchain network, but still, involve the transfer of assets or values. Here's how they work:
- Channel creation: Two or more parties can set up a channel using a smart contract on the Ethereum blockchain. This contract outlines the terms, as well as the assets that can be exchanged within it. All those involved consents to the terms of the agreement that have been written into the code of the smart contract.
- Transfer of assets: The participants in the channel can move resources back and forth as many times as they would like without having each exchange entered on the blockchain. This lessens the administrative burden of recording each transaction on the blockchain, which can lead to faster and more cost-effective transactions.
- Settlement: When the involved parties are prepared to terminate the channel, they can finalize their respective balances on the blockchain. This addresses any remaining assets and shuts down the channel, with the ultimate status of the channel being recorded on the blockchain.
Advantages Of Off-Chain Transaction
- Increase Speed
- Lower Fees
- Increased Scalability
Disadvantages Of Off-Chain Transaction
- Lack of Transparency
On-chain transactions are conducted on the main blockchain network, and their data is saved in a publicly accessible distributed ledger that is immutable, transparent, and secure. Even though these transactions need more time to process and are expensive, they are more secure and transparent than off-chain transactions which take place outside of the blockchain, like through a centralized payment processor. Off-chain transactions can be more convenient and faster, but their security and transparency can't be compared to those of on-chain transactions.