Off-chain transactions are value transfers facilitated either using a third party as a form of guarantee or other methods, with only the final state of the balances being recorded on the blockchain itself. They offer benefits, such as lower fees and a faster transaction processing speed as the validation isn’t performed by nodes. That makes off-chain transactions perfect for small-scale payments like coffee purchases at a local shop.
Layer 2 solutions are protocols built on top of an existing blockchain aiming to improve its scalability. They are projects that enable off-chain value transfers using mechanisms such as state channels, sidechains, and rollups.
While off-chain transactions occur outside the chain, the term “on-chain” describes the processes that happen directly on the blockchain (the main chain). On-chain transactions need to be validated by the peers and are confirmed only once recorded on the chain. Let’s take a look at the key differences between off-chain and on-chain.
For an on-chain transaction to be confirmed, it needs to be validated and included in the blockchain. As the average block confirmation time for Bitcoin is 10 minutes, the Layer 1 chain isn’t suitable for smaller purchases like buying groceries at a supermarket. Unlike on-chain transactions, off-chain payments don’t need to wait for miners or validators to be confirmed. As such, off-chain solutions can substantially increase the processing speed and are particularly useful for micropayments.
On-chain transactions implement standard blockchain security practices like hashing and cryptography. In contrast, projects offering off-chain payments need to come up with security frameworks to prevent the possibility of forging or modification of payments.
On-chain transactions are verified by the nodes that put in the work to validate them, include them in a block, and add that block to the chain. The block rewards and transaction fees incentivize them to keep the network running. Off-chain transactions can be processed quickly without the need for immediate confirmation, thus minimizing the costs and fees.
Off-chain transactions are key to solving the blockchain scalability problem and increasing its worldwide adoption. They act as the base for many Layer 2 solutions that aim to reduce the load on the primary chain.