Off-Chain vs. On-Chain Crypto Transactions: Which One Is Better?

Off-Chain vs. On-Chain Crypto Transactions: Which One Is Better?

You can speed up crypto transactions using off-chain transaction methods.

Knowledge is power; when it comes to cryptocurrency, the more you know, the better financial decisions you will make. There is a lot to learn within the cryptocurrency space, such as how the different layers of blockchain technology work and which blockchain has the fastest transaction speed. Another important thing you need to know regarding blockchain transactions is the differences between off-chain and on-chain transactions—and which one can save you more money!

Simply put, on-chain transactions occur inside the blockchain network, and off-chain transactions happen outside the blockchain network. Let’s take a close look at their differences to determine which one you should pick for your next crypto transaction. 

Differences between on-chain and off-chain transactions 

Transaction process

With on-chain transactions, all the relevant information is time-stamped and stored on the public ledger. The computers (or nodes) on the blockchain network verify these transactions based on the consensus mechanism (e.g. proof-of-work [PoW] or proof-of-stake [PoS]) the chain uses. For PoW blockchain networks, it can take up a lot of computational power to verify transactions and add new blocks to the chain. The intensive energy required will heavily pollute our environment and speed up global warming. 

On the other hand, you can conduct off-chain transactions in one of these three ways:

  • the parties involved can use a transfer agreement; 
  • one party can purchase coupons instead of crypto tokens and then give the code for said coupons to the other party; or 
  • they can use a third party as a guarantor for the transaction. 

Common third-party guarantors are layer-2 solutions (which aim to address the scalability issues present in the blockchain) specifically designed to reduce the burden on the main blockchain. Some of these include the Lightning Network and the Liquid Network.

Transaction speed and costs

Since on-chain transactions need to be verified by multiple nodes controlled by miners, it can take a long time to process one if there are a lot of transactions waiting in line. To incentivize the miner to prioritize your transaction over others, you need to pay a high transaction fee. The higher the transaction fee you are willing to pay, the faster your transaction will go through. This can become a major problem, particularly in the case of smaller trades where the amount to be transacted is lower than the fee itself. 

Since off-chain transactions don’t need to be verified by multiple nodes like the on-chain ones, they tend to go through at an almost instantaneous speed. They don’t involve miners and therefore tend to have no transaction costs

Security and transparency

Since on-chain transactions are recorded and time-stamped, no one can alter or reverse them, making them highly secure and transparent. 

In the case of off-chain transactions, the security level varies depending on the way you are conducting the transaction. If you use a layer-2 solution (e.g. the Lightening Network), a side channel will be created between the involved parties. Once the transaction has been completed, the side channel will be closed, and the transaction can be recorded on the main blockchain. In other kinds of off-chain transactions, there may be no record of the transaction to aid either party involved in the transaction in case of conflict. 

The higher transparency level of on-chain transactions comes at the cost of anonymity. Since the details of on-chain transactions are secured inside a public distributed ledger, the transaction patterns make it possible to at least partially identify the parties involved in the transaction. 

In contrast, off-chain transactions aren’t accessible to everyone, offering more privacy. Even off-chain transactions processed with layer-2 solutions, which might leave a record on the main chain, are encrypted and inaccessible until the chain is closed, ensuring the parties involved are anonymous. 

So, which one should you pick?

Whether you are a complete newbie to cryptocurrency or an avid investor, everyone is looking for a way to make the smartest financial decision and get the best return on their crypto investments. To do so, you want the cost incurred by every transaction to be as low as possible. 

On May 1, 2022—prior to “The Merge” in September, which took Ethereum from proof-of-work to proof-of-stake—the average transaction cost on the Ethereum Network reached the highest at US$196. The number has been between US$10-1 from June to now. For Bitcoin, the average transaction cost has been somewhere between US$4.5-0.7 since this year. These costs can add up with every transaction you make and eat away at your crypto reserves if you aren’t careful. 

While it is advised that you use the off-chain method for larger transactions, whichever method you should choose ultimately depends on your priorities. If your goal is to have a safe transaction that can be securely documented on the blockchain, the on-chain method might be the right choice for you. However, if you want your transactions to go through quickly and without a hefty transaction cost, off-chain methods might be the way to go. Either way, knowing the options available at your disposal can help you make a smart choice each time. 

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Header image courtesy of Freepik

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