ZoneBitcoin EditorialThe concept of on-chain and layer can confuse the cryptocurrency novice. However, these are mechanisms used by traditional payment operators that we know like VISA for example. These operators work with different structural layers in their payment systems. Each layer carries out a type of task and activity.
The structure of Bitcoin also runs with multiple layers. The creation of layers was necessary to enable the scalability of Bitcoin. We then had to create additional layers in order to unclog the main network.
So, today we have several types of transactions: on-chain and off-chain. For those looking for speed, anonymity and fewer fees, it seems more judicious to carry out off-chain transactions.
Let's see in this article what that means.
What are on-chain Bitcoin transactions (or main, base layer)
All transactions recorded in the Bitcoin blockchain are considered on-chain transactions. This means that they were carried out from start to finish on the main layer of bitcoin. These transactions are those that offer the most security and transparency.
They benefit, in fact, from the power of the decentralization of the Bitcoin network. They cannot be modified or deleted. All the participants in the network, all those who run nodes are there to validate them.
What are the advantages of on-chain transactions?
- La decentralization : There is no single central authority that will govern or control the network. No entity that can manipulate the network or single-handedly destroy it.
- La security : data recorded on a blockchain cannot be modified once recorded.
- La transparencye: Transactions are recorded and anyone can access a blockchain explorer. Thus, we can trace a transaction and view the activities of all addresses.
What are the limits of on-chain transactions?
On-chain transactions are the most secure and reliable because they are inviolable and immutable. It is the proof-of-work mechanism that makes the network so decentralized and secure. Certainly, it is a fact. However, the price to pay for this transparency is that on-chain transactions are slow and expensive.
- Possibility of congestion: The speed of a blockchain transaction varies depending on the volume of transactions to be processed in the queue in the mempool. Network congestion can happen very quickly.
- Slow transactions :New blocks are created approximately every 10 minutes on Bitcoin. And the network can support 7 transactions per second with a limit of 1 megabyte per block. This is very little, especially when compared to operators like VISA or Mastercard which can manage more than 20,000 transactions per second.
- Higher costs : The more the Bitcoin network grows, that is, the more people who use the network, the more mining fees increase. In times of high demand, costs can become very significant. It is then impossible to pay for a coffee because the costs would then be higher than the price of the coffee itself.
Additional layer solutions for Bitcoin scalability
It is to meet the need for scalability of Bitcoin that additional layer solutions (layer 2) have been thought of. Sidechains allow operations to be carried out without even hindering the main chain. One of the best known layers 2 is certainly the Lightning Network. It is a layer 2 solution that uses "payment channels". This is what makes transactions faster and cheaper. There are others such as Liquid Bitcoin or the solution RSK for example…
The Lightning Network: the most advanced solution
The Lightning Network is a network built on top of the Bitcoin network. Thus, the Lightning Network works by opening bidirectional "payment channels" between two users. This payment channel allows payments to flow in both directions. The network uses the function of the Smart contract (smart contract) to make almost instantaneous payments. The parties can then send and receive transactions locally, privately, outside the blockchain (i.e. off-chain). Unlike on-chain transactions, miners do not need to create new blocks on the blockchain.
Although the Layer 2 solution is built separately from the main network, this does not prevent it from being able to interact with it. The Lightning Network will then benefit from the security and decentralization of Bitcoin without hindering it.
What are the advantages of the Lightning Network?
- Significantly increase the number of payments per second (TPS).
- Allow privacy: Details of individual payments are not publicly recorded on the blockchain ledger.
- Reduced fees: Transactions cost very little (around 1 satoshi) and make bitcoin payment convenient for everyday life.
What are off-chain transactions?
Off-chain transactions will transfer only part of the work so that it is recorded in the blockchain. In fact, an off-chain transaction mainly consists of using layer 2. This is how it solves scalability problems. (However, be aware that there are several types of layer 2 which have different modalities).
Advantages of off-chain systems:
- Faster transaction speeds : Off-chain transactions do not need to wait for the main network to confirm a transaction.
- Fee reduction: The validation process does not go directly through proof-of-work mechanisms or proof-of-stake is not necessary.
- Greater anonymity: Off-chain transactions are more confidential because the data is not all distributed in detail on the network. This can also be a disadvantage as we will see below.
The disadvantages of off-chain transactions:
- Less transparency : Off-chain transactions are not fully visible in details. This can pose a problem, particularly for regulators.
- Less security: What happens outside of the main network is more vulnerable to possible attacks.
Final word on the difference between on-chain and off-chain transactions
For a long time, bitcoin detractors hid the fact that it was possible to create additional layers to improve the scalability of Bitcoin. The fact that we can carry out off-chain transactions has allowed Bitcoin to make great progress.
The largest networks we know like Bitcoin or Ethereum are limited in their scalability. Both networks then require (for the moment at least) systems to improve their power. So, off-chain transactions are a good solution for this.
- Read the article on the difference between Testnet and Mainnet
- Watch the video on Layer 2 and read the article on the subject here.
- Browse articles in the “ Educations Crypto »
Note: There is no financial advice in this or any other article on this site. This is information of which you are the sole judge and master. Be responsible with your investments and only invest as much as you are willing to lose.
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