Balancing On-Chain & Off-Chain Transactions To Securely Scale Blockchain

Blockchains are the driving force behind cryptocurrency transactions, enabling individuals to send and receive funds without the support of an intermediary, such as a bank. 

These “on-chain” transactions provide strong security and transparency, as they all take place out in the open. They’re verified and recorded on the blockchain, which is a distributed ledger that everyone can see. Once a transaction has been added to the blockchain, it cannot be reversed or changed. 

It’s the blockchain that allows crypto to be fully decentralized, eliminating the need for banks and stopping governments from censoring transactions or seizing anyone’s funds. 

There are some downsides to blockchain, though. When the network is busy, users may be charged excessive fees and they may have to wait a long time for their transactions to be processed. It’s not unheard of for some Bitcoin transactions to take a couple of days to be processed, while on Ethereum, some users have paid hundreds of dollars in gas fees! 

It’s because of these downsides that an alternative to on-chain transactions, known as “off-chain” transactions, has emerged, allowing crypto users to send funds to other users without those transactions immediately being submitted to the blockchain. This enables fund transfers to be confirmed instantly, and usually with much lower costs. 

How on-chain transactions work

On-chain transactions are those that are fully processed on the blockchain. All of the details of the transaction, including the wallet addresses involved and the amount sent, are recorded on the blockchain and publicly validated. It’s a completely transparent process that provides a high degree of security for users. 

When a user wants to make an on-chain transaction, details including the amount of funds they want to send and the wallet address of the recipient are broadcast to the network, which is made up of hundreds or even thousands of independent nodes, which all store and update a copy of the blockchain. 

On the network, miners or validators compete with one another to undertake the process of validating the transaction and posting it onto the blockchain, where it’s included in a block of other transactions. Blockchain networks use a range of different consensus mechanisms to validate transactions, with the most common being proof-of-work or proof-of-stake, though there are other types. Once the transaction has been verified and validated via the consensus mechanism, it’s then added to the next block, which is published on the blockchain. From that moment, it is permanently recorded on the distributed ledger by every node, and fully immutable (meaning it cannot be altered). 

On-chain transactions are entirely trustless because the underlying blockchain is decentralized. The community works together to process transactions democratically, and this eliminates the role of the intermediaries we have in traditional finance, such as banks, which perform the role of processing credit card payments, for example. 

This characteristic reduces the cost of transactions and makes crypto impossible to censor, but it turns out that this architecture struggles to scale as more people use the network. The consensus mechanisms that are essential to blockchain can be slow and resource-intensive, and they can struggle to keep up with the amount of users wanting to process transactions. 

Notable examples of on-chain transactions include a simple BTC or ETH payment on the Bitcoin and Ethereum blockchains. Both of these networks have struggled to scale. The average Bitcoin transaction usually takes between 30 minutes to one hour to process, and while Ethereum is often a bit faster, users are often surprised by the high transaction costs they’re required to pay. 

How off-chain transactions work

Off-chain transactions refer to crypto payments that occur outside of the underlying blockchain, on secondary networks such as Layer-2s or sidechains. These are separate networks that run independently of the main blockchain. However, they are linked to the primary blockchain and will periodically settle their accounts on it, so the main network is kept up to date. 

An example of a Layer-2 network is Polygon, which provides a standalone network to enable Ethereum payments to be processed much faster and at lower costs. Because the payments are not processed on Ethereum itself, they don’t have to go through the main consensus mechanism each time, meaning they can go through almost instantly. 

What Polygon does is it bundles many hundreds or even thousands of transactions together, processing them all off-chain, before ultimately settling them on the main Ethereum chain. It will update all of the wallet balances in all of those transactions as one, giant transaction on Ethereum. This is what enables Layer-1 blockchains to scale. 

Off-chain transactions can be executed immediately with lower costs, as the transaction fee is spread across many hundreds of users, so each person only has to pay a very small fraction of it. In addition, off-chain transactions can be considered more private, as the details of each one are not processed in public, and are ultimately obscured among all of the other transactions settled as one on the public blockchain. 

Still, there are downsides to off-chain transactions, as they introduce complexities to users and the process is not as secure. So, although they play a key role in helping blockchains to scale, they’re generally better suited to microtransactions. 

The main problem that some crypto users have with off-chain transactions is that they sacrifice transparency and trust, which are the two most fundamental principles of crypto. 

Getting the balance right

Some alternative architectures are attempting to strike a better balance between on-chain and off-chain processing, using a hybrid approach that integrates both models, depending on the importance of the transaction. 

One example of this is GRVT , a decentralized exchange platform that’s optimized for speed and scalability while still offering strong security. 

With GRVT, transactions are processed either on-chain or off-chain , depending on their importance. For instance, key functions like final settlement of transactions and dispute resolution occur on-chain, as it’s important that these can be fully verified out in the open, guaranteeing the security of its network. On the other hand, routine interactions such as the everyday trades between users are settled off-chain, ensuring the network can process them in real-time without excessive costs. 

This model ensures that most processes on GRVT occur off-chain, where they’re processed by its private servers. This helps to keep costs low and ensures that user’s account balances are updated in real-time, the moment they confirm a trade. At regular intervals, GRVT will record all of these transactions on-chain to provide transparency and trust for users. 

As an example, orders processed by its matching engine are generally done off-chain, before being periodically settled on-chain. Liquidations of user accounts are flagged off-chain before being verified on-chain, and the creation of new user accounts also occurs off-chain initially, before being verified on-chain. 

GRVT says it intends to strike a balance between the need for speed and low costs with security and trust, so it can handle the performance demands of its users while maintaining its credibility. 

Another example of a hybrid on-chain and off-chain infrastructure is Chainlink , the market leader in decentralized data oracles. In its new whitepaper , Chainlink 2.0: Next Steps in the Evolution of Decentralized Oracle Networks, it outlines a model for a decentralized meta-layer that promises to enhance smart contracts by enabling them to perform some tasks off-chain, and ultimately settle balances on-chain, based on external data from the real world. 

It refers to this concept as “hybrid smart contracts” and says they can support new use cases not possible with smart contracts that process everything on-chain. Chainlink’s Decentralized Oracle Networks will consist of a collection of nodes that can transfer data bidirectionally and perform off-chain computations in a decentralized way, using various consensus mechanisms. 

Scaling blockchains with a hybrid approach

As crypto becomes more mainstream, there’s a growing need for this kind of balance between on- and off-chain transactions. Blockchains simply cannot scale to support the billions of financial transactions processed globally each day, not unless they offload some of that load to off-chain servers. 

New hybrid models strive to achieve an equilibrium that will allow blockchains to scale, processing routine transactions off-chain while ensuring that the most critical interactions are done on-chain, ensuring full transparency and maintaining trust in the network. In this way, blockchains will be able to deliver the speed and low costs necessary to make them viable for day-to-day use, while maintaining the transparency that’s paramount to their security.