DEFINITION of On Chain Transactions (Cryptocurrency)
On-chain transactions refer to those cryptocurrency transactions which occur on the blockchain - that is, on the records of the blockchain - and remain dependent on the state of the blockchain for their validity. All such on-chain transactions occur and are considered to be valid only when the blockchain is modified to reflect these transactions on the public ledger records.
BREAKING DOWN On Chain Transactions (Cryptocurrency)
A transaction is a transfer of value in a particular cryptocoin token, of which details are recorded on suitable blocks of the blockchain, and the same are broadcast to the whole cryptocurrency network after suitable verification. Depending upon the network protocol, once a transaction garners sufficient confirmations from network participants or based on the network’s consensus mechanism, it becomes irreversible. It can only be reversed if the majority of blockchain’s hashing power comes to a consensus to reverse the transaction. (See also, Bitcoin Transactions vs. Credit Card Transactions.)
On-chain transactions are supposed to occur in real time in order to keep blockchain transactions secure, verifiable, transparent and instantaneous. However, in reality it rarely happens, and on-chain transactions come with a few disadvantages.
On-chain transactions rarely occur instantly, as it takes a random duration of time to accumulate the sufficient number of verifications and authentications from the network participants before confirming a transaction. For instance, if the transaction volume is high, a limited number of miners/nodes may take their own time to confirm a transaction making all involved parties wait for a longer time.
Public broadcasting and recording of on chain transaction details may also provide sufficient pointers to link addresses to participants’ identities, thereby posing a threat to the anonymity feature of the blockchain and security of its participants. For instance, it is possible to partially know a user’s identity if one carefully studies the received and send transaction patterns around the same addresses, like those used for purchasing online goods.
On-chain transactions also come at a cost, as miners command a fee for offering their validation and authentication services for confirming a transaction on the blockchain in the shortest possible time. At times, this fee can go very high depending upon the network’s scalability potential and transaction volume. For instance, the high fee has led to the problem of Bitcoin Dust, where fractional amounts of bitcoins cannot be transacted due to high transaction fees.
On-chain transactions also offer many advantages. During the initial phase of a blockchain when the transaction volume is low and the fee is zero/less, on-chain transactions offer instant settlements. New network protocols and cryptocurrencies that are aimed at keeping the transaction time and fee to minimal, yet providing instant settlement are making their way into the mainstream. Once verified and confirmed on the blockchain, on-chain transactions cannot be reversed unless the majority of the network’s hashing power agrees to do so, making on-chain transactions more reliable and fraud-resistant. (For more, see What does a block chain record in a bitcoin exchange transaction.)