On-Chain Transactions (Cryptocurrency): Definition and Validation

What Are On-Chain Transactions?

On-chain transactions refer to cryptocurrency transactions that occur on the blockchain and remain dependent on the state of the blockchain for their validity. On-chain transactions are considered valid only when the blockchain has been updated to reflect the transactions on the public ledger. On-chain transactions offer security and transparency since they can't be altered once they're verified and recorded on the network. However, there are some drawbacks to on-chain transactions, which include higher fees and slow processing times.

Understanding On-Chain Transactions

On-chain transactions are transactions that occur on a blockchain that are reflected on the distributed, public ledger. On-chain transactions are those that have been validated or authenticated and lead to an update to the overall blockchain network.

Transactions that occur on a blockchain must be validated by a number of the network's participants, who are called miners. A transaction is only valid once the participants verify the transaction and a consensus is reached about its validity. The transaction details are then recorded on the block and distributed to the network's participants.

Depending upon the network protocol, once a transaction garners sufficient confirmations from network participants based on the network’s consensus mechanism, it becomes almost irreversible. Typically, it can only be reversed if the majority of the blockchain’s hashing power comes to a consensus to reverse the transaction.

Timing of On-Chain 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 that way. On-chain transactions can take a long time to accumulate a sufficient number of verifications and authentications from network participants before confirming a transaction. Also, the miners have to validate the transactions by using computers to solve complicated math problems each time a block transaction is added to the blockchain.

If the transaction volume is high or there's congestion within the network, it may take longer for the miners to validate all of the transactions, particularly if there are a limited number of miners. As a result, the other parties involved in the transactions must wait for a resolution. However, participants may have the option to pay a transaction fee so that it can be validated sooner.

During the initial phase of a blockchain when the transaction volume is low, on-chain transactions may offer instant settlements. New network protocols and cryptocurrencies that are aimed at providing instant settlement are making their way into the mainstream.

Public Ledger

On-chain transactions are time-stamped and copied throughout the blockchain network, which provides transparency and security. On-chain transactions are also immutable, meaning they cannot be changed, which helps to bolster the security by preventing a hack in which transaction details could be altered. On-chain transactions are shared with all participants in the network, providing transparency, which also helps prevent transactions from being altered by a fraudster through a malicious attack.

Although there are benefits to the distributed ledger of a blockchain network, public broadcasting and recording of on-chain transaction details may also provide sufficient pointers to link addresses to participants’ identities. As a result, the public sharing of the transaction could pose a threat to the anonymity feature of the blockchain and the security of its participants. For instance, it is possible to partially know a user’s identity if one carefully studies the transaction patterns of sends and receipts around the same addresses, like those used for purchasing online goods.

Cost of On-Chain Transactions

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 be high, depending upon the network’s scalability potential and transaction volume. For instance, high fees have led to the problem of Bitcoin Dust, where fractional amounts of bitcoins cannot be transacted. However, for blockchain networks that are in their early stages of growth, when the transaction volume is low, their fees could be very small or zero.

How Is On-Chain Different from Off-Chain Transactions?

Off-chain transactions are conducted outside of the blockchain network. Off-chain transactions can be done by the participants in which they have an agreement that a third-party guarantees the transaction or verifies that it's valid or complete. The two participants could also exchange their private keys so that the crypto assets are exchanged without moving any money out of their digital wallets.

Nevertheless, off-chain transactions occur without any changes to the blockchain. As a result, there is no need to wait for validation by blockchain miners, which can speed up the process and lead to lower transaction fees. However, since off-chain transactions are not recorded on the blockchain, there is no network record of the transaction and the financial details, which could be an issue if there was a dispute between the two parties.

Conversely, on-chain transactions are processed on the blockchain network and are immutable. Although on-chain transactions take longer to process due to the validation process by the miners, it greatly enhances the security by having the transaction validated by participants and recorded on the blockchain network.

Whether an on-chain transaction or an off-chain transaction is best depends on the participants involved and what they desire the most. If the goal is security, immutability, and a validated transaction, an on-chain transaction would likely be best, but if low transaction fees and speed are important, an off-chain transaction might be better.

Real-World Examples of On-Chain Transactions

A cryptocurrency with a relatively fast transaction speed is NEO, which is under 25 seconds block time. Burstcoin (BURST) is another coin that not only has faster block time than mainstays like Bitcoin, it also uses far less energy to mine coins because of its proof of capacity system.

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.