The cryptocurrency community has a lot to keep up with. There are many different aspects of the networks that get debated in the crypto-community constantly. From blocksize, to blocktime, to specific transaction scripting, this nascent technology has a lot of neat features and customizations.
One of these features that can be taken advantage of is off-chain transactions, which allow for instant and free transfers of money. Because this type of transaction is not the default operation, some may misunderstand it as a bad thing and an insecure method of utilizing the blockchain.
Off-chain transactions will help scale Bitcoin and other cryptocurrencies by allowing for transfers that are secured by cryptography to be readily available without the need for the network to mine the transaction into a block. Full Nodes need to verify all the transactions in the blockchain – so the fewer operations there are, the quicker it can be done. This in turn lowers the barriers to allow more people to run a full node, and empowers new users with the opportunity to sync their full nodes.
Some great news is that Blockstream has launched a service in their satellite system that allows people to connect to a global communication and payment system from almost anywhere in the world instantly. It’s done through the Bitcoin Lightning Network nodes in orbit.
Perhaps one day there will be inter-stellar atomic swaps carried out with the Lightning Network. But for now, we are watching new wallets, hardware, protocol features, and developers get introduced into the space. All of this is very exciting. We will look more at the Lightning Network after we go over off-chain and on-chain transactions.
Well, What Is An On-Chain Transaction?
On-chain transactions pass transactions through the nodes you are connected to, anywhere from 1-1000+ different connections, which distribute to nodes they are connected to in the same manner until the transaction is distributed to all the nodes on the network. Nodes that run the mining algorithm can add it to the list of transactions to the block they are trying to solve.
A block is essentially a hash of transactions and a header that agrees with the consensus of how block headers should be formed – according to all full node user’s wallet software. The transaction is on-chain when it is added to a valid block that is found by a miner via Proof of Work. This is a trustless way to ensure transactions are valid and the original protocol for the settlement layer.
The limitation is the amount of transactions allowed in a block, in order to prevent the blockchain from growing beyond the ability for it to maintain its decentralized nature, by out-pacing growth of technology. The blockchain sync time is an important factor in maintaining a decentralized network. Currently sync time is still increasing for users around the world.
Then What are Off-Chain Transactions?
Off-chain transactions occur without logging the transaction in the public ledger until they are brought back on-chain, settled, and added to a block. While this sounds insecure, there are many forms of off-chain transactions.
From the beginning, one could print out the public and private key onto paper, and then give that out as a payment. Of course, the private key is compromised because the user giving the paper wallet could have copied the keys in order to just sweep the wallet back. The solution that was produced was scratch-off paint over the private key. Gold and Silver coins with bitcoin addresses engraved in them are also available. Furthermore, there is the ability to transfer funds on an exchange to someone else using the same service, which would take place instantly and off-chain. In all of these cases, trust is required.
In the newest version of off-chain transactions, the Lightning Network, trust is no longer required. Lightning Nodes create off-chain transactions based on the users’ Bitcoin full node data by creating smart contracts to the other nodes you wish to send funds to and from. This allows instant transfers of value at near zero fee through a private node route. This also increases the anonymity of the sender.
So Moving Funds Off-Chain Can Actually Be Secure?
Paper wallets were created for security, and are a type of cold storage. These are very secure if stored in a very secure physical space and have not been not used on a live network before. Users probably shouldn’t accept these as a payment since the keys are compromised by the previous user and the funds can be taken back. So unless there is a security scratch off over the private key, it’s probably not secure for payment.
This also goes for gold and silver coins with bitcoin QR codes and wallets. Unless you are the very first owner from a reputable source, then it probably isn’t secure as the last owner may also still have the private keys to the wallet. This leaves it as an insecure form of payment.
Exchanges hold their users’ bitcoin in giant pools of funds. Users do not control the keys. Instead, they rely on the exchange to maintain the unit of account in the servers database. There have been too many examples of people losing their bitcoin from an exchange, so we won’t even start to consider that centralized exchanges are secure.
The Lightning Network nodes solve these security policy issues by using cryptography and arithmetic off the bitcoin blockchain to create the channels in which secure, free, and instant transactions can be made. This also means that all Lightning Network nodes will have corresponding full nodes securing the transactions creating these channels. These channels are created by using the native scripting language and a full node to create a smart contract that locks in a selected amount of the native cryptocurrency. As long as the user secures their node, which is important for any user anyway, their transactions will also be secure. Trustlessness is gained by punishing users who try to corrupt the smart contract. This allows for a majority of transactions to be made off-chain while still maintaining the decentralized security model behind Bitcoin.
Off-chain Transactions on the Lightning Network can also include atomic swaps, or peer-to-peer instant cryptocurrency and token exchanges. Decentralized exchanges will use this process to make secure cryptocurrency exchanges without the need to hold private keys, or even user information. In the days of identity theft and credit card fraud, the more anonymous the communication takes place, and less data gets stored, and the less likely it is for the data to be stolen.
Just remember: as the technology grows and the developers adjust the protocol to allow for various types of transactions,, you may use several methods to transact – and the most robust methods require no trust. There are many cool ways developers are taking advantage of this new option on the Bitcoin network. With instant, virtually free or actually free, transactions on private channels using Bitcoin’s secure cryptography, expect some killer apps, and game changing innovations.