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Introduction to Off-Chain Protocols

By May 13, 2022June 11th, 20224 minute read

Blockchain technology has revolutionized the whole digitization system across sectors. The fundamental advantage of blockchain services is that they guarantee transaction transparency for both the grantee and the recipient. In recent years, organizations have been managing data for blockchain-based solutions as on-chain or off-chain storage techniques. This can be accomplished by storing information in a private or public blockchain service.

Let’s take a look at what an off-chain transaction entails.

What are off-chain transactions?

Off-chain transactions are transactions that take place outside of the blockchain and can be carried out in various ways. To begin with, a transfer agreement might be reached between two parties. Second, a third party may ensure that the transaction is complete and accurate. Finally, in the transaction, the third party acts as a form of a guarantor.

Off-chain transactions are instantaneous; however, on-chain transactions might take a long time to complete depending on the number of transactions awaiting confirmation on the same network.

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Why choose off-chain transactions?

There are several reasons why an off-chain storage mechanism should be considered when designing a blockchain system. Here are a few examples:

• It is quicker. The transactions are promptly recorded without the need to wait for network confirmations.

• It’s less expensive. Off-chain transactions are frequently accessible.

• It offers additional privacy. These transactions are hidden from the public blockchain.

Let’s take a look at the most popular off-chain protocols nowadays.

Off-chain protocols

While there is only one Bitcoin blockchain, several off-chain protocols provide various advantages over on-chain transactions. A couple of these will be covered further down.

  1. Lightning network

The Lightning Network (LN) is a decentralized, peer-to-peer network that allows users to send bitcoin off-chain instantly and with almost no costs. The Lightning Network is a layer two solution constructed on top of the Bitcoin network.

Using an on-chain transaction known as a funding transaction, the Lightning Network allows two parties to lock bitcoin in a multi-sig address. Then, the parties can use an arbitrary amount of off-chain transactions to change the balances within that address. These transactions are both quick and costless. Finally, when both parties have finished their transactions, they can balance their accounts via an on-chain transaction.

The Lightning Network compresses an infinite number of transactions into two on-chain transactions, substantially decreasing transaction costs and wait times.

  1. Liquid network

The Liquid Network is a Bitcoin-based sidechain system. The Blockstream firm established the Liquid Network, which runs on its blockchain. Since block reorganizations of more than two blocks are prohibited, and new blocks are generated every minute, Liquid allows for speedier settlement than Bitcoin’s network. Liquid also supports anonymous transactions, which hide the amount being transmitted, presently unavailable on the Bitcoin network.

Users can transfer bitcoin (BTC) to a multi-signature address on the Bitcoin network using Liquid. A peg-in transaction is what it’s called. The Liquid Network will release an identical quantity of Liquid bitcoin (L-BTC) to the user on the Liquid blockchain after pegging in bitcoin.

L-BTC is a distinct token representing a claim to actual bitcoin, similar to how paper money describes a claim to gold. The Liquid blockchain allows users to transact quickly and cheaply once they have L-BTC. They may use a peg-out transaction to exchange their L-BTC for actual bitcoin when they’re done trading.

Unlike Bitcoin’s blockchain, Liquid is administered by a federation of parties rather than being trustless and decentralized. As a result, the Liquid Network should be resistant to corruption due to its vast number of participants; however, the trust architecture is less secure than Bitcoin’s.

  1. Custodial services

Institutional investors who transact large amounts of bitcoin use custody solutions, which are third-party services that retain and secure tokens on their behalf. Online wallets and private keys can also store tokens, albeit they aren’t failsafe. As a result, intruders can obtain each user’s keys, which comprise complicated alphanumeric sequences that are tough to recall and utilize.

Online wallets are also attractive to hackers. Institutional investors’ increased interest in the bitcoin ecosystem has prompted the development of custody solutions.

Final words

The off-chain platform has advantages for consumers, but it also has disadvantages. Nevertheless, off-chain platforms offer similar benefits across different solutions: lower costs and quicker transactions.

Off-chain platforms have different disadvantages. The Lightning Network, for example, needs funds to be locked up, and each payment channel’s capacity limits Lightning payments. The Liquid Network compromises part of Bitcoin’s trustlessness for peg-in transactions by requiring 100 confirmations. Custodial solutions put trustworthiness, transparency, and decentralization at risk.

These trade-offs should be considered while deciding between off-chain methods.

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.
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Harshita Shrivastava

Harshita Shrivastava is an Associate Content Writer with WazirX. She did her graduation in E-Commerce and loved the concept of Digital Marketing. With a brief knowledge of SEO and Content Writing, she knows how to win her content game!

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