What is an Off-chain Bitcoin Transaction?

Bitcoin transaction fees remain a pressing issue to this very day. One way to bypass those fees includes using off-chain transactions. That is quite difficult for the average consumer, although most companies can complete such transfers with relative ease. This begs the question as to how these off-chain transactions work in the first place. Now is a good time to take a closer look at the concept of an off-chain transaction.

Off-Chain Bitcoin Transactions in a Nutshell

The concept of an off-chain transaction is relatively easy to explain. It all revolves around transferring value outside of the blockchain. Most people think Bitcoin can only be moved on-chain when transacting between different parties, but that is not entirely true. While on-chain transactions are far more common compared to their off-chain counterparts, the latter category can have its use more often than people would think.

There are quite a few different benefits to using off-chain transactions. First of all, one avoids the network transaction fee, which is exploding as of late. Some users pay 10% of their transaction in fees, which is far too expensive to make Bitcoin even worth considering as an alternative to traditional financial means. Unless this situation is resolved, Bitcoin will face some major issues when it comes to gaining mainstream traction over the coming years.

Another benefit of off-chain transactions is how they are much quicker. To be more specific, these transactions can be recorded immediately, without having to wait for network confirmations. Furthermore, off-chain transactions provide more privacy and a certain degree of anonymity. These transfers do not need to be visible on the public blockchain. This is quite an interesting trait which is often associated with on-chain transactions, even though Bitcoin is not anonymous in this regard by any means.

The bigger question is how one can complete an off-chain transaction. That is rather difficult to do when multiple parties are involved unless you and the other person in the transfer agree on creating a “debt” between each other. This method can be expanded to include multiple mutually trusting parties, such as is displayed by the Ripple ecosystem. This does mean Bitcoins themselves are not effectively changing hands, which makes this iteration of the concept somewhat unattractive.

It is also possible to use a trusted third party to record and guarantee the off-chain transaction. This is how most of the traditional payment processors are working these days, including the likes of PayPal. In the world of Bitcoin, there is such a solution in the form of redeemable codes, which are issued by the BTC-E exchange, for example. Such a “coupon” effectively allows users to move Bitcoin funds off-chain with relative ease, assuming one can redeem said coupon through another platform.

Quite a few e-wallet services pertaining to Bitcoin are making use of off-chain transactions as well. More specifically, some of these services allow users to transfer funds between different addresses on the system without an on-chain record. The same applies to services such as Coinbase, which allow transfers between platform users without on-chain transactions as well. This does require a lot of trust between all users and the third-party providing this service, though.

In its simplest form, an off-chain transaction would be two people exchanging the private key to a set amount of coins. If you print out a paper wallet and sell it to someone for fiat, the Bitcoins themselves stay in the same address but said ownership of coins actually changes. Off-chain transactions could be a great way to trade Bitcoins between trusted parties, but their use should be limited for more generic purposes.

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