Blockchain technology can be used to facilitate cryptocurrency transactions without the need for a trusted third party like a bank. “On-chain” transactions carried out on a blockchain offer greater security and transparency, becausse they’re verified and recorded on a public distributed ledger that cannot be changed.

But blockchain transactions may include high fees and slow processing times, depending on the network’s verification method. For example, on the Bitcoin network, it can take anywhere from a few minutes to a couple of days to confirm a bitcoin (BTC) payment.

Off-chain transactions are confirmed outside of the main blockchain network, often resulting in a cheaper and faster process for the user.

Here are the differences between on-chain and off-chain transactions and when they're both used.

On-chain transactions refer to a transaction that is carried out on a blockchain network from start to finish. Once verified, the transaction is recorded on a blockchain network’s public ledger.

Here’s how it works: When two parties want to trade cryptocurrency, information about the transaction is packaged and time-stamped on a digital collection of data called a block. That block is sent to an associated blockchain network where it waits to be validated by computers in the network called nodes and added to the blockchain.

There are different consensus mechanisms used to verify transactions and add new blocks to a blockchain. Bitcoin, for example, uses a method called proof-of-work, which rewards miners for competing against each other using specialized computer software to solve extremely difficult computational puzzles to guess or match the “hash” and win the block reward. Newer methods like proof-of-stake don’t require mining computations but require participants to lock up a set amount of the native crypto token – their “stake” – to have a chance to be the validator for a block of transactions.

Either process provides a high level of security and transparency because transaction data is public and constantly reviewed and updated by the network of miners or validators. However, the intricacy of the process means that it takes some time to process each transaction and add it to the blockchain.

In contrast, off-chain transactions transfer some of the work from a blockchain ecosystem, which can later be integrated back into a blockchain. On an off-chain network, the users agree that a third party will handle validating and authenticating transactions.

Off-chain systems tackle a blockchain network's scalability issues by facilitating faster and cheaper transactions. One off-chain transaction method is to employ a layer 2, which is a second blockchain built on top of the main blockchain (mainnet) to help the mainnet scale in speed and cost. This takes transactions off the main chain to another chain, but for the purposes of this explainer, we’ll focus on other off-chain methods.

Read more about layer 2 systems here.

Blockchain networks provide security, transparency and ease of use when conducting a transaction. Still, some blockchain networks such as Bitcoin or Ethereum remain limited in their scalability and sometimes require high fees to process transactions. Off-chain systems address these issues and promote faster processing speeds, lower fees and greater discretion.