Blockchains have several concerns associated with them.
They are:
Some of the on-chain issues can be addressed by moving them to another network.
An off-chain cryptocurrency transaction is one that takes place outside a blockchain network. The reason for this is increased speed and reduced transaction fees.
Lightning Network
Lightning Network is the best known example of transactions done off-chain. This is a layer 2 system that utilizes Bitcoin.
With this system, channels are opened between nodes enabling satoshis to be transferred. The transactions are batched before being delivered to the blockchain. These nodes handles all the transfers without having to get validated by the miners.
Lightning transactions are peer-to-peer (P2P) delivered directly between the two nodes that have the channel opened.
Advantages to Off-Chain Transactions
There are reasons to consider moving transactions off-chain.
They can be executed instantly. On-chain transactions can have a long lag time. This can depend upon the network load, number of transactions waiting to be confirmed, and design of the blockchain. Proof-of-Work (PoW) networks such as Bitcoin and Litecoin take a number of to produce the new blocks.
Off-chain transactions usually don't have a transaction fee, as nothing occurs on the blockchain. Since block producer is required to validate the transaction, there is no fee, making it an attractive option, especially if large amounts are involved. On-chain transactions often come at a high cost. This leads to problems of dust, a situation where small amounts of the coin cannot be processed because of the high fees.
Off-chain transactions offer more security and anonymity to the participants because details are not publicly broadcast. In the case of on-chain transactions, it is possible to partially determine a participant’s identity by studying transaction patterns.
Another benefit deals with the fact that data on blockchains is immutable. Anything posted on chain is very difficult to reverse. The same is not true for off-chain transactions. There is the ability to alter the data.
This could be beneficial when it comes to data storage. With some blockchains serving as decentralized databases, not all posted requires immutability. Here is where off-chain storage tied to the main chain could more functional.
Centralized vs. Decentralized
A lot of discussion around digital assets pertains to decentralization. Many want to promote blockchains as decentralized. This is the case with Bitcoin and a few others. For the most part, many are actually centralized when the coin distribution is taken into account.
Off-chain transactions can occur on either centralized or decentralized networks. There is the potential for both to be available, providing users with options.
Like applications, there is no rule of thumb. With Lightning, many feel the lack of incentives will mean that centralization is inevitable. This does not make Bitcoin centralized nor mean that decentralized layer 2 options cannot exist.