Off-Chain Transactions

This is the first of a series of articles detailing the inner workings of Bitcoin and RTWire. I’m going to start by talking about something that’s at the heart of RTWire: off-chain transactions.

london-buses.jpg

Sending money to someone can be done in many ways – cash, credit cards, bank transfers, gift vouchers, bitcoin, etc. – each with its own advantages and disadvantages. Take cash, for example: there are often no transactions fees, the transaction is instantaneous and, since it’s difficult to get your money back once someone has it, it’s irreversible. Conversely, it’s fiddly. Buses in London no longer accept cash because of this: not only does it hold up the bus while the driver counts a passenger’s change, they could be robbed or accept counterfeit cash. Transport for London decided that the benefit of not using cash outweighed the transaction fees and infrastructure costs required to accept only credit and prepaid cards.

Using the bitcoin network to send someone money in the conventional way, with on-chain transactions, also has its advantages and disadvantages. On the plus side, whilst there are transactions fees, they’re often less than £0.03 ($0.05). We can send the money to anyone with an Internet connection without needing to trust an intermediary or central authority like a bank or credit card processing company. However, it can often take an hour to be sure that we have sent or received the money. This doesn’t matter for remittances or buying goods online, but waiting an hour while my transaction is confirmed before a barista gives me my now-cold coffee is madness. The fees add up, too: that 3p transaction fee suddenly becomes a lot of money when multiplied by an large number of small winners on an online game.

Off-chain transaction systems such as RTWire can solve both of these problems. They allow instant, confirmed, payments of any amount in bitcoins with small, or no, transaction fees, to anyone else using the same system. They do this by, as the name suggests, transferring bitcoins between people not on the block chain but in a separate ledger.

off-chain-transaction-diagram

The great thing is that there are no downsides; we can finally wire real-time microtransactions to everyone! Just kidding, there are some serious potential downsides. Unlike the traditional banking system where a bank, whom you are required to trust completely1, acts as custodian for your money, core to the design of Bitcoin is the lack of a custodian. If you lose your bitcoins it’s your own fault. Contrary to this design principle, but crucial for providing immediate transactions and low or no cost transaction fees, most off-chain systems require that you trust them with your funds. Fly-by-night off-chain setups gave this area a bad name since the early days of Bitcoin. Sites got hacked and criminals posed as legitimate enterprises. Many people lost a lot of money.

Life, and business, is all about trade-offs, though. Just as London buses have chosen credit cards over cash, sometimes a business can benefit by using off-chain bitcoin transaction systems. So long as they understand the pros and cons.

RTWire came about by accident after creating Intus, a charitable bitcoin lottery. We started out wanting all transactions to be on-chain to benefit from the security the block chain gives. But we also wanted it to be cheap enough for everyone in the world to be able to buy several tickets per draw, so set the price at £0.30 each. A 3p transaction fee would be 10% of the price of a ticket – a large proportion that we’d much rather give to charity or put in the prize fund! We also felt that, since the gambling world is forever moving towards real-time rewards, waiting for an hour for a player’s transaction to be confirmed was just too long. Off-chain transactions were therefore a perfect fit.

The moral of this story is to think carefully about what your priorities are, and use on- and off-chain transactions as necessary. If you use off-chain transactions, choose your partner carefully and understand the trade-offs you’re making: while they can make up for some of the drawbacks of bitcoin, they introduce their own risks.

Further Reading

1. In many jurisdictions governments will provide a backstop if a bank goes under, so complete trust isn’t needed, but it’s often only up to a certain amount (£85,000 in the UK), and doesn’t cover the bank behaving fraudulently.

Images:
chain links – psyberartist
London Buses on Whitehall – Duncan Harris