How Do Bitcoin Transactions Work?

How Do Bitcoin Transactions Work in a Nutshell?

On the surface, they’re fairly easy to understand. When a person wants to send someone else some Bitcoin, they enter the recipient’s address and the amount and then click Send. This is as far as the user interface goes. Under the hood, however, a lot more happens in these Bitcoin transactions.

Once a user publishes their intention to send Bitcoin, nodes will proceed to scan the blockchain network to determine whether the user owns the coins in question and whether the funds haven’t been sent to somebody else before. If the information is confirmed, the transaction will be included in a block of transactions, which is then published and stored forever on the blockchain.

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Basic Explanation of the Blockchain Network

In this article, we will attempt to cover everything there is to know about Bitcoin transactions in depth. To understand how Bitcoin works, it is important for users to have a solid understanding of the blockchain network, which together with nodes create the backbone of the Bitcoin payment system.

The Bitcoin blockchain network represents a decentralized and digitized public ledger that stores all transactions that ever took place. The public ledger stores all transactions in a chronological order. Its main purpose is to serve as an accounting and processing method for digital currencies. However, it has great potential in a variety of other industries as well.

It has often been said that Bitcoin does not require a middleman or central authority thanks to its decentralized nature. Well, this decentralization alongside many of the other benefits associated with Bitcoin transactions are possible thanks to the blockchain. The reason for that is security. Bitcoin blockchain, thanks to the encryption technologies woven into it, is one of the safest currencies when it comes to transactions. No wonder then, that even the best bitcoin casinos in the USA use it as a basic currency.

As the name suggests, this public ledger comes in two sections: the blocks and the chain. The block represents the present part of the blockchain network. It’s responsible for recording and bundling a part of the network’s recent transactions. Once a block is completed, it permanently joins the chain, and a new block is created. All of these blocks are connected with one another, and they store essential data required for the system to run, including user addresses, balances, and several other components.

Basic Explanation of Bitcoin Addresses

So what is a Bitcoin address? When you want to send Bitcoin to someone, you won’t need their name, email, or other personal data. Instead, they’ll need to provide you with their Bitcoin address, which is an identifier consisting of 26 to 35 alphanumeric characters, representing the destination for the funds you wish to send. The Bitcoin protocol allows any user, wallet, exchange, or business to generate as many addresses as they’d like, free of charge. In fact, it is often recommended that different addresses are used for transactions, as doing so increases anonymity and security. The whole process is pretty much similar to that of Bitcoin mining.

Addresses are essential to understanding how Bitcoin transactions work, since they play an important role in all Bitcoin transactions.

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Bitcoin Transactions In Depth

Oftentimes, Bitcoin transactions are compared to other payment systems in terms of how they work. With this in mind, many people believe that addresses are responsible for holding the funds, hence when a transaction is made, a part of the sum is sent to another person, leaving the sender with the remaining coins.

Things work a bit differently here. When you make a Bitcoin transaction, in which you’re sending someone only some of your Bitcoins, you’re technically spending all of your coins at once. If there is a remaining balance left, it will be automatically sent back to your account. In other words, every time a transaction is made, all coins move back and forth.

Because of this model, a Bitcoin transaction is composed of several elements.

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Transaction Components

Most Bitcoin transactions are made up of three main components, these being the transaction header, the input, and the output. When you make a transaction, being aware of these components brings no benefit, as the entire process is automated. Now, things will get a bit more technical as we attempt to explain what these components are and what purpose they serve.

• The Header

This is the first element that makes transactions possible, allowing them to register on the blockchain network. The transaction header is made up of several parts, these being the hash, ver, vin_sz, and lock_time. The hash is by far the most important, since Bitcoin utilizes hash values in order to verify whether the Bitcoin transfer ID is authentic. The Bitcoin hash value is also used as a pointer. It points the transaction to its respective block, which will finally be added onto the chain.

The ver stands for the version number of the block in question. Its purpose is to clearly identify blocks and add an extra layer of security to the network. The vin_sz is responsible for counting the number of inputs associated with the Bitcoin transaction. Lastly, the lock_time is the header component that offers instructions related to how early a block can be added onto the blockchain. It plays an important role, since Bitcoin protocol dictates that approximately 10 minutes must pass before another block can be added onto the chain.

• The Input

This transaction element is responsible for initiating the transaction and offering the network details on the outstanding balance. It also keeps tab on funds that you are spending, and proof that the transaction creator has permission to spend the funds in question. The input is made up of three sections, these being the previous Bitcoin transaction output hash, the n, and the scriptSig.

The output hash points the network towards the unspent transaction output at your disposal—basically the funds you own that haven’t been spent yet. The n is an index giving access to the list consisting of the outputs associated with all previous transactions, while also representing the funds that you are currently spending. Lastly, the scriptSig is a security element that proves to the network that, as the BTC transaction creator, you have the right to spend the funds—in other words, you own the address, and the funds are yours alone.

• The Output

The output is a bit easier to understand, since it’s only made up of two parts: the value and the scriptPubKey. The value stands for the amount of coins, or Satoshi to be exact, you’re spending on the current transaction. Lastly, the scriptPubKey is the second script involved in Bitcoin transactions. Its purpose is to direct the coins to the recipient’s hands by using their hashed public key.

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Verification

Once a transaction has been made, several other processes begin to happen, the most important being transaction verification. This is handled by Bitcoin nodes. Nodes are a network of computers that broadcast messages across the network and are responsible for verifying transactions. Each Bitcoin transaction activates a network of randomly selected nodes that will run a Bitcoin verification or two to ensure the authenticity of the transaction. Some of the technical functions associated with nodes include verifying the following:

• Whether the data structure and the transaction’s syntax are correct;
• If the transaction input and output have values;
• Whether the transaction is below the block size limit;
• If the lock_time is respected;
• Whether all outputs being claimed by the transaction inputs are part of the UTXO pool;
• If the value of the transaction input is higher than the value of its output—to ensure that a miner fee can be obtained and that the user isn’t attempting to spend more funds than they own.

So to check a Bitcoin transaction, you simply need to enter the transaction ID or your address. Via these verifications, the network of nodes keeps the Bitcoin system alive and secure. No transaction can be processed without a number of nodes. The block explorer will then showcase the number of confirmations and raw data, but also output and input information. A block explorer is a Bitcoin transaction tracker, and a simple Google search will show you a few.

During the last couple of months, the number of Bitcoin nodes has decreased, hence leading to worry on the market. This is mostly due to the fact that they consume electricity. Users have no incentive whatsoever to keep the nodes operational. This leads to a decrease in the number of people supporting the Bitcoin blockchain network. While miners are given block rewards for cracking proof-of-work solutions, the Bitcoin protocol needs to find a suitable solution for node operators to ensure Bitcoin’s future sustainability. However, recently, with the introduction of Lightning Network, this may change.