Most people who buy and sell Bitcoin don’t think about what is actually occurring when they use it.
We wanted to break down for you how a Bitcoin transaction truly works, as understanding it can help you realize what is occurring and the change coming to finance.
First (and briefly) let’s touch on a few questions.
HOW DOES BITCOIN WORK?
One of the biggest questions people often ask is “How Does Bitcoin Work?”
And it’s not for good reason.
If you are a developer or programmer, than you can understand the ins and outs.
Although, for regular folk it can be hard to breakdown and understand this new revolutionary technology. And that’s why GCA is here, to help you easily get a hang on cryptocurrency.
Bitcoin works via a few principles (which we breakdown in the article on its 4 pieces of technology):
With these four qualities and technologies in Bitcoin, it becomes a lot easier to understand.
Bitcoin is peer-to-peer meaning it operates between two people and not a central entity.
Bitcoin has proof-of-work to guarantee that a transaction has been completed and verified.
Bitcoin has the blockchain to store ledgers, similar to database, and allow others to verify and see them.
Bitcoin has cryptography meaning that it is secure.
These are the fundamental core of Bitcoin as a cryptocurrency and the way that Bitcoin works.
Now keep these in mind as we move through the question of “how do Bitcoin transactions work?”
HOW TO SEND BITCOIN?
The second thing we need to understand is how to actually send Bitcoin.
When one person sends Bitcoin to another using peer-to-peer (p2p) methods, there are a few steps involved.
Each person needs a public address (and a private but not for the transaction) and that can either be in a string of numbers and letters or from a QR code given from where it is stored.
Now when one person gives the other person their QR code (if on a phone) or public address, that person can send Bitcoin via their exchange or storage mechanism for relatively cheap or free.
Miners mine the Bitcoin, verifying the transactions, storing them into the blockchain with security.
Hitting on all four points of how bitcoin works.
Essentially John sends Jimmy 1 BTC and in the process it is verified by miners, after enough confirmations, the BTC ends up in Jimmy’s wallet and it is recorded on the blockchain for good.
It is non-reversible, you can’t lie and say it didn’t happen, and the world knows what occurred (or at least the blockchain).
We can now dive into the question at hand…
HOW BITCOIN TRANSACTIONS WORK
Let me start by saying we are going to get technical for a bit, so if the above answer suffices you, then thank you for reading.
But if you want to dive into the nitty-gritty then keep reading.
In history there has always been a problem of trust between the exchange of value, and in this case money.
Then banks were developed as a central entity which we “trusted.”
The bank would verify a transaction and let a party move money around (with their rules) without having to worry about it.
Although, the trust in a central entity proved to have similar untrustworthy signs (bailouts, closing days, rules about one’s own money, etc.).
Which is where the problem came up:
How can we solve trust and allow people to send money from one party to another?
That was the development and question answered by Satoshi Nakamoto when he created Bitcoin and the blockchain.
The blockchain helps provide trust, and its front facing currency allows for quick transfers and holding of value.
Yet diving into it, the systems get a lot deeper.
A fantastic resource (if you want to dive as deep as possible) is mastering Bitcoin by Andreas Antonopoulos.
An Input and an Output
Say you want to send money to someone via Bitcoin.
You give a desired amount, let’s use 10 BTC, and then that amount is entered into the system.
It is input and the output value is 10 BTC to whoever gets it (please be me).
Although, it’s not that smooth.
When you send 10 BTC you are actually sending your whole portfolio as an input, and the output is the 10 BTC that was sent.
Whereas the rest of it is returned to you.
Instead of pushing only a bit of your money, the 10 BTC, you are claiming that the output is 10 BTC.
Meaning that your wallet and public address is dedicating itself to the output, and proving that it has the amount of BTC within it.
That’s the proof that the miners are helping to guarantee.
Here are a few variables that one needs to understand:
- Previous Output Hash: Money that you are about to spend that actually belongs to you (or the address associated)
- N: The output you are actually spending
- Scriptsig: A signature to prove that you are signed off on the transaction (or the owner is)
- Value: The amount being spent (1 BTC = 100,000,000 satoshis)
- ScriptPublicKey: The second script provided in the transaction where the BTC is sent and received.
Now with the input and output there is a central entity that connects them and which contains:
- Hash: This is the searchable number associated with the transaction.
- Ver: Version number to verify the block
- Vin_sz: The number of inputs into the transaction
- Lock_time: The time and block that the transaction will be using.
Okay, tech stuff over for a minute…
This essentially is the algorithm and variables to help solve the intermediary trust with math instead of a 3rd party vendor (like a bank or credit card processor).
If you know these variables than you will understand the transaction a lot more (and what you are seeing).
Often times people head to somewhere like Blockchain.info to search their transaction, this is what you are seeing and getting.
When all of these are input and you are sending 1 BTC to your friend, what ends up happening is that your hash (public address) triggers the scriptsig.
The Scriptsig checks both your public and private keys and the scriptpublickey makes a copy of the public address for the transaction.
That is then stored in the blockchain with the Transaction ID (TX address) searchable on blockchain.info
The input and output are added, which block you are using is added, verification by miners are added and so on.
This process makes up the Bitcoin transaction.
Which is pretty complex, yet it allows users to trust each other without knowing each other.
Sure you can trade Bitcoin with your friend, but what about someone overseas?
That’s where the power of this transaction method comes in.
3rd party verification by people with only incentives to verify.
Digital signatures, address copying, and storage of what had actually occurred…
Put them all together and it becomes a powerful transaction that goes down in history on the blockchain stored for anyone to see, and for the rest of eternity.
And that’s how a Bitcoin transaction works.
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