The world of cryptocurrencies has drastically evolved since the launch of Bitcoin (BTC) in 2009 as the first digital cash in history. Since then, thousands of other cryptos, so-called altcoins have been launched with the aim of providing users with various functionalities and advantages that would attract people towards using them. Most cryptocurrencies don’t really achieve widespread popularity such as Bitcoin or Ethereum (ETH), but a lot of coins have a considerable market capitalization, with huge trading volumes.
Even so, BTC remains the king of cryptos, with the highest market cap and this position of Bitcoin will hardly change soon. Just like gold, oil, or company stocks, Bitcoin is also traded on specialized exchanges, cryptocurrency exchange platforms such as Binance, Kraken, Coinbase, and hundreds of others where millions of people are trading BTC. All of these trades are facilitated and made possible by the Bitcoin blockchain network, a first of its kind, and the process through which trades are made is called Bitcoin transactions.
We are going to take a bit more detailed look at how these BTC transactions work, but in order to do that, we must first need to go over the basics of how BTC works and the role of mining in the Bitcoin ecosystem.
Bitcoin Blockchain Basics
As the first digital currency in the world, Bitcoin had the complex task of providing users with a trustworthy and reliable system for storing value and exchanging digital funds. When it comes to fiat money like USD or EUR, people can physically hold the cash and exchange it with each other for goods or have it deposited in banks and use the money with their credit cards and debit cards. With Bitcoin and other cryptocurrencies, people can’t physically hold them or keep them in their wallets.
For this reason, the Bitcoin network was created using blockchain technology, an innovative solution that quickly won the trust of millions of people worldwide. The BTC blockchain is a decentralized, distributed public ledger of transactions that aren’t stored on any single, centralized server, but instead, identical, constantly updated copies are stored on numerous computers, network nodes that are actually miners and their computers.
The blockchain stores transaction data in the form of data blocks set in a chronological string from first to last. Each data block can contain 1MB of transfer data, but this doesn’t mean that it can contain just one transaction. Depending on the size of a transfer a block can contain several transactions. In the case of Bitcoin software, data blocks are used for housing transaction data for the Bitcoin digital cash.
However, blockchain technology can be used for facilitating all sorts of data transfers such as smart contracts, powering decentralized applications, and controlling various automated aspects of corporate business systems. In fact, blockchain technology is finding numerous use cases in all sorts of fields from healthcare, production to smart cities and education. All of this wouldn’t be possible without the BTC blockchain as the first network of this sort.
The Importance of Bitcoin Mining
The total amount of bitcoins is capped at 21 million coins by the founder of BTC Satoshi Nakamoto, but not all of these coins are in free circulation. New bitcoins have to be mined using the computing power of powerful computers specialized for mining BTC. These computers are called mining rigs, and they use the power of graphics processing units (GPUs) to solve complex mathematical problems in order to find appropriate 64-digit hashes for each and every transaction on the BTC blockchain before it can get processed to its final destination.
Bitcoin miners invest considerable amounts of money in assembling strong mining rigs with high hashing power in order to mine Bitcoin faster. The mining process is actually the process of verifying transactions and adding them to new blocks of the blockchain. Every transfer has to be verified by multiple, independent miners and that’s why the blockchain system is so secure. It’s impossible for the network to simply verify a fake transaction or to allow a malicious individual to double-spend the same funds.
The proof-of-work algorithm is a key part of the Bitcoin protocol and acts as a safeguard against fake transactions and scams. This means that as soon as a miner finds the appropriate 64-digit combination for a certain transaction, that combination is sent out to other network nodes that check it and ensure the transfer is legit.
When a transaction is finally verified, it is added to the new data block that is then added to the blockchain, thus creating a new block of the network. After each new block is added to the chain, the miner responsible for verifying the transaction in the previous block is awarded freshly mined Bitcoin. So, we can conclude that Bitcoin is mined by verifying transactions.
Transactions are an essential part of the BTC system, making it possible for Bitcoin users to securely, reliably, and quickly move their funds and use them for all sorts of financial operations such as Bitcoin payments, lending, or storing value in the form of BTC. Bitcoin has to be stored in cryptocurrency wallets or Bitcoin wallets because it doesn’t exist physically. In fact, Bitcoin doesn’t exist beyond its blockchain. When people send BTC through the blockchain to each other—trading it or exchanging it—the Bitcoin just changes virtual addresses on the blockchain but stays on the network.
In order to access your BTC and prove a certain amount of coins is actually yours, you need to use a private key that acts as your BTC password and show the system that you are the owner of those coins. In case you want to receive some BTC, you need to provide the sender with a public key or public address which is the digital location where you keep your BTC on the blockchain. In case you keep your BTC in a crypto wallet, your public key is your Bitcoin wallet address.
All of these movements on the blockchain are enabled by BTC transactions that are a form of messages which carry specific data about the movement of funds through the blockchain.
How Do Transactions Work?
For a Bitcoin transaction, people first need some BTC in their cryptocurrency wallet or in their trading account on their favorite crypto exchange platform. It is possible to store your BTC on your exchange platform account since these websites offer users an integrated wallet service but it’s far more secure to have a separate crypto wallet for storing your BTC. Exchange platforms are prone to cyberattacks, especially if they are centralized exchange platforms that keep large amounts of data on their servers.
To move your BTC from your chosen exchange platform to your wallet, or from your wallet to a third party as payment, you have to initiate a transaction using your private key to prove your ownership over the bitcoins in question. You will also need the public key of the destination Bitcoin address in order to send the funds through the blockchain.
Once you’ve initiated a new transaction, information about the funds you are sending is going to start the transaction verification process during which miners will verify your transaction and use their rigs to find the appropriate 64-digit hash combination. This process usually takes 5 to 10 minutes, depending on network traffic. The data of your transfer will go through the blockchain with the help of the asymmetric hash cryptographic process, a programming feature based on advanced cryptography that powers the network and makes transactions possible.
Elements of Each Bitcoin Transaction
Let’s take a look at the main elements every BTC transaction consists of and their roles in the transfer process.
The transaction input is the entry point for transaction data into the BTC blockchain. When a transaction is initiated, its input carries all the necessary information regarding the sender of the coins. Your BTC address from which you are sending the coins is a key part of the transaction input. Even though the input holds the sender’s address, there is no reason for you to be afraid of any breach of privacy since no personal details are disclosed to any of the miners that are verifying the transaction. The data is only used to confirm the funds come from a legitimate source.
The transaction output carries the receiver address and acts as data that shows the destination of the sent funds along with the amount of bitcoins that are sent. One of the roles of transfer output data is to highlight where the transaction returns are sent. A single transfer can therefore have several outputs and only one input. When you want to send some bitcoins to your wallet, from your crypto exchange account, your first output is the amount you are sending to your wallet, but you also have a second output which is the standard transfer fee paid to the exchange platform for processing your transaction.
Transactions on the Bitcoin blockchain aren’t free. The blockchain runs very smoothly and miners are responsible for this by verifying millions of transactions and making sure everything runs quickly and without flaws. The work of the miners should be appreciated and that’s why apart from the block rewards in fresh BTC, miners get transaction fees from each transfer.
The miner fee is much lower than an entire Bitcoin. It’s a small portion of satoshis that acts as an extra incentive for miners to process transfers and it is also a sign of appreciation for their work, without which the BTC blockchain wouldn’t be able to work. You should always be careful and at least select an average miner fee, because if you add a too low fee, the transfer might get ignored by miners who simply select transfers with higher fees and verify them instead. You should check a website such as BitcoinFees to calculate how much satoshis you should add to your transfer as a miner fee.
Miner fees are small portions of BTC that intentionally don’t have any exit destination, which is a signal for the miner who verifies the transaction to automatically collect that amount as a fee.
A transaction ID (TXID) is the unique identification of every transaction on the Bitcoin blockchain. With millions of transfers of various volumes happening around the clock, a TXID helps people track their transactions on the blockchain. It would probably be impossible for the blockchain to work so fast if the transactions didn’t have any ID. The process of finding the unique 64-digit hash for each transaction is closely linked to the fact that every transfer also has its unique ID.
You can use a blockchain explorer website such as Blockchain.com to track your transaction through the network and monitor it in case of high traffic that might cause a delay in the verification process.
A Few Ending Words…
Electronic cash like Bitcoin has enabled a whole new field of possibilities for financial operations, both for individuals and for international corporate users such as PayPal. All of these processes wouldn’t be possible if the BTC blockchain didn’t enable such fast and reliable transactions that simplify all of those slow processes associated with sending fiat money from your bank account and using traditional financial instruments.
These are some of the basics of how Bitcoin transactions work, as a real and trustworthy alternative to fiat currency transactions.