It’s prudent to know a bit about how Bitcoin transactions work if you’re considering buying them or accepting them as payment. Before we get into the technicalities of Bitcoin transactions, it’s worth knowing what precisely a Bitcoin is.
According to the Bitcoin white paper, a Bitcoin is nothing more than a record of a transaction. In other words, Bitcoins don’t exist. They are a social construct. Bitcoins are IOUs.
Don’t let that put you off, however. The cash in your wallet is also just IOUs. A coin or note is nothing more than a record of debt, which can be redeemed for good or services.
With that out of the way, let’s have a look at what happens during a Bitcoin transaction.
How Bitcoin transactions work
A Bitcoin transaction has three components:
- Transaction output (the sender’s Bitcoin wallet address)
- Transaction input (the receiver’s Bitcoin wallet address)
- Amount (the amount of Bitcoin being sent)
Your Bitcoin wallet address creates a transaction output when you send Bitcoin to another wallet address. The transaction output includes the receiver’s Bitcoin wallet address as a reference to where to Bitcoin went.
The receiving wallet address will, in turn, create a transaction input when your Bitcoin has been received. The transaction input includes your Bitcoin wallet address as a reference to where the Bitcoin came from.
If the person you sent Bitcoin to decide to send it on to someone else, a transaction output with the new owner’s wallet address is created. The wallet address you sent money to initially will, in turn, become the transaction input.
In short, a Bitcoin transaction is merely a record of where the Bitcoin came from, where it went, and the transaction amount.
All these transaction records are stored in blocks of information. The blocks of data are what constitutes the blockchain.
The blockchain is a permanent and immutable record of every single Bitcoin transaction ever made. Most importantly, you can trace the journey of a Bitcoin to see how many times it had changed hands from when it was first created.
What are public and private keys?
You may have heard these terms being bandied around in the cryptocurrency space and wonder what they mean.
To make everything a bit more complicated, your Bitcoin wallet is not a wallet at all. It doesn’t store your Bitcoin, nor does it save any transaction records. These are all stored on the Bitcoin blockchain.
A wallet is a collection of keys to the blockchain. A public key is a string of characters (like a bank account number) that allow people to send you Bitcoins. A private key is also a string of characters (like a PIN-number for your card) that will enable you to access your Bitcoins.