Anatomy of a Bitcoin Transaction

The Significance of Bitcoin Transactions

Transactions are the backbone of the Bitcoin network, and everything in the Bitcoin system is designed to ensure transactions can be effectively broadcasted, validated, and confirmed.

Bitcoin transactions facilitate:

  • Users exchanging bitcoin peer-to-peer without an intermediary
  • Miners “mining” new bitcoin and securing the network
  • The addition of new blocks to the blockchain

Parts of a Bitcoin Transaction

Each transaction on the Bitcoin blockchain consists of cryptographically-signed inputs (what was sent) and outputs (what was received) as well as a network of nodes to validate and confirm these transactions.

Another prerequisite for a bitcoin transaction is both the sending and receiving parties having public keys, addresses on the Internet (not unlike email addresses or social handles--except that they hold bitcoin), as well as the sending party having a private key, a password that unlocks the bitcoin from this public address. 

The Steps of Bitcoin Transaction: A Basic Overview

Let’s say Sandra the Sender wants to send one bitcoin (1 BTC) to Ray the Receiver.

  1. Sandra creates an “unspent transaction output,” known as a UTXO.

    A UTXO is like a bank check: a guaranteed form of payment that has an origin (Sandra the Sender), a destination (Ray the Receiver), and contents or value (1 BTC).

  2. Next, Sandra signs the transaction with her private key and broadcasts it (plus a fee) to the Bitcoin Network. On this network are miners who provide computer processing power and prevent fraud in the system in exchange for rewards in the form of transaction fees.

  3. Miners on the network then begin validating the transaction to confirm Sandra’s origin address has the 1 BTC she intends to send Ray.

  4. After validating Sandra and other unspent transaction outputs, miners package all the unspent transactions into a group (called a block) and broadcast the block to other network participants (called nodes) that ensure the transaction inputs have been digitally signed and are not being spent elsewhere.

  5. If other nodes agree on the validity of the block, miners will pass the block along and queue it for inclusion in the blockchain. Called “mining a block,” the process happens through solving complex mathematical puzzles, and miners receive new bitcoin as a reward for doing so (called the coinbase). This is also how the bitcoin money supply increases until 21 million.

  6. Eventually, other miners build on top of this block in a process called confirmation. When a block has sufficient confirmations, it becomes irreversible. At this point, the transaction (confirmed in a larger block) becomes part of the blockchain.
  7. Ray receives the 1 BTC Sandra sent and can now use this newly received bitcoin in an outgoing transaction since the network confirmed that the received bitcoin is not being “double spent” elsewhere as part of another ongoing transaction.
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