How Do Bitcoin Transactions Work?

Bitcoin (BTC) and Ethereum (ETH) are the two most popular cryptocurrencies on the market. They are the two most traded digital assets and are used in various ways, ranging from a means of storing value, to all kinds of payments for products, services, and even as salaries offered by some companies.

The digital ecosystem of cryptocurrencies is ever-expanding and people worldwide are making millions of dollars worth of crypto transactions, especially in Bitcoin, on a daily basis.

Since BTC and other cryptos don’t physically exist beyond their native blockchains, they can’t be stored in physical wallets or bank accounts. This is why crypto wallets (in the case of BTC, Bitcoin wallets) were invented: to store digital currency. Once stored in digital wallets, cryptocurrencies can be used in numerous ways, including payments and fund transfers. All of these operations require crypto assets to be transferred from one digital location to another. These transactions occur on the native blockchain networks of each currency.

But to really understand how BTC transactions work, we need to take a look at the Bitcoin blockchain and how BTC is mined.

How Does the Bitcoin Blockchain Work?

Bitcoin runs using its own blockchain network that was launched back in 2009 by Satoshi Nakamoto, the developer (or group of developers) who presented the basics of Bitcoin in the BTC whitepaper. Since the emergence of the BTC blockchain technology, thousands of altcoins have been launched with their own blockchains that mirror the original Bitcoin software to some extent. 

Basically, the blockchain consists of blocks of data in a chronological string. There is no central authority on the blockchain – the whole network is decentralized and depends on system nodes.

The data blocks can contain all sorts of information such as contracts, bond trades, personal information, transfer data, etc. Theoretically, any sort of agreement or contract between two parties can be facilitated through the blockchain network. These blocks are used to carry out transactions on the BTC network.

The blockchain itself acts as a distributed ledger that anyone can publicly access and see transaction details for each and every transfer that’s happened. However, the network does offer a high level of anonymity since personal details about senders and receivers can’t be seen unless someone chooses to identify themselves purposely by name on the blockchain. 

Bitcoins don’t exist beyond the blockchain public ledger, which means that when you store some BTC in your wallet, you aren’t actually storing the BTC itself, but codes accessible by your private key that acts as your BTC assets and lets you manage your coins as you please. The coins themselves exist only on the blockchain, and transactions are the way to use your BTC as you please.

Bitcoin Mining

Bitcoin mining is the method used to create new bitcoins and it is also essential for facilitating transactions through the blockchain. Network nodes of the BTC blockchain are actually miners that use their computing power to constantly solve mathematical problems in order to discover new blocks on the blockchain and get rewards for mining.

Each block of the blockchain contains 1MB of data and transactions of BTC use these blocks to travel between sender and receiver. Once the previous block of transactions is mined, miners commence creating the next block of the blockchain until they process 1MB of data.

Miners record every transaction on the network, as by mining, they are basically verifying the validity of each and every transaction. Each block can carry a different number of transactions, but it can’t exceed the 1MB limit of data.

You can’t just send some BTC through the blockchain without any verification, because if that were the case, there would be lots of fraud. Malicious individuals would be able to spend the same BTC several times, gaining huge financial gains by pulling scams. This is called the double-spending problem.

The role of miners is to make sure that double-spending doesn’t occur and that is why every transaction needs to be verified by several, independent miners, in order to be processed. This process is called proof of work (PoW). Miners keep the network secure and trustworthy, and in turn, they get BTC block rewards for processing verified transactions and discovering new blocks.

Bitcoin Transactions

A BTC transaction is the core process of transferring Bitcoin through the blockchain from one destination to another. In financial terms, a transfer is the shipment of funds between two interested parties on agreed upon terms.

When it comes to fiat money, when you want to facilitate a bank transfer, you need to either physically deposit your money into a bank account or have it wired to your bank account from your employer or another party. In any case, the money behind the figures you are sending physically exists. With BTC, the transfer process is carried out through the blockchain network, so a transaction is basically just strings of information that are stored in blocks.

A BTC transaction is a message that contains information about your transfer and your funds. These messages are programmed and signed digitally using cryptography and then disseminated throughout the whole BTC blockchain for verification. Once sent out, the transactions need to get verified by miners, which can sometimes take time.

How Do Transactions Work?

In order to carry out a BTC transfer, Bitcoin users need to have some coins stored in a wallet or in an exchange platform account like Binance or Coinbase, but it’s generally recommended to store your assets in crypto wallets since they are more secure than your exchange platform accounts.

Crypto wallets are software solutions that enable you to manage your funds and store your private keys easily, so you can send or receive BTC as fast as possible.

Once you send some funds through the blockchain, the transaction starts going through the network on a journey to get verified and while doing so, your data goes through the asymmetric hash cryptographic process, which is responsible for the security of your transfer. The whole cryptographic process is handled by Bitcoin scripting, which is a highly advanced programming language developed by Satoshi Nakamoto and upheld by developer teams and the BTC community.

Key BTC Transaction Elements

Every transaction has several key elements that can help us understand the whole transfer process of sending Bitcoins.

Input

Every transaction has its entry point or entry data to the blockchain. The input has all the necessary information about the source of the funds that are being transferred. The original address of the BTC you are sending is contained in the input and it clearly shows the address where the BTC was first received when the transfer started. This is a vital part of the transfer data because it enables miners to confirm the validity of the assets being used in the transfer.

Output

This part of the data shows the exact amount of BTC you are transferring, along with the destination wallet address which you are sending the funds to. Transaction outputs also show directions of change or where the returns of the transactions are sent, which means it is possible to have several outputs in a single transaction. For example, you have two outputs in a transaction when you are sending some BTC: first, output to the receiver, and second, output in the form of a transaction fee on the exchange platform.

Commission Rate

The commission rate is a fee that miners receive from every transaction for the service of processing the transfer through the blockchain. The specific miner that participates in the processing of your transaction and the creation of a new block on the blockchain will receive a commission fee.

Since anonymous and independent miners verify each transaction and it isn’t known in advance who will be the miner that will process your specific transaction, the small amount of BTC that is intended as a miner’s fee is left without an exit destination. When miners process your transaction, they see this small amount and the miner that has verified your transfer will automatically take this fee for their services.

Transaction ID (TXID)

There are millions of BTC transactions happening on a daily basis and it would be very hard for the network to work properly if all of these transfers were completely anonymous, with no means to differentiate between them. This is why every transaction has its identifier or TXID. With this transaction ID, every transfer has its unique identity on the network and thus its own traceable path on the blockchain.

Why Do Some BTC Transfers Take So Long?

Remember how we mentioned that all BTC transfers have to be processed by miners? Well, this can take some time. Miners don’t mine transactions, they mine blocks, and there is no rule about how many transactions can fit in one block. It all depends on the amount of data of each transaction, but the key issue is that a transfer is processed only once the whole block is mined and all previous transactions are verified.

Each 1MB block of data usually takes around 10 minutes to mine, thanks to the Bitcoin protocol that dynamically adjusts the density and complexity of transactions that fit into blocks.

However, transactions can sometimes take much longer and some transfers may even remain unconfirmed for different reasons. Low transaction fees are one of the top reasons for slow transfer verification. Another common reason is if you misspelled the destination address and your funds are sent through the Bitcoin network but can’t be processed to a nonexistent destination.

Transfers may also last longer than usual if the blockchain is jammed with high volumes of transfer traffic. When the entire Bitcoin network is really busy, like in the event of a sudden rise or fall in the value of BTC, then it’s quite common for transactions to last longer in order for the blockchain to process them, which creates scores of pending transactions that may take far more than 10 minutes.

Cryptocurrency Transaction Fees

When conducting a cryptocurrency transfer, you always have to pay a certain transfer fee. This is a standard procedure when transferring any crypto, including BTC. A Bitcoin transfer fee goes to miners that help process transactions with their computational power.

Numerous crypto wallets allow users to choose how much they want to pay for their transactions, but generally, you should make sure to pay at least an average transaction fee so that your transfer gets mined within a reasonable time frame.

If you choose a lower-than-average transfer fee, miners simply won’t want to waste their time on processing your funds, and they will instead choose to verify transactions with higher fees. If you want to really be sure that your transfer is going to get verified quickly, then it’s a good idea to choose a transfer fee that’s a bit higher than average. If you already sent a transfer with a very low fee, it is better to cancel it and send a new transaction with a higher transfer fee.

Advantages of BTC Transactions Over Fiat Money Transfers

Using BTC transactions as a financial tool for different purposes has numerous advantages over fiat money transfers. These are some of the key advantages.

Lower Commission Fees

Banks usually require seriously high transfer fees and percentages when transferring large amounts of money. Compared to this, BTC transaction fees are very low and represent a literal act of appreciation for the work miners do to keep the blockchain running. Regardless of the amount of Bitcoin you’re sending, the transfer fees stay low.

High Security

The BTC blockchain provides fraud-proof security because every transfer is checked by several independent miners before it is processed and verified. There is literally no chance of a fraudulent double transfer with the same funds. Transactions are made with public addresses and private keys to the funds. A public key or Bitcoin address enables you to receive or send funds without the possibility of them getting stolen, while private keys enable you to spend your BTC and act as a digital signature.

High Speed

BTC transfers are much faster than classic bank transfers. A bank transaction can take days, while transferring BTC takes approximately 10 minutes, which gives it an unbeatable speed advantage over bank transfers. Every BTC transaction has to be verified by multiple miners but even so, the whole verification process takes mere minutes, compared to several hours or days that a bank transfer can last. So, if you need to pay someone in a short time span,  Bitcoin payments are always the fastest option.

A Few Words Before You Go…

Bitcoin transactions are the core process for using BTC. Millions of people are trading and transferring BTC every day!

Regardless of whether you are a beginner in the crypto world or an experienced crypto enthusiast, you need to know and understand what a Bitcoin transaction is and how it works, since Bitcoin is the most popular type of electronic “cash” on the market.

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