Bitcoin transactions are more complex than exchanging cash for goods like in everyday life. It involves technical details and protocol that not only make these dealings safe, but also ensure transparency for everyone involved in the network.

If you’re new to bitcoins and have recently completed transactions using your wallet, you might be wondering what those numbers and letters mean. This short guide aims to explain just what happens in bitcoin transactions – and other vital points to help make your bitcoin experience a pleasant one.

 

Basics of Bitcoin Transactions

Peer to Peer blockchain network graphic

Believe it or not, bitcoins technically DO NOT exist – and NO ONE owns any of it.

Bitcoins, according to the original paper penned by its creator Satoshi Nakamoto states that bitcoin is a ‘chain of digital signatures’. It’s basically a series of transactions. These are all kept in a public ledger called a blockchain that’s accessible to everyone online.

Keeping this type of digital currency isn’t like depositing cash in a bank or keeping money in a physical wallet. When you buy bitcoins for example, what you gain is a series of numbers from where they were previously kept. This is what’s inside your bitcoin wallet.

How Do Bitcoin Transactions Work
Image credits to U.S. Government Accountability Office

 

When you spend them, another series of characters will show up in your wallet as proof that you’ve made a transaction.

There are three parts to a transaction that every bitcoin user needs to understand. These are:

  • The INPUT – bitcoin address(es) where you got your bitcoins
  • An AMOUNT – how much bitcoin you wish to spend or send out
  • The OUTPUT – the receiver’s public key, also known as a ‘bitcoin address’

For bitcoin transactions to be successful, it needs two things: a PUBLIC key or a ‘bitcoin address’ and a PRIVATE key. These always come in a pair! This means when you open a bitcoin wallet and start generating your first bitcoin address, it will come with another key you’ll eventually use to authenticate transactions.

The final outcome is a signature unique only to you and that specific transaction. These are sent to the bitcoin network where miners will verify it through complex calculations. Once verification is complete, it’s entered in the blockchain and becomes irreversible (this means NO chargebacks like in credit cards).

How Do Bitcoin Transactions Work

5 Tips To Keep in Mind for Future Bitcoin Transactions

Encryption and security for cryptocurrencies

Understanding how bitcoin transactions work is vital to a) helping you keep your wallet secure from digital threats, such as hacking; and b) making sense of the entire bitcoin protocol and ecosystem. Things will get easier once you get the hang of the fundamentals.

In this sense, be sure to keep these crucial points in mind for future bitcoin transactions:

1. There will be wait times (of usually no more than 10 minutes) because miners need to verify your transaction.

This is how the bitcoin remains both secure yet transparent at the same time. If you will be spending bitcoins to buy goods or services, some merchants will make you wait until the transaction is verified by miners. Others will take a chance on you and you’ll be able to avail of the product right away. This is more common for low value dealings, where there’s little risk of fraud or double spending.

2. Users cannot split a transaction into smaller amounts.

For example: let’s say you previously received 3 bitcoins from Alice, and 1 bitcoin from Fred. In your wallet, you will see two INPUTS – one from Alice and the other from Fred’s public bitcoin address.

How Do Bitcoin Transactions Work

If you want to buy a shirt online for 2 bitcoins, this will not be deducted from the total bitcoins in your wallet. Remember that wallets only contain inputs and outputs – you can’t mix amounts like you can in a physical wallet or bank account!

When you type in the amount of 2 bitcoins for your payment, the wallet will take the 3 bitcoins from Alice (because it has the sufficient amount) to send to the merchant. The wallet will automatically generate a separate bitcoin address for your change. You will then see two OUTPUTS.

3. Transactions might involve transaction fees.

The transfer or exchange of bitcoins often requires a small fee – depending on the platform involved. Bitpay for example, a global bitcoin payment service provider, includes miner fees when you pay using bitcoins. Make sure to factor this in before making a transaction.

4. Never share your private keys!

Back them up so you always have access to your bitcoins. Copy them somewhere safe because a single change or error in any of the characters in your private key will invalidate a transaction.

5. What about receipts?

In general, the nature of bitcoin wasn’t intended for receipts. However, payment processors and bitcoin ATMs will usually print one out merely for purposes of recording the actual transaction. This should not be treated as regular receipts.

For instance: bitcoin ATMs may issue two types of receipts – one contains the public and private keys, while the second records transaction details. It’s a good idea to hang onto these (especially if it contains your private key!) for recordkeeping.

 

But what if you don’t have a complete bitcoin? Can you still take part in bitcoin transactions? Of course! The great thing is that denominations can be as small as one hundred millionth of a bitcoin. This is known as a Satoshi. However, as they are so small, only transactions involving 5430 satoshis are accepted in the network.

That shouldn’t stop you from ‘collecting’ bitcoins though. In fact, now is the best time to buy some so you can soon have fun spending them!

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