What is Bitcoin Transaction: Components, Verification and Privacy
Key Questions Answered
Bitcoin transactions are cryptographically-secured asset exchanges on the BTC blockchain between network participants. They are broadcast to the entire network for verification, and upon verification of their validity, are added to the chain of records permanently. Every day, around 250,000 Bitcoin transactions are carried out on the world’s first and largest blockchain platform. The largest Bitcoin transaction occurred on April 10th, 2020, when one bitcoin wallet moved 161,500 BTC, which at the time was worth roughly $1.1 billion.
The first Bitcoin transaction was received by Hal Finney. On the day it was released, Hal downloaded the bitcoin software and received 10 bitcoins from Satoshi Nakamoto. Hence, the first bitcoin transaction took place on January 12th, 2009.
Public and Private Keys in Bitcoin Transactions
To understand the process of Bitcoin transactions, it is important to have a basic idea of the public and private keys used on the blockchain.
Public keys are encrypted pieces of data that act akin to email addresses. Network participants use public keys to send and receive crypto funds. Your Bitcoin address is the hashed version of your public key.
Similar to an email address, a user’s public key is known to others on the network. When you send BTC coins to another user, your transfer contains the information about your public key and the receiver’s public key. Additionally, you “sign” the transfer with your private key.
A private key is a cryptographically-secured piece of data, with a function similar to your email account password. You use the private key to access funds available in your Bitcoin address and initiate transfers. Just like an email account password, only you should know your private key and never share it with any network user.
Both the public and private keys are sequences of digits and symbols run through a cryptographic hash function to ensure data exchange security.
Let’s assume that a Bitcoin user named Satoshi wants to send you one BTC. To do so, Satoshi will use his public key to designate the sender of the message – his Bitcoin address, your public key to designate the receiver, and he will additionally sign the message with his private key to confirm that he has valid access to the sending address.
You will then use your own private key to access and unlock the funds Satoshi sent you.
The Main Components of a Bitcoin Transaction
Each Bitcoin transaction has three main components – inputs, transaction amount, and outputs.
- The inputs refer to the information about the sender’s address balance prior to the currently executed transaction. When Satoshi sends you that one BTC, the system must ensure that he has that one full BTC to share with you.
If all the prior transactions on Satoshi’s address are outgoing transfers, and he never received any funds, he cannot possibly send anything to you, can he?
The inputs, therefore, ensure that the transfer happens from an address with enough unspent balance. When the transaction is added to the blockchain, the sender’s address balance will be updated accordingly. If Satoshi had 30 BTC in his address prior to the transfer, the transaction inputs will help the system adjust its balance to 29 BTC.
- The second part, the transaction amount, is pretty much self-explanatory. It refers to the amount the sender wants to transfer to the receiver, which is 1.0 BTC in our example.
- The third key component, the outputs, include the information about the allocation of the transfer amount to the receiver’s address. The receiver’s address balance is updated, and this updated information will later be used as inputs to a future transaction involving this address.
When you send funds from one address to another, an unconfirmed transaction is created on the network. The transaction is “broadcast” to the entire network, where it is added to a block of transactions waiting to be verified. Therefore, an unconfirmed bitcoin transaction is when a transaction fails to receive a confirmation on the blockchain within 24 hours.
Special network nodes, called miners, verify transaction blocks using a Proof of Work (PoW) verification process. When a block is verified by the miners, all the transactions in it are recorded permanently on the blockchain.
How long does a Bitcoin transaction take?
The current median time it takes to verify a Bitcoin transaction is around six minutes. Around half of all transactions are confirmed in that amount of time or less.
However, depending on the network congestion, transaction details, and most importantly, transaction fees allocated to the transfer, the actual confirmation times may vary wildly.
When a transaction on the blockchain is initiated, the sender allocates some fee to incentivize block miners to process and verify the transaction. The transaction fee is often referred to as the gas fee, a term which originated on another blockchain – Ethereum (ETH).
As noted above, the fee is the key determinant of the time required to verify a transaction. Miners are, naturally, more likely to allocate their time and resources to verify transactions with higher monetary rewards.
If you set your transaction fee very low, or send a transaction without any fee at all, it might remain in the unconfirmed state for much longer than the averages may suggest. It is not uncommon for some transactions with very low or no gas fees to hang in limbo on the platform for days, sometimes even for more than a week.
If a transaction stays in an unconfirmed state for many days, it is typically dropped from the waiting list and gets rejected. At this point, the funds are released back to the sender, who may choose to initiate another transfer by setting a higher fee.
As of October 2021, the average transaction fee stands at a little over $2.
Privacy of Transaction Records
While many people assume that Bitcoin provides total anonymity, in reality, it is a pseudo-anonymous network.
All BTC transactions are publicly viewable on the blockchain. Using online Bitcoin explorers, such as blockchain.com/explorer, even people without a blockchain address or a supported wallet can see the transaction history of any address. It also allows them to track bitcoin transactions.
While transactions will not reveal anything about users’ identities, the complete transaction history of each BTC network address is out there for anyone to track and analyze. If, at any time, the address is somehow linked to an identifiable person, the person’s complete history of transactions will no longer be private.
On-Chain vs Off-Chain Transactions
Transactions described so far presume standard on-chain transfers. On-chain transactions remain completely within the boundaries of the blockchain, and involve the transfer of value from one address to another.
On the other hand, off-chain transactions involve cryptocurrency value transfers off the blockchain. This can happen when using various online sources that accept BTC payments. Payment processors such as PayPal are actively integrating BTC payments as cryptocurrency becomes a valid online payment method.
Off-chain transactions are gaining popularity due to a number of key advantages, whether real or perceived:
- They have no transaction/gas fees associated with them. Many users cite it as the key advantage.
- They are usually executed instantly or extremely quickly. There is no process of waiting for the miners to confirm your operation as it happens with the on-chain transactions.
- They add a new payment method to the arsenal of online shoppers. It is always nice to have BTC as another payment method to use online, in addition to credit cardsor services such as PayPal.
- For some users, off-chain transactions are actually more preferred from the privacy point of view, since they do not involve the public broadcast of transaction details to all and sundry on the network.
The key argument against off-chain transactions is that they weaken the overall security and decentralized design of the Bitcoin ecosystem. As more value is moved off the blockchain, these assets lose the cryptographic protection and the decentralized independence from an authority enjoyed by the funds held on-chain.
Bitcoin transactions involve the transfer of the BTC cryptocurrency value between different blockchain network participants. Cryptographic encryption using the public-private key pairing is used to ensure the validity and security of these transactions.
As the transactions are initiated, they are added to the blocks waiting to be verified by the miner nodes. When miners verify a block, all the transactions in it move from the unconfirmed to the verified status, and are permanently added to the immutable ledger of records.
To facilitate this verification, senders add a transaction fee to each transfer as an incentive for the miners. The average transaction fee is currently slightly above $2. The majority of transactions take only minutes to verify. However, transactions with very low or no fees attached risk remaining in an unconfirmed state for days. Some of these transactions, eventually, are not verified at all and are “cancelled out,” with the funds released back to the sender.
In addition to the standard on-chain transactions, off-chain Bitcoin transactions are also widely used. These transactions move the crypto value off the BTC blockchain. Their main advantages are the lack of transaction fees and nearly instant execution times.
While off-chain transactions are growing in popularity, some analysts believe that their use may threaten the key advantages of the Bitcoin environment – transaction security and independence from a centralized authority.