It’s something that is among the basics of investing in crypto: Learning how Bitcoin transactions work. It may sound a little silly, but many traders and investors don’t really know what happens behind the scenes to get cryptocurrency into the buyer’s possession.
It’s always worth reviewing how a Bitcoin transaction works. While this may be covered in almost any guide to cryptocurrency, it’s a good thing to keep in mind before you start buying Bitcoin.
Read on to find out how Bitcoin transactions work, how long they take, and the verification processes that ensure they’re safe and secure.
Bitcoin Basics
Before getting into the nitty-gritty details of Bitcoin transactions, it’s worth revisiting the foundational cryptocurrency of Bitcoin itself.
Bitcoin is a digital currency. In essence, bitcoins are simply just small pieces of computer code. The currency has no physical manifestation — you can’t hold it in your hands, or stick it in an envelope — but can be used as a medium for transactions. That is, you can use it to buy or sell things, as long as the party on the other end of the transaction is willing to accept it.
Bitcoin is also a decentralized currency, meaning that it has no regulatory authority like a bank. Its value is dictated by the market, much like a stock. Bitcoin dates back to 2009, when it first became available to the public as the initial cryptocurrency.
Also worth noting: Bitcoin is built on something called “blockchain” technology. Read on for a quick primer on blockchain, and how blockchain works.
Blockchain
Blockchain technology is, in its most basic form, a chain of blocks containing data. The blockchain itself is decentralized — not controlled by a single entity. Instead, a blockchain network is spread across the globe, with hundreds, or even thousands of users participating in it.
Blockchain enables cryptocurrency transactions. It keeps a record of those transactions — storing the data in blocks — using a sort of distributed ledger. Imagine an Excel spreadsheet saved on thousands of different hard drives, all of which reference each other to validate the data’s accuracy.
Blockchain allows for faster, more secure (but not 100% secure) transactions. That’s why blockchain and Bitcoin are so often mentioned in the same sentence.
Crypto Exchanges
As for actually executing a Bitcoin transaction, most of the time this will take place on a cryptocurrency exchange. (Unless you’re into Bitcoin mining, which is a different story altogether.)
How do cryptocurrency exchanges work? More or less like any other financial exchange.
Crypto exchanges are where cryptocurrencies are exchanged between parties. They’re similar to a stock market, in that traders or investors can buy or sell cryptocurrencies, usually in exchange for dollars or other fiat currencies. There are different crypto exchanges, often with different rules and offerings.
Traders sign up on the exchange, create an account, fund that account, and then execute a transaction for bitcoin or any other cryptocurrency they’re looking to add to their portfolio.
Given that these exchanges are typically where Bitcoin transactions go down, let’s run through an example of what that might actually look like.
How Bitcoin Transactions Work (with Example)
Here’s an example of a Bitcoin transaction: Imagine you want to send a bitcoin to your friend, Ted.
You know where the bitcoin is now: in your wallet. And where it needs to go: Ted’s wallet. So, we have point A, and point B. Here are the steps to get there:
1. Consider your crypto storage. There are a couple of ways to store crypto: “Hot wallets” which is typically another word for “online,” and “cold wallets,” which means your crypto is being stored offline, and thus, more securely. If you want to transact, though, you’ll need to get your holdings out of any crypto cold wallets and into hot ones, so that the transaction can commence.
Recommended: Hot Wallet vs. Cold Wallet: Choosing the Right Crypto Storage
2. Enact the transaction. To do this, send a message to the network with all of the details, including
a. Which bitcoin you want to send. This is called an input, and it’s the record of the bitcoin’s address and history.
b. The amount, or value of bitcoin to be transacted.
c. Where it’s going. That’s the output, or verification address.
So, to get your bitcoin to Ted, the network references the coin’s address, verifies that you want to send one bitcoin, and then verifies Ted’s public key, or Bitcoin address.
3. Wait for verification and confirmation. Once the network verifies the transaction, and that Ted is able to receive the bitcoin based on the message you sent. A confirmation process takes place — this is what we often refer to as “mining,” as the data in blocks is verified by other users — and the transaction is enacted.
Each bitcoin has its history written into the blockchain. You can trace each transaction back to each coin’s original creation by following its record over time. That’s how we know that each individual bitcoin exists, and that it belongs to (or is in possession of) the entity that claims it.
Yes, it’s a little abstract, and not as simple as handing Ted a $20 to cover your lunch tab. The thing to remember is that there are a lot of things taking place in the background during a Bitcoin transaction.
Transaction Confirmations
It often takes a little bit of time for the network to verify or confirm Bitcoin transactions. That’s because miners need to get to work, and as such, a transaction won’t be confirmed until a new block has been added to the blockchain.
Miners are rewarded with new bitcoins for creating new blocks on the blockchain. That process involves confirming and verifying data in the blocks. So there’s an incentive for the network to constantly confirm and verify the data on the network, including transaction information.
Until the network creates a new block and verifies the transaction data, the transaction will remain unconfirmed.
Transaction Speeds
Just how long a transaction can take typically depends on a few factors, such as the value or amount of bitcoin being transacted. Much of the delay has to do with the structure of the Bitcoin network itself — a new block is created roughly every 10 minutes, on average.
There is also often a queue to get your transaction confirmed. In some cases, you may have the choice of paying higher fees to get priority treatment.
Bitcoin Transaction Fees
Because “block demand” exists in the Bitcoin network, with users that want to confirm their transactions and thus have the data written into new blocks, there can be backups. Higher demand leads to higher prices, or fees, to confirm a transaction. Essentially, traders are paying a “miner’s fee” to have a transaction processed and confirmed on the blockchain, and the busier the network, the higher the tolls.
For example, fees skyrocketed during late April of 2021 as the crypto bull rush hit its heights. Average fees were around $60. But during calmer times on the network, the costs are typically much more reasonable, at less than $5.
It really comes down to supply and demand. The more demand on the network at a given time, the higher the transaction costs.
The Takeaway
A Bitcoin transaction relies heavily on the blockchain network, but at its heart it’s as simple as transferring one or more bitcoins from your account to someone else’s. Variables like transaction speed and transaction fees can vary based on demand.
Photo credit: iStock/Olemedia
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