A transaction in the cryptocurrency context is essentially a transfer of value (cryptocurrency) from one address (or user) to another, recorded and verified on a blockchain. It is not the same as a traditional banking transaction, where money is moved between accounts managed by a central bank. In a crypto network, transactions are decentralized and rely on cryptography.
How does a crypto transaction work?
To understand a crypto transaction, think about the following essential steps:
Transaction Initiation:
- A user (let’s call him the Sender) decides to send a certain amount of cryptocurrency to another user (the Recipient).
- The Sender uses a digital wallet (software or hardware) to initiate the transaction.
- In the wallet, he specifies:
- Recipient’s public address: a long string identifying the wallet to which the funds are being sent.
- The amount of cryptocurrency to send.
- Transaction fee (gas fee): A small amount of cryptocurrency that the Sender is willing to pay to the miners/validators to process their transaction. A higher fee may mean faster processing.
Digital Signature:
- The transaction is digitally signed by the Sender using their private key. This is a unique cryptographic feature that proves that the Sender is the rightful owner of the funds and that they authorized the transaction. Without the private key, no one can move the funds.
- The digital signature ensures authenticity (that the Sender is the real one) and integrity (that the details of the transaction cannot be changed after signing).
Network broadcasting:
- After signing, the transaction is broadcast (transmitted) to all nodes (computers) in the blockchain network.
- The nodes receive the transaction and add it to a “mem-pool”(memory pool) or “transaction pool”, where it waits to be included in a blockchain.
Verification and inclusion in a block:
- Miners (in Proof of Work) or Validators (in Proof of Stake) collect transactions from the mem-pool.
- They check the validity of each transaction (e.g. Sender has sufficient funds, digital signature is correct).
- Validated transactions are grouped into a new block.
- The block is then added to the blockchain, through a process that depends on the consensus mechanism of the network (e.g. solving a cryptographic puzzle in PoW, or stake validation in PoS).
Transaction confirmation:
- Once the transaction is included in a block and that block is added to the blockchain, the transaction is considered confirmed.
- As more blocks are added after the block containing your transaction, the number of “confirmations” increases, making the transaction increasingly irreversible and secure. Usually, after a few confirmations, the funds are considered safe and available to the Recipient.
Important features of crypto transactions
- Immutability: Once a transaction is recorded on the blockchain and confirmed, it cannot be changed or deleted. It is permanent.
- Transparency: All transactions are public and can be verified by anyone on the blockchain (although the real identities of senders and receivers remain pseudonymized, represented by addresses).
- Decentralization: There is no central authority to approve or block transactions. They are validated by the distributed network of nodes.
- Global: Transactions can be sent anywhere in the world, 24/7, without geographical or time restrictions.
- Irrevocability: Once confirmed, a crypto transaction cannot be canceled or “reversed”, unlike bank transactions which can be reversed under certain conditions.
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