A Basic Cryptocurrency Transaction

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Introduction Transactions are the most important part of the digital coin system. Everything else in bit‐ coin is designed to ensure that transactions can be created, propagated on the network, validated, and finally added to the global ledger of transactions (the blockchain).

Trans‐ actions are data structures that encode the transfer of value between participants in the bitcoin system. Each transaction is a public entry in bitcoin’s blockchain, the global double-entry bookkeeping ledger. In this chapter we will examine all the various forms of transactions, what they contain, how to create them, how they are verified, and how they become part of the permanent record of all transactions. Transaction Lifecycle A transaction’s lifecycle starts with the transaction’s creation, also known as origina‐ tion.

The transaction is then signed with one or more signatures indicating the author‐ ization to spend the funds referenced by the transaction. The transaction is then broad‐ cast on the bitcoin network, where each network node (participant) validates and prop‐ agates the transaction until it reaches (almost) every node in the network. Finally, the transaction is verified by a mining node and included in a block of transactions that is recorded on the blockchain.

Once recorded on the blockchain and confirmed by sufficient subsequent blocks (con‐ firmations), the transaction is a permanent part of the bitcoin ledger and is accepted as valid by all participants. The funds allocated to a new owner by the transaction can then be spent in a new transaction, extending the chain of ownership and beginning the lifecycle of a transaction again. 109 Creating Transactions In some ways it helps to think of a transaction in the same way as a paper check. Like a check, a transaction is an instrument that expresses the intent to transfer money and is not visible to the financial system until it is submitted for execution.

Like a check, the originator of the transaction does not have to be the one signing the transaction. Transactions can be created online or offline by anyone, even if the person creating the transaction is not an authorized signer on the account. For example, an accounts payable clerk might process payable checks for signature by the CEO. Similarly, an accounts payable clerk can create bitcoin transactions and then have the CEO apply digital sig‐ natures to make them valid. Whereas a check references a specific account as the source of the funds, a bitcoin transaction references a specific previous transaction as its source, rather than an account.

Once a transaction has been created, it is signed by the owner (or owners) of the source funds. If it is properly formed and signed, the signed transaction is now valid and con‐ tains all the information needed to execute the transfer of funds. Finally, the valid trans‐ action has to reach the bitcoin network so that it can be propagated until it reaches a miner for inclusion in the pubic ledger (the blockchain). Broadcasting Transactions to the Bitcoin Network First, a transaction needs to be delivered to the bitcoin network so that it can be propa‐ gated and included in the blockchain. In essence, a bitcoin transaction is just 300 to 400 bytes of data and has to reach any one of tens of thousands of bitcoin nodes.

The senders do not need to trust the nodes they use to broadcast the transaction, as long as they use more than one to ensure that it propagates. The nodes don’t need to trust the sender or establish the sender’s “identity.” Because the transaction is signed and contains no con‐ fidential information, private keys, or credentials, it can be publicly broadcast using any underlying network transport that is convenient. Unlike credit card transactions, for example, which contain sensitive information and can only be transmitted on encrypted networks, a bitcoin transaction can be sent over any network.

As long as the transaction can reach a bitcoin node that will propagate it into the bitcoin network, it doesn’t matter how it is transported to the first node. Bitcoin transactions can therefore be transmitted to the bitcoin network over insecure networks such as WiFi, Bluetooth, NFC, Chirp, barcodes, or by copying and pasting into a web form. In extreme cases, a bitcoin transaction could be transmitted over packet radio, satellite relay, or shortwave using burst transmission, spread spectrum, or fre‐ quency hopping to evade detection and jamming. A bitcoin transaction could even be encoded as smileys (emoticons) and posted in a public forum or sent as a text message or Skype chat message.

Bitcoin has turned money into a data structure, making it vir‐ tually impossible to stop anyone from creating and executing a bitcoin transaction. 110 | Chapter 5: Transactions Propagating Transactions on the Bitcoin Network Once a bitcoin transaction is sent to any node connected to the bitcoin network, the transaction will be validated by that node.

If valid, that node will propagate it to the other nodes to which it is connected, and a success message will be returned synchro‐ nously to the originator. If the transaction is invalid, the node will reject it and syn‐ chronously return a rejection message to the originator. The bitcoin network is a peer-to-peer network, meaning that each bitcoin node is con‐ nected to a few other bitcoin nodes that it discovers during startup through the peerto-peer protocol.

The entire network forms a loosely connected mesh without a fixed topology or any structure, making all nodes equal peers. Messages, including transac‐ tions and blocks, are propagated from each node to the peers to which it is connected. A new validated transaction injected into any node on the network will be sent to three to four of the neighboring nodes, each of which will send it to three to four more nodes, and so on. In this way, within a few seconds a valid transaction will propagate in an exponentially expanding ripple across the network until all connected nodes have re‐ ceived it. The bitcoin network is designed to propagate transactions and blocks to all nodes in an efficient and resilient manner that is resistant to attacks.

To prevent spamming, denialof-service attacks, or other nuisance attacks against the bitcoin system, every node in‐ dependently validates every transaction before propagating it further. A malformed transaction will not get beyond one node. The rules by which transactions are validated are explained in more detail in “Independent Verification of Transactions” on page 177. Transaction Structure A transaction is a data structure that encodes a transfer of value from a source of funds, called an input, to a destination, called an output.

Transaction inputs and outputs are not related to accounts or identities. Instead, you should think of them as bitcoin amounts—chunks of bitcoin—being locked with a specific secret that only the owner, or person who knows the secret, can unlock. A transaction contains a number of fields, as shown in Table 5-1. Table 5-1.

The structure of a transaction Size Field Description 4 bytes Version Specifies which rules this transaction follows 1–9 bytes (VarInt) Input Counter How many inputs are included Variable Inputs One or more transaction inputs 1–9 bytes (VarInt) Output Counter How many outputs are included Variable Outputs One or more transaction outputs 4 bytes Locktime A Unix timestamp or block number Transaction Structure | 111 Transaction Locktime Locktime defines the earliest time that a transaction can be added to the blockchain. It is set to zero in most transactions to indicate immediate execution.

If locktime is nonzero and below 500 million, it is interpreted as a block height, meaning the transaction is not included in the blockchain prior to the specified block height. If it is above 500 million, it is interpreted as a Unix Epoch timestamp (seconds since Jan-1-1970) and the trans‐ action is not included in the blockchain prior to the specified time. The use of locktime is equivalent to postdating a paper check. Transaction Outputs and Inputs The fundamental building block of a bitcoin transaction is an unspent transaction out‐ put, or UTXO. UTXO are indivisible chunks of bitcoin currency locked to a specific owner, recorded on the blockchain, and recognized as currency units by the entire net‐ work.

The bitcoin network tracks all available (unspent) UTXO currently numbering in the millions. Whenever a user receives bitcoin, that amount is recorded within the blockchain as a UTXO. Thus, a user’s bitcoin might be scattered as UTXO amongst hundreds of transactions and hundreds of blocks. In effect, there is no such thing as a stored balance of a bitcoin address or account; there are only scattered UTXO, locked to specific owners. The concept of a user’s bitcoin balance is a derived construct created by the wallet application.

The wallet calculates the user’s balance by scanning the block‐ chain and aggregating all UTXO belonging to that user. There are no accounts or balances in bitcoin; there are only unspent transaction outputs (UTXO) scattered in the blockchain. A UTXO can have an arbitrary value denominated as a multiple of satoshis. Just like dollars can be divided down to two decimal places as cents, bitcoins can be divided down to eight decimal places as satoshis.

Although UTXO can be any arbitrary value, once created it is indivisible just like a coin that cannot be cut in half. If a UTXO is larger than the desired value of a transaction, it must still be consumed in its entirety and change must be generated in the transaction. In other words, if you have a 20 bitcoin UTXO and want to pay 1 bitcoin, your transaction must consume the entire 20 bitcoin UTXO and produce two outputs: one paying 1 bitcoin to your desired recipient and another paying 19 bitcoin in change back to your wallet.

As a result, most bitcoin trans‐ actions will generate change. 112 | Chapter 5: Transactions Imagine a shopper buying a $1.50 beverage, reaching into her wallet and trying to find a combination of coins and bank notes to cover the $1.50 cost. The shopper will choose exact change if available (a dollar bill and two quarters), or a combination of smaller denominations (six quarters), or if necessary, a larger unit such as a five dollar bank note.

If she hands too much money, say $5, to the shop owner, she will expect $3.50 change, which she will return to her wallet and have available for future transactions. Similarly, a bitcoin transaction must be created from a user’s UTXO in whatever de‐ nominations that user has available. Users cannot cut a UTXO in half any more than they can cut a dollar bill in half and use it as currency.

The user’s wallet application will typically select from the user’s available UTXO various units to compose an amount greater than or equal to the desired transaction amount. As with real life, the bitcoin application can use several strategies to satisfy the purchase amount: combining several smaller units, finding exact change, or using a single unit larger than the transaction value and making change. All of this complex assembly of spendable UTXO is done by the user’s wallet automatically and is invisible to users.

It is only relevant if you are programmatically constructing raw transactions from UTXO. The UTXO consumed by a transaction are called transaction inputs, and the UTXO created by a transaction are called transaction outputs. This way, chunks of bitcoin value move forward from owner to owner in a chain of transactions consuming and creating UTXO.

Transactions consume UTXO by unlocking it with the signature of the current owner and create UTXO by locking it to the bitcoin address of the new owner. The exception to the output and input chain is a special type of transaction called the coinbase transaction, which is the first transaction in each block. This transaction is placed there by the “winning” miner and creates brand-new bitcoin payable to that miner as a reward for mining. This is how bitcoin’s money supply is created during the mining process.

Transaction Outputs

Every bitcoin transaction creates outputs, which are recorded on the bitcoin ledger. Almost all of these outputs, with one exception (see “Data Output (OP_RETURN)” on page 130) create spendable chunks of bitcoin called unspent transaction outputs or UTXO, which are then recognized by the whole network and available for the owner to spend in a future transaction.

Sending someone bitcoin is creating an unspent transaction output (UTXO) registered to their address and available for them to spend. Transaction Outputs and Inputs | 113 UTXO are tracked by every full-node bitcoin client in a database held in memory, called the UTXO set or UTXO pool.

New transactions consume (spend) one or more of these outputs from the UTXO set. Transaction outputs consist of two parts: • An amount of bitcoin, denominated in satoshis, the smallest bitcoin unit • A locking script, also known as an “encumbrance” that “locks” this amount by spec‐ ifying the conditions that must be met to spend the output The transaction scripting language, used in the locking script mentioned previously.

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