Transactions are the most important part of the bitcoin system. Everything else in bitcoin 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. Transactions are data structures that encode the transfer of value between participants in the bitcoin system. Each transaction is an public entry in bitcoin's global double-entry bookkeeping ledger, the blockchain.
In this chapter we will examine all the various forms of transactions, what they contain, how to create them, how they are verified, and become part of the permanent record of all transactions.
A transaction's lifecycle starts with the transaction's creation, also known as origination. The transaction is then signed, with one or more signatures indicating the authorization to spend the funds referenced by the transaction. The transaction is then broadcast on the bitcoin network, where each network node (participant) validates and propagates 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 (confirmations), 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 spend in a new transaction, extending the chain of ownership and beginning the lifecycle of a transaction again.
In some ways it helps to think of a transaction in the same way as a paper cheque. Like a cheque, 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 cheque, 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 cheques for signature by the CEO. Similarly, an accounts payable clerk can create bitcoin transactions and then have the CEO apply digital signatures to make them valid. While a cheque 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 was properly formed and signed, the signed transaction is now valid and contains all the information needed to execute the transfer of funds. Finally, the valid transaction 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.
Next, a transaction needs to be delivered to the bitcoin network so that it can be propagated and be included in the blockchain. In essence, a bitcoin transaction is just 300-400 bytes of data and has to reach any one of tens of thousands of bitcoin nodes. The sender does 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". Since the transaction is signed and contains no confidential 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 copy and paste in 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 frequency hoping 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 virtually impossible to stop anyone from creating and executing a bitcoin transaction.
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 it is connected to and a success message will be returned synchronously to the originator. If the transaction is invalid, the node will reject it and synchronously return a rejection message to the originator. The bitcoin network is a peer-to-peer network, meaning that each bitcoin node is connected to a few other bitcoin nodes which it discovers during startup through the peer-to-peer protocol. The entire network forms a loosely connected mesh without a fixed topology or any structure, making all nodes equal peers. Messages, including transactions and blocks are propagated from each node to the peers it is connected to. A new validated transaction injected into any node on the network will be sent to 3-4 of the neighboring nodes, each of which will send it to 3-4 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 received 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, denial of service attacks or other nuisance attacks agains the bitcoin system, every node will independently validate 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 <<tx_validation>>
Some of the nodes in the bitcoin network participate in "mining". Mining is the process creating new blocks of transactions that will become part of the blockchain. Miners collect transactions and group them into blocks, they then attempt to prove each block with the proof-of-work algorithm. Blocks with a valid proof of work are added to and extend the linked chain of blocks called the blockchain. Once a transaction is added to the blockchain, the new owner of the funds can reference it in a new transaction and spend the funds.
The blockchain forms the authoritative ledger of all transactions since bitcoin's beginning in 2009. The blockchain is the subject of the next chapter, where we will examine the formation of the authoritative record through the competitive process of proof-of-work, also known as mining.
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 which only the owner, or person know knows the secret, can unlock.
Note: 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 non-zero 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 transaction is not included in the blockchain prior to the specified time.
The fundamental building block of a bitcoin transaction is an _unspent transaction output_ 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 network. 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 may be scattered as UTXO amongst hundreds of transactions and hundreds of blocks. In effect, there is no such thing as a 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 construct created by the wallet application. The wallet calculates the user's balance by scanning the blockchain and aggregating all UTXO belonging to that user.
Unlike cash which exists in specific denominations, one dollar, five dollars, ten dollars, etc., a UTXO can have any arbitrary value denominated as a multiple of satoshis (the smallest bitcoin unit equal to 100 millionth of a bitcoin). While 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, bitcoin transactions must occasionally generate change.
In simple terms, transactions consume the sender's available UTXO and create new UTXO locked to the recipient's bitcoin address. Imagine a shopper buying a $1.50 beverage, reaching into their 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 bank note (five dollar note). If they hand too much money, say $5, to the shop owner they will expect $3.50 change, which they will return to their wallet and have available for future transactions. Similarly, a bitcoin transaction must be created from a users UTXO in whatever denominations that user has available. They cannot cut a UTXO in half anymore than they can cut a dollar bill in half and use it as currency. The user's wallet application will typically select from the users 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.
The UTXO consumed by a transaction are called transaction inputs, while 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 unlocking it with the signature of the current owner and create UTXO 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 as we will see in <<mining>>
What comes first? Inputs or outputs, the chicken or the egg? Strictly speaking, outputs come first because coinbase transactions, which generate new bitcoin, have no inputs and create outputs from nothing.
Every bitcoin transaction creates outputs, which are recorded on the bitcoin ledger. Almost all of these outputs, with one exception (see <<op_return>>) 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.
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 associate a specific amount (in satoshis) to a specific _encumbrance_ or locking-script that defines the condition that must be met to spend that amount. In most cases the locking script will lock the output to a specific bitcoin address, thereby transferring ownership of that amount to the new owner. When Alice paid Bob's Cafe for a cup of coffee, her transaction created a 0.015 bitcoin output _encumbered_ or locked to the Cafe's bitcoin address. That 0.015 bitcoin output was recorded on the blockchain and became part of the Unspent Transaction Output set, meaning it showed in Bob's wallet as part of the available balance. When Bob chooses to spend that amount, his transaction will release the encumbrance, unlocking the output by providing an unlocking script containing a signature from Bob's private key.
In simple terms, transaction inputs are pointers to UTXO. They point to a specific UTXO by reference to the transaction hash and sequence number where the UTXO is recorded in the blockchain. To spend UTXO, a transaction input also includes unlocking-scripts that satisfy the spending conditions set by the UTXO. The unlocking script is usually a signature proving ownership of the bitcoin address that is in the locking script.
When a user makes a payment, their wallet constructs a transaction by selecting from the available UTXO. For example, to make a 0.015 bitcoin payment, the wallet app may select a 0.01 UTXO and a 0.005 UTXO, using them both to add up to the desired payment amount. The wallet then produces unlocking scripts containing signatures for each of the UTXO, thereby making them spendable by satisfying their locking script conditions. The wallet adds these UTXO references and unlocking scripts as inputs to the transaction.
Note: The sequence number is used to override a transaction prior to the expiration of the transaction locktime, which is a feature that is currently disabled in bitcoin. Most transactions set this value to the maximum integer value (0xFFFFFFFF) and it is ignored by the bitcoin network. If the transaction has a non-zero locktime, at least one of its inputs must have a sequence number below 0xFFFFFFFF in order to enable locktime.
Most transactions include transactions fees that compensate the bitcoin miners for securing the network. Mining and the fees and rewards collected by miners are discussed in more detail in <<mining>>. This section examines how transaction fees are included in a typical transaction. Most wallets calculate and include transaction fees automatically. However, if you are constructing transactions programmatically, or using a command line interface, you must manually account for and include fees.
Transaction fees serve as an incentive to include (mine) a transaction into the next block and also as a disincentive against "spam" transactions or any kind of abuse of the system, by imposing a small cost on every transaction. Transaction fees are collected by the miner who mines the block that records the transaction on the blockchain.
Transaction fees are calculated based on the size of the transaction in kilobytes, not the value of the transaction in bitcoin. Overall, transaction fees are set based on market forces within the bitcoin network. Miners prioritize transactions based on many different criteria, including fees and may even process transactions for free under certain circumstances. Transaction fees affect the processing priority, meaning that a transaction with sufficient fees is likely to be included in the next-most mined block, while a transaction with insufficient or no fees may be delayed, on a best-effort basis and processed after a few blocks or not at all. Transaction fees are not mandatory and transactions without fees may be processed, eventually, but including transaction fees encourages priority processing.
Over time, the way transaction fees are calculated and the effect they have on transaction prioritization has been changing. At first, transaction fees were fixed and constant across the network. Gradually, the fee structure has been relaxed so that it may be influenced by market forces, based on network capacity and transaction volume. The current minimum transaction fee is fixed at 0.0001 bitcoin or a tenth of a milli-bitcoin, recently decreased from one milli-bitcoin, per kilobyte. Most transactions are less than one kilobyte, however those with multiple inputs or outputs can be larger. In future revisions of the bitcoin protocol it is expected that wallet applications will use statistical analysis to calculate the most appropriate fee to attach to a transaction based on the average fees of recent transactions.
The current algorithm used by miners to prioritize transactions for inclusion in a block based on their fees will be examined in detail in <<mining>>.
The data structure of transactions does not have a field for fees. Instead, fees are implied as the difference between the sum of inputs and the sum of outputs. Any excess amount that remains after all outputs have been deducted from all inputs is the fee that is collected by the miners.
[[tx_fee_equation]]
.Transaction fees are implied, as the excess of inputs minus outputs
----
Fees = Sum(Inputs) - Sum(Outputs)
----
This is a somewhat confusing element of transactions and an important point to understand, because if you are constructing your own transactions you must ensure you do not inadvertently include a very large fee by underspending the inputs. That means that you must account for all inputs, if necessary by creating change, or you will end up giving the miners a very big tip!
[WARNING]
====
If you forget to add a change output in a manually constructed transaction you will be paying the change as a transaction fee. "Keep the change!" may not be what you intended.
For example, if you consume a 20 bitcoin UTXO to make a 1 bitcoin payment, you must include a 19 bitcoin change output back to your wallet. Otherwise, the 19 bitcoin "leftover" will be counted as a transaction fee and will be collected by the miner who mines your transaction in a block. While you will receive priority processing and make a miner very happy, this is probably not what you intended.
Let's see how this works in practice, by looking at Alice's coffee purchase again. Alice wants to spend 0.015 bitcoin to pay for coffee. To ensure this transaction is processed promptly, she will want to include a transaction fee, say 0.001. That will mean that the total cost of the transaction will be 0.016. Her wallet must therefore source a set of UTXO that adds up to 0.016 bitcoin or more and if necessary create change. Let's say her wallet has a 0.2 bitcoin UTXO available. It will therefore need to consume this UTXO, create one output to Bob's Cafe for 0.015, and a second output with 0.184 bitcoin in change back to her own wallet, leaving 0.001 bitcoin unallocated, as an implicit fee for the transaction.
Now let's look at a different scenario. Eugenio, our children's charity director in the Philippines has completed a fundraiser to purchase school books for the children. He received several thousand small donations from people all around the world, totaling 50 . Now, he want to purchase hundreds of school books from a local publisher, paying in bitcoin. The charity received thousands of small donations from all around the world. As Eugenio's wallet application tries to construct a single larger payment transaction, it must source from the available UTXO set which is composed of many smaller amounts. That means that the resulting transaction will source from more than a hundred small-value UTXO as inputs and only one output, paying the book publisher. A transaction with that many inputs will be larger than one kilobyte, perhaps 2-3 kilobytes in size. As a result, it will require a higher fee than the minimal network fee of 0.0001 bitcoin. Eugenio's wallet application will calculate the appropriate fee by measuring the size of the transaction and multiplying that by the per-kilobyte fee. Many wallets will overpay fees for larger transactions to ensure the transaction is processed promptly. The higher fee is not because Eugenio is spending more money, but because his transaction is more complex and larger in size - the fee is independent of the transaction's bitcoin value.
