Want to really understand how bitcoin works? Here’s a gentle primer

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How bitcoin transactions work

The generic digital cash scheme I described in the previous section is very close to how real bitcoin payments work. Here's a simplified diagram of what real bitcoin transactions look like:



A bitcoin transaction contains a list of inputs and outputs. Each output has a public key associated with it. For a later transaction to spend those coins, it needs an input with a matching digital signature. Bitcoin uses elliptic curve cryptography for digital signatures.

FURTHER READING
A (relatively easy to understand) primer on elliptic curve cryptography
For example, suppose you own the private key corresponding to Public Key D in the diagram above. Someone wants to send you 2.5 bitcoins. The person will create a transaction like Transaction 3, with 2.5 bitcoins going to you—the owner of Public Key D.

When you're ready to spend those bitcoins, you create a new transaction like Transaction 4. You list Transaction 3, output 1 as a source of the funds (outputs are zero-indexed, so output 1 is the second output). You use your private key to generate Signature D, a signature that can be verified with Public Key D. These 2.5 bitcoins are then split up between two new outputs: 2 bitcoins for Public Key E and 0.5 bitcoins for Public Key F. Now they can only be spent by the owners of the corresponding private keys.

A transaction can have multiple inputs, and it must spend all of the bitcoins from the corresponding outputs of earlier transactions. If a transaction outputs fewer bitcoins than it takes in, the difference is treated as a transaction fee collected by the bitcoin miner who processed the transaction (more details on this later).

On the bitcoin network, the addresses people use to send each other bitcoins are derived from public keys like Public Key D. The exact details of bitcoin's address format are complicated and have changed over time, but you can think of a bitcoin address as a hash (a short, seemingly random string of bits that serves as a cryptographic fingerprint) of a public key. Bitcoin addresses are encoded in a custom format called Base58Check that minimizes the risk of mistyping. A typical bitcoin address is "18ZqxfuymzK98G7nj6C6YSx3NJ1MaWj6oN."



This transaction took 6.07 bitcoins from one input address and split it between two output addresses. One output address got a bit more than 5 bitcoins, while the other got slightly less than 1 bitcoin. Most likely, one of those output addresses belongs to the sender—sending "change" back to themselves—while the other belongs to a third-party recipient.

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