8- Addresses, wallets, transactions

You are coming from two intense chapters — technicalities, big numbers and jargon.
Now, finally, it’s time to take a rest.
Just kidding. Another nerdy lesson coming your way; let’s keep the momentum going.
We can relax in later chapters, but now, I need your full attention again, because we are about to explore something that’s incredibly important in Bitcoin.

We talked about how nodes validate transactions, which are later gathered into blocks and added to the blockchain by miners.
That’s great, but we still haven’t discussed how it actually works — what is a transaction? What’s an address? And wallets: is that where I store my Bitcoin?

Bitcoin transactions are like the protocol’s fuel: they sustain it. Imagine a world where users stopped sending Bitcoin — the system may stall, as nodes would have nothing to validate, and miners would have no blocks to compete for. The blockchain would look like a ghost town, if you will.
Don’t forget: Bitcoin’s main “use case”, at least in the eyes of its creator, is to be exchanged as a currency and as a form of payment. 

Once I press the magic “send” button, a Bitcoin transaction is initiated.
For you, that’s pretty easy: you don’t really have to do anything. Behind the scenes, however, a whole lot of stuff takes place.
That’s what you will learn today.

We can start by saying that, in order to send or receive Bitcoin, you must use an address.
Crucially, though, you cannot use an address without first having set up a wallet — one depends on the other.
Let’s begin with wallets, then: an often misunderstood and overlooked piece of the Bitcoin ecosystem.

Transactions wouldn’t be possible without wallets, here personified and illustrated as a servant.

🟠The birth of a Bitcoin address.

Your address is a long string of letters and numbers, such as: bc1qxy2kgdygjrsqtzq2n0yrf2493p83kkfjhx0wlh.
This is, as we just said, the vital piece of information you need when sending or receiving Bitcoin.
It shares similarities with a standard bank account number but, of course, the two are not the same: among other things, a Bitcoin address does not store any personal information, granting you a certain level of privacy. 

The address is only the last stage of a process that begins with setting up a wallet, which is not to be confused with a real-life wallet. 
This is, in fact, merely a piece of software that manages and protects certain things for you. It does not store any money: it simply helps you to “unlock” and spend your Bitcoin.

A Bitcoin wallet is, as depicted in the image above, your “servant”: it basically takes care of everything, and it makes sure your transactions are being conducted smoothly, by “digitally signing them”.

We are now getting to the heart of “cryptography”: one of Bitcoin’s founding fathers — a pillar the entire system is built on.
This fascinating and complex field is all about protecting information.
Cryptography uses “keys”, together with mathematical techniques and advanced algorithms, to ensure that only the intended recipient can access a particular piece of information — no one else.
Do you hold the corresponding key? You are in.
If not, then you are out. You cannot hack, or brute-force your way in.

Have you heard of terms such as “private key”, “public key” before?
These are what your wallet, your “butler”, stores for you.
Cryptographic keys, as the word aptly suggests, are like passwords that are indispensable to process a Bitcoin transaction. They must be used. There is no way around it.

However, the wallet doesn’t really “own” them: it only manages them.
The keys, together with the address, all come from a higher authority: the mighty seed phrase!
And if cryptography is like one of the founding fathers, then we can say the seed phrase is the wallet’s mother: the one that gives birth to everything.

Let’s get this out of the way: the seed phrase is your most prized possession, in the world of Bitcoin. We will discuss this topic in more detail, together with “self custody”, types of wallets, and safety tips.
For now, at least, let’s try to understand what this is.

The seed phrase is often described as the “master key”: the supreme password that has the power to create — and restore — a wallet, together with its corresponding  keys and address.
That’s its role, and please note that you never get to use your seed phrase, as it’s not needed during transactions.

As you set up a wallet which, again, is mandatory if you want to buy, sell, send, or receive Bitcoin, the seed phrase is generated first.
It sits on its throne, on the top of the hierarchy, and everything else, as we are about to find out, comes as its by-product. No wonder it’s called “seed”.
This is the very first step of the process that ends with the creation of the address.

A seed phrase is a set of 12 or 24 human-readable words, randomly picked from a pool of 2048 English words.
An example of what a seed phrase could look like is:

“mirror timber coin salad river eagle mango canyon honey ticket river jazz”.

This combination is generated for you, in real time, in a completely random manner. 
What comes after, however, is not. And this is important.
The same seed phrase will always generate the same keys and address. This is the opposite of “random": it’s “deterministic”.

Let me use a gaming analogy.

Do you know how, in some “rogue-like” videogames, such as “Slay the spire”, “Hades”, or “Balatro”, as you start a new game, everything that will happen during that run is predetermined and randomly generated the moment you press “play”?

Fun fact — the “run” is also called… the seed! This can be saved and “pasted” by other players, in order to recreate that exact same game.

It’s the same here. “Plant” the same seed phrase, and it will always generate the same keys": every single time.

That’s how, just by typing your seed phrase, you are able to restore (recreate) the exact same wallet, together with its keys and its address, in case you lost access to it. 
And that’s also how someone is able to steal your Bitcoin, in case they found your magic 12 words — but I digress: we’ll discuss this, as promised. 

Don’t be scared: your seed phrase is incredibly safe. Unless you make some silly mistake, you are absolutely guaranteed no one is able to steal it, or to guess it with brute force.
Just to give you an idea of how secure this is, I can tell you that there are a million trillion more possible 12 word combinations than there are stars in the universe.
And if a computer were able to compute — and that’s impossible as of now — 1 billion combinations per second, trying to get your phrase, it would take approximately 10^22 years before it could successfully hack it. 
Your duty is to keep it as safe as possible, that’s all.

Just like a king, the seed phrase represents the highest authority, and it must be protected.

🟠After the seed phrase

It all began with you setting up a Bitcoin wallet, which is software — an app, you may say — that guards and uses your keys for you.
Very convenient, that’s for sure. But where are those keys, and what are they? Great question.

After the seed phrase is randomly created for you, a cascade effect is triggered.
The “first born” is the private key.
As the name aptly suggests, this 64-character string must not be shared with anyone, for any reason whatsoever. But you shouldn’t worry too much — with modern wallets, you never actually get to see or interact with your private key: everything’s being taken care of.

The private key is effectively what authorises a transaction, as we’ll see in a minute. Its role is simple, yet fundamental — it provides a “digital signature”.
It basically announces to the network :“Hey, the person controlling this key is the rightful owner of the Bitcoin they are about to send”.
That’s because your private key is unique, and it cannot be guessed or forged: it only exist within your wallet.
It’s like when you are shopping online and before you press the “pay” button, your phone requires your fingerprint as the ultimate proof of your identity.
Of course, that’s just an example. In Bitcoin, your wallet does not store any of your personal data.

Let’s keep the family analogies going. The private key now generates — gives birth — to the public key: the seed phrase’s grandchild.
It’s called “public”, and this tells us one thing: unlike its parent, the secretive private key, this one is not that afraid of being shared, although this shouldn’t be done casually.

If your private key is stolen, one could easily drain all of your money by sending it to another address, because they are in control of the fundamental piece that authorises transactions.

But the public key’s job is different: it lets nodes verify that the transaction has been signed. Let me explain.
Remember what we discussed earlier? Cryptography — this is where it comes into play.
The two keys are mathematically related, and one corresponds to the other.
Your public key solely exists because the private key generated it: they share an unbreakable link.

When nodes “see” that your transaction bears your public key, they know — mathematically — that the corresponding private key must have been used to sign it.

That’s the public key’s role: to let the network verify the digital signature that was earlier provided by its parent, the private key.
In a system where your identity is hidden, this is what ensures that you are truthfully your Bitcoin’s real owner.

We’ll make this process crystal clear at the end of the chapter, don’t worry.

The hierarchy illustrated by one of the Dojo’s sensei.

At last, the final member of the seed phrase’s dynasty is born, as the public key creates a shorter, safer version of itself: the famous address.
Everyone knows what a Bitcoin address is, kind of.

It’s what we use to send or receive money, essentially — it is meant to be shared.

Notice how, with each “generation”, the secrecy tends to decrease, to the point it completely vanishes.
The seed phrase: the ultimate treasure, the most important secret.
The private key: it must stay hidden, because it authorises all spending.
The public key: it should not be shared mindlessly, and it may still be visible by everyone on the blockchain.
The address: it must be made public for it to be of any use.

Now, time to dispel an enormous misconception: is my Bitcoin “stored” inside my address, or is it inside my wallet? Neither of these is true!

🟠Where is my Bitcoin?

All of the Bitcoin that is currently in circulation lives on the blockchain.
To answer your question: no, Bitcoin is not really transferred or moved.
Even after my transaction went through, that money stays exactly where it’s always been: on the blockchain. However, it simply changes owners.

Let’s say I own 1 Bitcoin.
Well, I don’t really own it myself, but it is associated with my address instead.

My address, let’s call it “XYZ" in this hypothetical scenario, is what has the ability, by using “its own” keys, to unlock that 1 Bitcoin.

This coin — or balance, rather — is on the blockchain, and it has a “label” on it, called UTXO: unspent transaction output.

Basically, this label says “this one Bitcoin is only spendable or accessible by address XYZ, using its corresponding keys”.

If I wish to send you that Bitcoin, what really happens?
The system now sees it as spent Bitcoin, which means my UTXO is “expired”. In other words, it’s no longer “mine” — my address cannot access it anymore, because it has just been spent.

The label now changes, and it reads: “This coin is now unspent, but it’s only unlockable by address YYY (your address) by using its associated keys”.

Ultimately, just remember: you are not sending Bitcoins, you are sending UTXOs! Your address does not hold or store any money — it simply “receives” UTXOs, which are only spendable — via cryptography — by using the right private key.

🟠The transaction process: let your wallet shine

With all this newly learned information in mind, it should now be easy to piece it all together and have a solid understanding of how a transaction works.

It starts with me, the sender, requesting the receiver’s address.
After it’s been copied and pasted inside my wallet app, and the amount of Bitcoin has been selected, I press the “send” button — let’s continue from where we left, at the top of the chapter.

Please note there’s no going back now. A Bitcoin transaction is notoriously  irreversible: no “undo” option is available.
If, for any reason, you copied the wrong address, or selected an excessive amount of money to be sent, there is absolutely nothing you can do to change that, so please be careful.

This is where your humble and loyal servant, the wallet, makes its appearance. It does all the heavy lifting for its master: you can relax and sit back, while your wallet is hard at work.

The private key comes into play, and the transaction is signed: your Bitcoin is unlocked, and the existing (my) UTXO is destroyed, only for a new one to be created (yours).

A fee is calculated and charged to the sender, before the transaction is finally broadcast to the Bitcoin network, where a node will carefully examine its authenticity by verifying, among other things, the signature.

Once the transfer is cross-checked by thousands of other nodes and approved by the network, it sits in the waiting room known as the “mempool”, where, sooner or later, a miner will pick it up and include it in a block which, as we know, is bound to be published on the blockchain.

And there you go! The “technical” side of the Bitcoin protocol is now behind us. 
Keys and cryptography are not easy to understand. There is a lot of math and nerding behind them. The good news is that you don’t really have to “get them”, as of now. 

The key (funny, I know) concepts I want you to take away from this chapter are: what a wallet actually is, what it actually does, the sheer importance of the seed phrase, and the correct hierarchy within the wallet microcosm.

This guide ain’t over, though. There is still a lot of ground to cover.
Next up: how to buy, or sell, Bitcoin.

 I’ll see you soon.