8- Addresses, wallets, transactions

Bitcoin transactions are, needless to say, a centrepiece of the ecosystem.
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. 
It goes without saying that, with no transactions taking place, the whole thing would be kind of “dead”: nodes would have nothing to validate, miners would have no blocks to compete for, and the blockchain would look like a ghost town. 

As I press the “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 is happening.
And that’s what you are about to learn, together with a few more important notions.
We’ll start by saying that, in order to send or receive Bitcoin, you must use an “address”.
Importantly, though, you cannot use an address, without first having set up a “wallet”.
Let’s talk about wallets, then: an often misunderstood and overlooked piece of the BTC puzzle.

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

Wallets and 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 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 the creation of 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.

Your 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. 
We are now getting to the heart of “cryptography”: one of the technologies Bitcoin is built on.
Have you heard of terms such as “private key”, “public key”, or “seed phrase” before?
These are what your wallet, your “butler”, manages and stores for you.
Keys, as the word aptly suggests, are like passwords that are indispensable to process a Bitcoin transaction. They must be employed. There is no way around it.
However, the wallet doesn’t really “own” them: it only manages them.
The keys, together with the address, belong to a higher authority: the mighty seed phrase!

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, address, and the money associated with it. 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”.
What even is it? 
A seed phrase is a set of 12 or 24 humanly-readable (not a strange combination of letters and numbers) 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”.

These words are 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 begin a new game, everything that will happen during that run is predetermined and randomly generated as you press “play”?
And you know how you can “save” the seed (keyword) and recreate that exact same run?
It’s the same here. If you “plant” the seed (phrase), it will always generate the same keys.
That’s how, just by remembering 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. We’ll discuss this, as promised. 

Your seed phrase is incredibly safe, fear not. Unless you make some silly mistakes, 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 (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.

The second step of the process is the creation, from the seed phrase, of something known as the “private key”. This is a 64 character string that’s comparable to your bank account’s password: its main role is to provide a “digital signature”, which effectively authorizes and kickstarts a transaction.
The name “private” reminds you of the fact this must not be shared with anyone. Don’t stress though: you never get to see it, or interact with it: this is where your wallet comes in.

From the private key, a “public key” is then derived. This one is not “secret” and it doesn’t compromise your safety, nor is it related to “sensitive” information. You can see it as your “blockchain ID”, in a way.
Nodes use it to verify that the matching (and mathematically related) private key was used to sign off the transaction. This is what ensures, in a system where your identity is “hidden”, that you are the rightful owner of your Bitcoin, and that you are allowed to move it.

This cascade effect ends with the address, which is essentially a readable version of your public key: the two are closely related and they are somewhat similar. The address can, of course, be shared with anyone, and it’s what allows you to send or receive Bitcoin (together with the keys, of course).

But is Bitcoin “stored” inside the address, or inside the wallet? That’s a common misconception. Let’s see what it actually looks like.

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; it simply changes owners.

Let’s say I own 1 Bitcoin.
Well, I don’t really own it myself. We know that, unlike fiat, Bitcoin is not related to your identity. It is associated with an address.
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 1 coin is on the blockchain and it has a “label” on it, called UTXO: unspent transaction output.
Basically, it’s as if this label said “this one Bitcoin belongs, and it is only accessible by the address XYZ, using its corresponding keys”.
If I wish to send you that Bitcoin, what happens? Well, that coin is not going anywhere.
The system, however, now sees it as “spent” Bitcoin, which means my UTXO is “expired”.
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”.

The transaction process: where your wallet shines

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

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

Please note that there is now no going back. 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, once the transaction has been initiated.

This is where your humble and loyal servant, the wallet, makes its entrance. It does all the heavy lifting for its master: you can relax and sit back, while everything is being taken care of. 
The private key is deployed, and the transaction is signed: your Bitcoin is unlocked, and the existing UTXO is destroyed, only for a new one to be created. 
A fee is calculated and charged to the sender, before the transaction is finally broadcasted to the Bitcoin network, where a node will carefully examine its authenticity, by verifying, among other things, that the public key corresponds to the freshly used private key.
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) concept I want you to take away from this chapter is just how important the seed phrase is. Everything you do, in Bitcoin, is directly tied to it. It cannot be overstated: the seed phrase is king, and you must guard it, protect it, by any means necessary.

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.