In this series "What is actually ...?", Oliver Völkel explains various terms and concepts relating to blockchain and distributed ledger technology (DLT). This article is again dedicated to fundamental concepts, namely the concepts of addresses, transactions and private keys.
Blockchain technology is based on the idea of the distributed ledger. A distributed ledger is a public and decentralized ‘account book’. As described in the thought experiment in this series' article What is actually ... a public blockchain?, it is used to record user transactions. At its core, the blockchain is therefore simply a record of transaction data; we say a certain value is being transferred from one address on the blockchain to another address, or certain functions are being called. The address from which a crypto-asset is transferred is called the sender address. The address to which it is transferred is called the recipient address.
Addresses are also used to uniquely identify smart contracts. A smart contract simply refers to a computer program whose program code is stored in compiled form on a blockchain and can be interacted with as part of transactions via the address assigned to the respective smart contract.
The address is an alphanumeric character string. Everyone can generate any number of new addresses. No "connection" to the blockchain or communication with miners or validators is required to generate addresses. Instead, new addresses can be generated offline by following certain mathematical steps. To receive crypto-assets, the desired address must be provided.
The term ‘transaction request’ refers to a validly signed and correctly structured technical instruction to transfer coins from certain addresses (sender addresses) to one or more other addresses (recipient addresses), or to interact with a smart contract, such as calling certain functions. In addition to the technical instruction and the signature, the transaction request also includes a promised transaction fee. The term ‘transaction’ then refers to a transaction request that is included in a block and thus becomes part of the blockchain.
When interacting with the blockchain, a distinction can be made between simple and complex transactions. Simple transactions only involve the transfer of crypto-assets. Complex transactions interact with smart contract functions.
It is possible and also common for multiple crypto-assets to be transferred from different sender addresses to the same recipient address. A look at a single transaction therefore does not necessarily show the quantity of crypto-assets on any specific address. To determine this, all past transactions that have transferred crypto-assets to a specific address must be verified. The blockchain therefore does not store absolute values but only transaction data or changes. The crypto-assets available on a single address can therefore originate from several transactions. The following example is intended to illustrate this.
Example 1: A has received five bitcoins in one transaction on an address. In a second transaction, A receives another five bitcoins on the same address. Two transactions are now stored in the blockchain for this address. A can dispose of a total of ten bitcoins.
Crypto-assets do not always have to be transferred from exactly one sender address to exactly one recipient address. Rather, crypto-assets can be transferred from several sender addresses to just one recipient address, too. The following example is intended to illustrate this. <u> Example 2: A has five bitcoins on each of two different addresses. A intends to transfer ten bitcoins to one of B's addresses. In order for A to transfer ten bitcoins to B, the bitcoins that were initially transferred in two transactions to two separate addresses must be combined into a single transaction to B. In this transaction, crypto-assets are therefore transferred from two sender addresses to one recipient address</u>.
The reverse is also conceivable. This means that crypto-assets are transferred from one sender address to several recipient addresses. This is a very common case and can be observed, for example, when not the entire amount of crypto-assets on a sender address is to be transferred to a recipient address, but only part of it. In such a case, a second transfer back to the sender address can be noted in the blockchain in addition to the actual transfer to the recipient address.
Example 3: A has ten bitcoins on a single address. A intends to transfer five bitcoins to an address belonging to B. In the transaction, it is recorded that A transfers five bitcoins to B's address and that the remaining five bitcoins are transferred back to the sender address.
This type of recording is a specific feature of the Bitcoin blockchain, which stipulates that all crypto-assets on an address must always be transferred. If you only want to transfer part of it, the remaining amount must be transferred back to yourself.
In order to technically initiate a transaction request, the sender must inform the DLT network of the respective blockchain of its intention to transfer a certain amount of crypto-assets from a specific sender address to a specific recipient address or to interact with the blockchain in some other way. Wallet software is used to generate such a transaction request.
The wallet software formulates the desired transaction—which crypto-assets are to be transferred from which sender address(es) to which recipient address(es), or in what other way is interaction with the blockchain to take place. The legitimacy of the transaction must be proven to the DLT network. A digital signature with the private key is used for this purpose.
When new addresses are created, a suitable private key is generated by following the relevant mathematical steps. Each address has its own private key. To receive crypto-assets, it is sufficient to enter the address. To transfer coins from a sender address to a recipient address, however, knowledge of the private key of the sender address is required. Only the person who knows the private key can sign a transaction request so that it is accepted by the DLT network of the respective blockchain. When signing, the private key is not publicly disclosed; instead, the transaction request is signed in a way that allows any third party to recognize that the private key was actually used for the signing. As the signature is also only valid for exactly the desired transaction request, it cannot be copied and used for a falsified request. Only the person who knows the private key can therefore initiate transfers to another address.
In summary, a private key is an alphanumeric character string that is required to sign a transaction request in such a way that the disposition of an address on the blockchain described in said request is accepted as authentic by nodes of the respective DLT network in order to ultimately be included as a transaction in a block. Further, signing refers to the process by which a person completes a transaction request to dispose of an address in such a way that, without disclosing the private key, third parties are able to recognize that the transaction request originates from a person who actually has knowledge of the private key.
The private key can be stored digitally or printed. The combination of address and private key is also called a wallet. Hot wallet refers to software that is connected to the internet and is used to manage addresses and private keys in order to transmit transaction requests to the respective DLT network that underlies a specific blockchain. Cold wallet refers to a physical carrier medium such as paper, plastic or metal on which an address and the corresponding private key are stored. Paper wallet is a subset of the cold wallet, where paper serves as the carrier medium.
Sometimes a third party also holds the private key. This is often the case with intermediaries such as brokers or exchanges. In this case, the third party holds the private key, not the user; in this case, only the intermediary can sign transactions.
