How Does a Bitcoin Transaction Work? |

How Does a Bitcoin Transaction Work?

If you find bitcoin confusing, you’re not alone. Many Filipinos also want to know what bitcoin is, where to buy bitcoin, and how it works. While the mechanics behind bitcoin are pretty complex, it can be used just like you would any traditional currency like the Philippine peso.

Bitcoin, just like standard money, is a medium of exchange. It has value, can be converted to pesos, and can be used to purchase goods and services from merchants. Bitcoin is not controlled by a single government or organization, though companies that operate bitcoin services are regulated in the Philippines by the Bangko Sentral.  

To get a general understanding of how bitcoin works, it helps to compare it against a bank transaction.

How Banks Send Money to Each Other

Sending money from one bank to another is a more complicated process than you’d think. Consider the following scenarios:

Scenario 1: Sending money locally

You owe a friend P1,000, who requested that you deposit it in her bank account. You each have savings accounts at different major banks in the Philippines.

So the P1,000 leaves your bank account, and your bank sends it to the Central Bank. When major banks in the Philippines do transactions with each other, they do it through the database of the Bangko Sentral, which is known as an Automated Clearing House (ACH). The ACH processes a large number of debit and credit transactions between banks.

Once the ACH processes your transaction, the P1,000 goes to your friend’s bank, who then deposits it into her account.  

Scenario 2: Sending money overseas

The process gets a little more complicated when you send money overseas. That’s because there’s no global ACH for international transactions. Instead, domestic banks send money internationally through correspondent banks, which processes transactions on their behalf.  

Now let’s say you’re working in Singapore and want to send money to your parents in the Philippines. The infographic below illustrates how a typical international wire transfer would look like when you’re sending money from your Singapore bank to a Philippine-based bank.

In this example, your Singapore bank doesn’t have a presence in the Philippines. So your bank would have to send the money to Standard Chartered, its domestic correspondent bank. This example assumes that Standard Chartered doesn’t do retail banking in the Philippines.

So instead, Standard Chartered sends the money to its correspondent bank in the Philippines, HSBC. HSBC then withdraws the funds from Standard Chartered’s account and sends it to your parents’ Philippine-based bank. But then another bank handles the foreign exchange conversion between SGD and PHP.

All these banks send international messages to each other about the transaction using SWIFT codes (the  Society for Worldwide Interbank Financial Telecommunication).

Is your head spinning yet? This is actually an oversimplified representation of what happens when you transfer money through banks. The reality is a lot more complex and involves head offices and central banks. There are also additional complications such as having cut off times, clearing times, different rates for different amounts transferred, and currency exchange rates.

How a Bitcoin Transaction Works

In contrast to banking, a bitcoin transaction is simpler. To send bitcoin, you need a bitcoin wallet, which lets you store bitcoin, send bitcoin, or receive bitcoin. You also need your recipient’s bitcoin wallet address.

Now, let’s say you want to send bitcoin to a friend. To start a bitcoin transaction, you simply have to copy or scan your friend’s bitcoin wallet address into your bitcoin wallet’s Send interface, then enter the amount you want to send. Once you hit the “send” button, the transaction is created by your wallet and broadcast into the Bitcoin network, where they undergo confirmation for security and transaction integrity. The process goes like this regardless of the location of the sender and recipient.  

Once your transaction is verified, bitcoin miners group it with other transactions into a “block” and add this block to the Bitcoin “blockchain” – a shared, public record of all bitcoin transactions ever made. Once your transaction has been added to the block, your wallet will send you a confirmation. The recipient then gets bitcoin in their wallet.

With bitcoin, there is generally no need for correspondent banking. Every bitcoin user is under the same network. Transactions are made possible through blockchains, which metaphorically speaking, plays the role of regulator, securer, organizer, communicator, and recorder.

Disclaimer: Trading bitcoin and other virtual currencies carries a high level of risk, and may not be suitable for everyone. Read the full BSP advisory to understand the risks of buying, holding, or trading cryptocurrencies.

 In Blog, Digital Currency
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