Transactions and Coin Creation

A transaction is the transfer of coins from one user to another, such as 0.5 Litecoin (LTC) from user 1 to user 2. In this example, user 1 initiated the transfer within their wallet, and specified the address for user 2 as the address to send to. Every transaction is recorded permanently and publicly in a blockchain, which is typically described as a public ledger. (Although the transaction is public, the identities of sender and receiver are not.) The blockchain consists of, not surprisingly, blocks, and is stored on many separate nodes (computers) across the network. Each block contains a set of transactions and is doubly linked, to the previous block and the next block (when it is created).

The creation of a block is called mining, and those that create the block are called miners. Creating a block involves solving a mathematical problem as defined when the coin was designed and created. Often this problem involves finding a hash value (a value that represents all the data in the block) with certain characteristics. Arriving at the correct solution is an iterative process; different coins have different methods but all involve heavy usage of resources: computational power or memory space, or a combination of the two. The Bitcoin (BTC) network, for example, is designed to have a block created (puzzle solved) once every ten minutes. To maintain this rate, a difficulty level is adjusted every so often based on how many blocks were created since the last adjustment time. CoinDesk has a brief article specific to Bitcoin where you can learn a bit more about mining than this simplified explanation.

This newly created block contains pending transactions, which then become part of the blockchain and thus the permanent record. It is during the creation of a block that new cryptocoins are created. These new coins, called the block reward or mining reward, are awarded to the miner that created the block. This reward provides incentive for people to create new blocks - without new blocks being created transactions would come to a halt. However, we previously discussed that many cryptocurrencies are deflationary, and have a maximum amount that will ever exist. On these networks the block reward eventually ends; in Bitcoin the reward started at 50 coins and as of March 2017 is at 12.5, continuing to halve at a fixed rate until the maximum supply is achieved. With no reward, where is the incentive to mine new blocks? It is costly to discover new blocks, and thus there is another source of income for miners: transaction fees.

A fee is included with each transaction, paid by the sender, and is provided to the miner creating the block. Unlike most fees which are based on transaction amount (even though increased transaction values often have no impact on the cost of a transaction), crypto coin fees are based on how much space within a block a transaction takes up. On the Bitcoin network, the minimum fee is 0.00001 BTC per kilobyte (kB) of transaction data. For a transaction of very small value, this could be a large percentage. For a large value transaction, this is miniscule. However, the typical fee paid per kB can be much higher. The reason for this is that many cryptocurrencies limit the size of a block; it is 1MB in Bitcoin. With many transactions and limited space, supply and demand drives the price up.

It is important to understand that because transactions are linked through history, and can be completely reconciled through the blockchain, multiple transactions that you receive are not bundled together into one piece. The software you are using may make it look that way; for example, you may have received 0.1 BTC ten times, and thus have 1 complete Bitcoin. The software shows you have one, and exactly one (1.00000000). However, you really have ten separate transactions that make up the total. When you send that 1.0 BTC onto the network, the transaction will be constructed showing each of those previous ten transactions as the input and a single transaction (of 1.0 BTC) as the output. This construction takes up space, and more space means a higher fee. One can imagine the fee for hundreds of 0.00001 transactions being consolidated for a send onto the network. You can read why this is important in the Free Coins! section.