How is a Transaction Verified on a Cryptocurrency Network?

What is a Cryptocurrency Transaction?

A cryptocurrency transaction transfers a cryptocurrency balance between cryptocurrency wallets or blockchain addresses. Transfers must be signed or authorized with the private key corresponding to the address.

Once a transaction is created, it is broadcast to the cryptocurrency’s blockchain network for validation. When a transaction is validated, it is verified or confirmed by the blockchain’s consensus mechanism, such as proof of work (PoW). Verified transactions are then immutably (permanently) added to the blockchain.

Importance of Transaction Verification in Cryptocurrency

Transaction verification is fundamental to cryptocurrency because it provides trustless integrity, security, immutability, and reliability at the center of cryptocurrency’s purpose. Blockchains are called trustless, not because there is no trust but because there isn’t a need for trust between parties making transactions.

A fiat currency transaction requires trust that a bank will transfer funds from one account to another. Decentralized blockchains are trustless because there’s no central entity to rely on. The network autonomously performs a requested transaction.

A blockchain network is also immutable. Once a transaction is verified using the cryptographic algorithms in the consensus mechanism, a new block is formed and added to the blockchain. Every participating node in the network is updated, and the change cannot be reversed. This provides security and prevents fraud because verified transactions cannot be tampered with or changed.

Every record, or block, on a blockchain, is connected to previous and subsequent blocks. An attacker must alter an entire blockchain to change a single record. This would take significant resources, and the premise is that how transactions are validated and verified using the consensus mechanism provides sufficient security to deter hackers.

Cryptocurrency transaction verification ensures that a transaction is validated and true, authenticates the sender and recipient, ensures sufficient funds for the transaction, verifies the timestamp, provides security, and prevents double-spending. Verification is part of a blockchain’s consensus mechanism and essential to its operation.

Basics of Blockchain Technology

A blockchain is a digital, distributed ledger, in essence, a database, where the data is stored on every participating computer (or node) in the system rather than on a single central server. Blockchains enable digital assets or cryptocurrency transactions but can also be used for transferring data and for digital verification and authentication.

How Blockchain Ensures Secure Transactions

A cryptocurrency transaction can be processed by a blockchain’s algorithms and network of computers within seconds or minutes.

Top cryptocurrency wallets hold the secure blockchain account address where cryptocurrency funds are held. Transactions are initiated from the wallet, signed with a private key, and broadcast to blockchain nodes to be validated and verified by the blockchain’s consensus mechanism.

When consensus is achieved, a new block is formed and added to the blockchain, and the entire network is updated and cannot be changed. As we’ve covered, every block is connected in a chain, and it’s impossible to change a single transaction without altering the entire blockchain, which deters hackers and provides security.

What Are Network Nodes in Cryptocurrency?

Network nodes are pivotal to validating and verifying cryptocurrency transactions. A node is a computer that runs relevant software and uses its hardware to perform the node’s prescribed function.

Node functions can vary depending on the blockchain and consensus mechanism, but usually, nodes store an up-to-date copy of the blockchain and broadcast and validate transactions. In some blockchains, all nodes validate transactions, but in others, only select nodes are responsible for final transaction verification and creating new blocks on the network.

The Process of Transaction Verification by Nodes

For example, on the Bitcoin blockchain, which uses a proof-of-work (PoW) consensus mechanism, mining nodes are a subset of the network’s validation nodes, and it’s only these mining nodes perform PoW, final validation, and verify new blocks to the Bitcoin blockchain. This process is energy-intensive and requires significant processor power; Bitcoin mining nodes are much more powerful than standard computers.

Bitcoin miners operating mining nodes receive a reward for their work in the form of newly minted Bitcoin. Bitcoin also has light nodes that only relay information and don’t validate or keep a copy of the Bitcoin blockchain.

Proof of Work (PoW) Mechanism

In a proof-of-work (PoW) consensus mechanism, a mining node solves a cryptographic problem for the chance to perform the verification process, confirm the new block of transactions immutable to the blockchain, and receive the reward.

Validation nodes check that transactions are valid, authentic, and accurate and that sufficient sender balances are available; they group transactions into blocks before transmitting them to the entire network. Mining nodes picking up these new blocks compete to be the first to solve the cryptographic problem and verify the block successfully.

Proof of Stake (PoS) and Other Consensus Models

There are no mining nodes in proof-of-stake (PoS) consensus; every node can validate and verify new transactions. Instead of nodes competing to complete cryptographic problems, validating nodes stake cryptocurrency to participate. Staking ensures validators act in the interests of the blockchain network. Dishonest or malicious activity can result in “slashing,” where the validator loses their staked coins and is removed from the network.

PoS blockchains will have a fair method of selecting the validator to process and verify each block of transactions. Ethereum validators, for example, are chosen at random to be the block proposer to check the transactions and the node that adds the verified block to the blockchain. A committee of other validators is also chosen randomly, and their votes determine the proposed block’s validity.

There are other consensus models and hybrid consensus models. Two more examples are proof-of-authority (PoA), where validators are selected by reputation, and delegated proof of stake (DPoS), where voters elect delegates to validate blocks.

1)   Initiation of a Transaction

A transaction is initiated from a cryptocurrency wallet and the blockchain address of the funds being transferred. It’s secured by the user’s private keys and broadcast to the blockchain network.

2)   Verification by Network Nodes

The transaction waits in a “mempool” to be picked up by a node. Network nodes check the transaction’s details, authenticity, and that funds are available, and once satisfied, create a block of transactions ready for the next step.

3)   Achieving Consensus and Adding to the Blockchain

A node that can add new blocks to the network is selected to verify and process the block. It performs any further validation and follows the blockchain’s consensus rules to verify the block, seal it with a hash, and confirm the transaction.

4)   Finalising the Transaction

The block is recorded permanently to the network and broadcast to all nodes. All nodes have the updated copy of the blockchain ledger, the transaction is made, and any newly minted coins or transaction fees are distributed.

Network Scalability Issues

Scalability is one of the key challenges for blockchain technology. Since the inception of Bitcoin, blockchain developers have been working to solve this issue so that blockchain can compete with conventional payment processing networks such as Visa.

A blockchain network can struggle to process transactions quickly if the number of transactions increases. This leads to slower confirmation times and higher fees. The problem lies with the consensus mechanism if every participant participates in validation and stores a copy of the entire network. The security that consensus provides can limit transaction speeds.

The Bitcoin blockchain, for example, has a limited block size of 1MB, and it takes around 10 minutes to create a block, which results in about 7 to 10 transactions per second (TPS). Ethereum is faster and working on further improvements, and many competitors promise to be faster still.

Security Concerns in Transaction Verification

Although blockchain technology secures cryptocurrency transactions, there are still security concerns. Blockchain developers strive to address these concerns.

Cryptocurrency users can be targeted by phishing attacks that steal their wallets and private key information. The data transfers with blockchain networks can be subject to routing attacks. Blockchains can also be subject to Sybil attacks, where hackers create and use many false network identities.

A further concern for public and decentralized blockchains is the threat of a 51% attack. If, for example, a group of Bitcoin mining nodes became powerful enough and controlled over 50% of the network, they could gain and manipulate the blockchain.

Three challenges of blockchain, scalability, decentralization, and security, are often called the blockchain “trilemma.” Developers are working at a substantial pace to answer the trilemma and improve networks constantly to garner mainstream adoption. 

Emerging Technologies and Innovations

In addition to Bitcoin and Ethereum, there are hundreds of other blockchain networks, each with crypto coins and novel approaches to network infrastructure, consensus, governance, and answering the trilemma.

Ethereum cryptocurrency has conducted major upgrades and is still working towards Ethereum 2.0. Several blockchain networks are developing layer-2 solutions where transactions are processed away from the main blockchain and added back only to be finalized to increase speed and lower costs. Other blockchains have novel layer-1 designs like directed acyclic graphs (DAG) or multi-chain mainnets. These are just a few examples.

Predictions for Cryptocurrency and Blockchain Evolution

Cryptocurrencies and blockchain are still incredibly new, and the underlying network technology is complex. Blockchain technology will continue to evolve, focusing on the sector’s challenge “trilemma” and answering issues of interoperability between chains. The approaches taken by developers to data are likely to persist and iterate, and new solutions will emerge. Here at Coin Hint, we believe that as transaction processing gets faster while retaining security, digital assets will become more attractive to enterprise-level organizations and financial institutions. 

Summary of Cryptocurrency Transaction Verification

As a recap, the transaction process and its security begin when a user initiates a transfer from a wallet secured with their keys. The transaction is then broadcast to the network, following a validation and verification process that varies from blockchain to blockchain. A network’s consensus mechanism and nodes eventually finalize the transaction and its record, minting new coins and solidifying a new, immutable block of transactions. The ledger is updated across all nodes, and the process is repeated for every new block of transactions.

Key Takeaways and Final Thoughts

Blockchain networks and, thus, cryptocurrency transaction processing speeds are getting faster. Ethereum currently processes around 20-30 transactions per second but could be capable of up to 100,000 TPS when its upgrades are completed. In contrast, Visa processes around 24,000 TPS. Other blockchain networks promise to be just as fast, and each has differing levels of security and decentralization as they all try to achieve the perfect combination to achieve wider adoption.
The competition between blockchain networks is intense, driving innovation in the space. At Coin Hint, we envision this one day resulting in the perfect blockchain network, which consumers and businesses will be able to rely on for fast and secure data transactions.