Cold water goes into bottom of WH Tank
WH heats it up and Hot water comes out top of WH Tank
Bypass connects Cold inlet line with Hot outlet line ////bypassing water in/out of WH Tank
WH Tank valving can be several methods
Cold inlet valve, bypass valve, Hot outlet valve
Cold inlet/bypass valve, hot outlet/bypass valve
Cold inlet, Bypass and Check valve in Hot out
Etc
Normal service
Cold In OPEN
Bypass Closed
Hot Out OPEN
BYPASS Service
Cold In Closed
Bypass OPEN
Hot out Closed (or if check valve vs shutoff valve then it closes when bypass is open)
3 valve system
2 valve system (check valve in hot out)