UTXO Model: Understanding Its Functionality and Goals

What is a UTXO? An unspent transaction output is the residual digital currency after a cryptocurrency transaction. It can be compared to the change you get back after a purchase, but distinctively, it isn’t a smaller denomination of the currency; instead, it’s a transaction output in the network-generated database, facilitating non-exact change transactions.

This unspent portion of the cryptocurrency functions as an accounting measure, paralleling the principles of double-entry accounting, where each transaction involves both input and output.

For instance, take 1 BTC as a bucket filled with coins, each representing a UTXO. When you buy something from a seller for 0.5 BTC, the network hands over the entire coin-filled bucket to them, returning the 0.5 BTC owed to you as “change.” Sequentially, you possess a UTXO valued at 0.5 BTC, indivisible into smaller units.

Understanding the UTXO Model

Unspent Transaction Output operates as a protocol handling the distribution of the finer bits of data constituting cryptocurrency. Its perception differs significantly for a cryptocurrency network or developer compared to the everyday user navigating the cryptocurrency landscape.

What is in the Network?

Vis a vis cryptocurrency, a transaction involves exchanging information within a database. The intricacy arises when cryptocurrency is broken down into smaller units, scattered across the entire database, and termed UTXOs. Since most transactions don’t occur in whole number increments, UTXOs are generated as a natural outcome of these transactions.

This implies that spending doesn’t occur in a straightforward single data byte. Instead, the process involves retrieving multiple fractions of cryptocurrency to fulfil the spending request. When you initiate a transaction from your wallet, the UTXOs associated with your information are identified, unlocked, and linked with the recipient’s information. Subsequently, these UTXOs are locked again, ready to be employed by the new owner in subsequent transactions through a similar process. Interesting, right?

Still, as transactions unfold, the database becomes a repository of ownership changes, with records reflecting the fractions of cryptocurrency you sent to others that remain unspent. These unspent fractions are then logged into the database as inputs, representing fractional ownership of the cryptocurrency.

The User’s Perspective

When you choose to use your Bitcoin, you notice the deduction of the amount spent and the remaining balance in your wallet. It’s akin to paying a £1 bill for a £0.50 item—you get your change, stash it in your pocket, and carry on with your day.

The Goal of the UTXO Model

The UTXO model finds widespread use in various cryptocurrencies, enabling users to monitor ownership of every fraction of a specific cryptocurrency. Since anonymity is key in creating cryptocurrencies, UTXOs are linked to public addresses visible to the entire network.

While users remain unidentifiable through their ownership unless they voluntarily publicise their address, the model still upholds transparency through these addresses.

The Downside

The abundance of small coins in a cryptocurrency network can render specific transactions economically impractical, as this would mean the transaction cost may exceed the actual value of the product being bought with cryptocurrency. For instance, it wouldn’t be sensible to purchase a £2 cup of coffee if the transaction fee on the Bitcoin network is higher than the coffee’s price.

Is Bitcoin considered a UTXO?

Typically, unspent transaction outputs play a role in the distributed database technology that underlies Bitcoin and many other cryptocurrencies. While Bitcoin utilises UTXOs, it’s important to note that Bitcoin itself is not categorised as a UTXO.

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Disclaimer: This article is provided for informational purposes only. It is not offered or intended to be used as legal, tax, investment, financial, or other advice.