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What is a bitcoin UTXO and why do they matter?

utxo stands for

This consensus mechanism ensures that only valid transactions are added to the blockchain. When you send or receive Bitcoin, you create a new transaction. The inputs are the UTXOs you are spending, and the outputs are the new UTXOs being created for the recipient and, possibly, change back to yourself.

  • Your wallet might not show you the different UTXOs but only a balance.
  • It’s possible to have 1 million KMD in a single UTXO, instead of the thousands of fiat bills that would be required to hold the same amount in cash for a fiat currency.
  • Blockchain technology now is being used in numerous areas such as finance, business, payment methods, even the music industry.
  • While all nodes within a blockchain network must consent on the block history, the blocks relevant to an account’s balance are unique to that account.
  • This article will explain what an unspent transaction output is, how it works, and provide examples to illustrate the concept.

In the EUTXO model, UTXOs can be linked to arbitrary pieces of data and logic in the form of smart contracts. This allows UTXOs to carry state in a way that remains compatible with the parallel processing of transactions and the predictable resource consumption inherent to the UTXO model. In the UTXO model, each object is immutable – units of coins cannot be ‘edited’ in the same way an account balance is modified when a transaction occurs.

However, a transaction would definitely be more expensive if it is unnecessarily made out of more bytes. This brings us to the next section of this article, managing UTXOs. He now has a new UTXO worth 3 BTC which he can use to complete future transactions. The difference between the total input value (3.5 BTC) and the amount Alicia sent (3 BTC) will be 0.5 BTC. Since we’re talking about UTXO, we’re going to focus on the Input and Output parts of the structure. As mentioned before, UTXOs are indivisible native tokens that you use in transactions.

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Every Transaction input consists of a pointer and an unlocking key. And the key is used to unlock the previous output it points to. Every time an output is successfully unlocked by an input, it is marked inside the blockchain database as “spent”. Thus you can think of a transaction as an abstract “action” that defines unlocking some previous outputs, and creating new outputs.

utxo stands for

It’s possible to have 1 million KMD in a single UTXO, instead of the thousands of fiat bills that would be required to hold the same amount in cash for a fiat currency. However, not all blockchains that use the UTXO model are Bitcoin forks. Monero, the well-known privacy coin, is one prominent example. The Monero Development Team uses an implementation of the UTXO model established by Bitcoin, but it is not a Bitcoin fork. Cardano is another great example of a blockchain that uses UTXO but not the Bitcoin protocol itself. In the real-world, the UTXOs are almost similar to physical cash/coins.

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Let us start with the most glorified data structure of this decade, A Blockchain. Its the largest of all the structures in the protocol and as of writing sized about 310 GB for Bitcoin, which is a long list of Blocks (blocks are also structures). The biggest risk factor of managing your UTXOs, especially when performing consistent consolidation, is privacy. When you consolidate all your UTXOs into one or maybe a couple of UTXOs, you would indeed be saving on fees. A bitcoin transaction is made of “bytes”, and the fees are based on how many bytes a transaction has.

utxo stands for

Blockchain technology now is being used in numerous areas such as finance, business, payment methods, even the music industry. Top music companies are now starting to adopt the technology to help users discover and listen to music easier. The concept of UTXO was first created and used by Satoshi Nakamoto on the Bitcoin blockchain. The purpose of UTXO is partly to check whether or not a certain wallet holds sufficient balance to make a requested transaction. Consequently, the UTXO model could also bring some benefits over fiat currency bills. It’s possible to have even 1,000 Bitcoins in a single UTXO instead of dealing with several thousands of fiat currency in cash.

Comparison: UTXO Model vs. Account Model

Additionally, Bitcoin developers are continuously improving the transaction mechanisms to optimize the UTXO database. If you’re new to Bitcoin and have not ventured down the self-custody rabbit hole, what is stopping you? If you’re already self-sovereign, how has the experience been since you took hold of your funds?

However, UTXOs equally have their limitations when compared to fiat currency. For example, the amount of UTXOs in each individual’s digital wallet has to be documented. To initiate a transaction in Bitcoin or other cryptocurrencies, you must have an available balance, and that balance must be registered as a UTXO within your wallet. It means some payment must be made through an “exit or UTXO” to you so that it becomes your “entry” to give you an available balance to spend. UTXOs are, therefore, an important component of transactions because, without them, transactions would be impossible.

  • As transactions continue, the database becomes populated with records of ownership changes.
  • The UTXO model works as a blockchain mechanism for keeping track of where the coins are at any time.
  • If you have nine UTXOs of 0.1 BTC each, you can consolidate them.
  • It is basically a form of coin control done automatically by the wallet.
  • Nodes store the UTXO database in RAM, so it’s important to keep the data set at a manageable size.
  • Other wallets such as Wasabi Wallet 2.0 offer “privacy control” which is an improved version of coin control.

This post will explain everything you need to know about UTXO. There are trade-offs to deciding how many UTXOs you wish to keep in your wallet, and what UTXOs you will choose from when sending bitcoin to a new address. As explained above, bitcoin that is condensed into larger UTXOs can help you save on fees, but may also reduce your privacy.

for future blog articles.

Now, if you want to send 100 BTC to your friend, you need to ship one full UTXO to complete the transaction. In this case, you need to send your 140 BTC UTXO and receive a new UTXO that’s worth 40 BTC. A UTXO model works better for scalability, privacy, and efficiency.

Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author does not own cryptocurrency. The UTXO model has proven to be a robust and effective approach to transaction management in the Bitcoin network. By grasping its intricacies, you’ll be better equipped to understand and participate in the ever-changing world of Bitcoin.

Instead, you’ll need to overpay with one (or several) of your bills and then receive a little bit of money in return. You might pay for the coffee with four $1 bills, in which case you would receive two quarters in return. Or you might pay for the coffee with a $20 bill, in which case you would get one $10 bill, one $5 bill, one $1 bill, and two quarters in return. If you have $45 in cash, you must have more than one bill because there’s no such thing as a forty-five dollar bill.

utxo stands for

The outputs are fractions of cryptocurrency you sent to someone that aren’t spent. They are recorded into the database as inputs in fractions of cryptocurrency. UTXOs are critical in preventing double-spend attacks, and they stop you from spending coins that don’t exist. Network nodes record and maintain a database that contains every UTXO (i.e., unspent coin) available for spending. If you try to send a transaction with a coin that isn’t in that database, the nodes will reject it.

While all nodes within a blockchain network must consent on the block history, the blocks relevant to an account’s balance are unique to that account. The data required for your transaction depends on several factors, particularly the number of inputs and outputs. While most bitcoin wallets enable you to select the fee rate you’re willing to pay, what you have less control over is the amount of data your transaction will use. Each block contains two types of structures, a Header, and a Transaction List. The header contains all metadata regarding a particular block, and among them is the previous block hash that points to an earlier block (aka parent block). In this way, each block points to its parent, which points to its parent, so on and so forth, all the way back to the first block ever created (aka the genesis block).

The bank account model is a custodial service holding your cash for you, which is analogous to an exchange that holds people’s bitcoin—everyone’s bitcoin is mixed together. Although many users may not realize it, all bitcoin wallets need some level of maintenance to be properly managed. However, when you hold your bitcoin in self-custody, no one is responsible for managing your wallet but you.

Python code to manually create 12/24 worded seed and passphrase without trusting Bitcoin wallets.

The best way to explain UTXO is to compare it to real life cash payments. Let’s assume you go to a store to buy bacon for $5, but you only have a $10 bill. In this case, you pay with your $10 bill and the cashier would simply give you a $5 bill as change. In order to provide a transaction fee, nothing needs to be mentioned, if you don’t send the remaining amount to anyone, it is assumed a transaction fee.

Thankfully, there are a few solutions to the potential storage problems. Firstly, nodes don’t have to store the entire UTXO database in RAM. They can opt to store part of it in a less expensive solid-state disk (SSD) or spinning hard disk. Although utxo stands for these storage types lead to slower validation times for each node, there shouldn’t be an issue as long as they’re still under the ten minute average block time. Furthering the example, let’s assume that you’re shopping around for a new car.

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