What is UTXO? Why is it important for Bitcoin?

1. What is UTXO?

UTXO in the field of blockchain and cryptocurrency stands for "Unspent Transaction Output", which means unused output. In the transaction system of Bitcoin and other open source-based cryptocurrencies, UTXO refers to the output of a previous transaction that has not been spent.

Each output transaction becomes a UTXO, and can only be used once. When a new transaction is created, it consumes one or more UTXOs from previous transactions and creates new UTXOs. The UTXO mechanism helps track the balance of each wallet address and ensures the consistency and security of the blockchain system.

Based on this mechanism, market transactions will be created using existing UTXOs and creating new UTXOs in their place. UTXOs can be split or combined to achieve the desired amount for each specific transaction, similar to how we do with cash.

2. How it works

One point to note when talking about UTXO is that it is quite similar to the balance change in fiat currency transactions. To illustrate this, let's also look at the following example:

Let's say you have a Bitcoin balance of 9.5 BTC and want to buy a product priced at 1.5 BTC. You will then send 1.5 BTC to the seller and the remaining 8 BTC will be converted into UTXO. You can then use these unused UTXOs to make other purchases or transfers in the future.

The Blockchain platform will store all these UTXOs and everyone can track them. Each person has a unique identifier called an “outpoint” - This is a hash of the previous transaction and an index of that transaction's output.

When a user wants to create a new transaction, they will select one or more UTXOs to use as input for the transaction. For example, you could have 2 UTXOs worth 1 BTC and 4 BTC left over from previous transactions on the Bitcoin network. If you want to buy an item worth 4.5 BTC, you will have to send both UTXOs above to pay the invoice. The transaction is completed when you receive back 1 new UTXO worth 0.5 BTC.

Another thing to note about UTXOs is that the total amount of UTXOs must be greater than or equal to the amount sent, plus any transaction fees. Once a transaction has used UTXOs, those UTXOs cannot be reused.

3. Change in UTXO model

Just like cash, UTXO is indivisible. Suppose, when you use cash, if a meal costs 4.75 USD and you only have a 10 USD bill, you will give the 10 USD bill to the seller and receive change of 5.25 USD.

The way UTXOs work is similar in that you cannot tear off a portion of a UTXO to pay for a transaction, just like you cannot tear off a portion of a $10 bill to pay for a meal. If you want to send 4.75 BTC to someone but only have a UTXO worth 10 BTC in your wallet, you will have to send that entire UTXO to the recipient and receive your change back as UTXO.

This process will be handled by the Blockchain protocol , ensuring that you do not need to worry that the recipient will not return your change. The recipient receives only the desired amount and the excess is sent back to your address as a new UTXO of smaller value.

4. Bitcoin UTXO model compared to other blockchain

*UTXO compared to the account base of Ethereum and some other blockchains*

4.1 Key differences

Instead of using the UTXO model, Ethereum and some other popular blockchains apply the account base model - Where accounts manage asset value on the blockchain.

This helps these systems perform tasks on smart contracts more effectively in terms of execution and cost. However, this model also has its own disadvantages such as creating vulnerabilities in the security of smart contracts and the risk of manipulation in ledger management.

This is also the biggest difference that creates unique advantages and disadvantages of other models compared to UTXO. Because UTXO focuses on simulating the use of money with coins, providing a safe way to trade and convert assets but comes with high transaction fees and some inconvenience when using.

As for models based on Account base, although convenient and fast, they carry security risks, especially when depending on smart contracts.

4.2. Advantages of the UTXO model

The UTXO model possesses many outstanding advantages compared to other models, including:

This model is dynamically scalable as the number of transactions processed per second is limited only by network speed.
Privacy: each transaction in the UTXO model generates new addresses making it difficult to trace the origin of transactions.
Easier authentication: Each UTXO can be traced back to the input, which is especially useful in detecting fraudulent activities.
UTXO also provides the ability to perform off-chain transactions that are secure and verifiable on the blockchain network, enhancing scalability and privacy.
The UTXO model allows certain types of smart contracts to operate without dependence on language - A capability that other models cannot achieve.

4.3 Limitations of the UTXO model

The UTXO model also has some disadvantages as follows:

Since each UTXO is signed individually, this often results in higher transaction fees.
Second, UTXOs can lead to the accumulation of "dust", i.e. small amounts of coins that cannot be spent because they are less than the minimum transaction amount. However, this amount of "dust" can be accumulated and used when large enough over time
Finally, UTXOs are quite limited in terms of storage space. Each UTXO represents a separate output from a transaction, and each output must be stored separately. This can quickly create large data storage requirements, especially for applications that must process many transactions.

5. The importance of UTXO for Bitcoin

*UTXO is increasingly becoming an indispensable part of BTC*

The UTXO model plays an important role in the Bitcoin network by creating transparency and efficiency when processing transactions. At the same time, maintain the smooth operation of the network system. In addition, there are several important aspects that make UTXO an indispensable element such as:

Fraud prevention: When a new transaction is initiated, UTXOs act as a validation suite, ensuring that each UTXO is used only once. This helps prevent fraudulent practices such as double-spending on the Bitcoin network.
Linkage to future transactions: The periodicity of UTXOs ensures that every Bitcoin spent becomes a UTXO for subsequent transactions, establishing a reliable method for transaction flow on Bitcoin.
Transaction Fees and UTXOs: Transaction fees are closely related to UTXOs, with each time a UTXO is spent, a certain fee will be calculated and deducted directly from the receivable Bitcoin balance. This incentivizes miners to participate in validating transactions.
Simplify transaction verification: UTXO simplifies verification by providing an easy mechanism to check the legitimacy of a transaction. By using existing UTXO information, the network can efficiently verify transactions without having to recheck the entire transaction history.

6. Summary

UTXO is a fundamental concept in blockchain technology, used to ensure the uniqueness of each cryptocurrency and ensure that it can only be spent once. The UTXO model is promised to continue to play an important role for the blockchain platform in the near future. Hopefully the information TheBlock101 shared in the above article has helped you better understand UTXO and how this model works.

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