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The Beginner’s Guide to Unspent Transaction Output (UTXO)

Unspent Transaction Output (UTXO) has sparked numerous debates within the crypto community. Although UTXO presents some disadvantages, it is necessary for the successful completion of blockchain transactions. The UTXO model is a fundamental pillar of several blockchains, including Bitcoin.

This article explores UTXO in-depth and includes everything you need to know. It highlights what it is and how it works before discussing the advantages and disadvantages.

UTXO Defined: What is it?

UTXO stands for Unspent Transaction Output. It refers to the digital currency left over after a complete transaction on the blockchain.

Crypto transactions on any blockchain start with some digital coins to help balance the ledger. Once a transaction is complete, the spent coins are removed from the UTXO database. Thus, UTXOs are responsible for all transactions and are processed continuously, leaving a record on the ledger.

So, how does the UTXO database work?

The unspent outputs are necessary to start and complete any transaction on the blockchain. The ledger uses the UTXO database to store any change left behind after every transaction.

Initially, this database starts from zero. However, as crypto transactions increase, the protocol assembles all the change records and deposits the unspent coins in the database. Later on, these coins can be used as inputs for new transactions.

Example of the Model at Work

Let’s take an example for a better understanding.

Say your crypto wallet balance is at 50 BTC. Cryptocurrencies are unique in that they can have use in multiple fractions. Therefore, even though your wallet displays one balance, the coins could be a combination of several UTXOs.

Your 50 BTC balance could be broken down into two UTXOs worth 25 BTC each. Alternatively, you may have the UTXO’s balance set at 20, 17, 3, and 10 BTC. The breakdown isn’t critical, as long as it adds up to your wallet’s balance.

Now, suppose you want to deposit a beachfront real estate investment valued at 30 BTC. None of the UTXO balances in your wallets equals the 30 BTC. Therefore, the ledger will need to find a way to pay the 30 BTC since splitting the UTXOs isn’t possible.

You could spend 17, 3, and 10 BTC, totaling the needed amount. Another option is paying the 20 and 17 UTXOs, and receiving 7 BTC as your change. Suppose the balance in the wallet was broken down into 35 and 15 UTXOs. In this case, the ledger may pick the 35BTC one. The protocol will mint two new UTXOs to complete the transaction. These new tokens have to reach the value of 30 BTC and 5 BTC, respectively. The 30 BTC goes to the realtor, while you receive the 5 BTC as change.

As you can see, the combination of UTXOs used in a transaction doesn’t matter. It’s also worth mentioning that the protocol determines this combination, and the users have no control over them.

The Good and the Bad of UTXOs

Perhaps UTXO is a cause of concern among the crypto community since unspent coins present pros and cons. On the one hand, UTXOs make accounting on blockchain networks much more manageable. Rather than track all the transactions on the ledger.

Since bitcoins can only be spent once, unspent coins are either new or come from miners’ rewards. Thus, UTXOs are crucial in preventing double-spending since the database keeps all change records. Therefore, network nodes can reject attempted transactions with coins not available in the database.

Additionally, this model allows the network to process several transactions in parallel. Further, UTXPOs create a stateless environment, such that network users have to make new addresses for each transaction. In this way, the privacy level on the blockchain is slightly better.

On the flip side, the model’s programmability is weak, making it difficult to implement complex computations. Attempts to compute complex logic increase the storage costs while increasing the low state-space utilization.

Further, computational and storage needs strain UTXO-based protocols over time. This is because increased inputs from the increasing network transactions also increase the associated witness scripts. These, in turn, burden the network in terms of verifying and storing the data.

Upgraded UTXOs

With the Alonzo upgrade, the third-largest cryptocurrency by market cap introduces an Extended Unspent transaction Output (eUTXO) model. This improved version allows Cardano to support multiple assets and smart contracts. Cardano points out that with the eUTXO, users have access to a more secure and versatile environment. This way, they can count on a platform to support various applications.

Yet, the eUTXO has sparked debates in the crypto community over its concurrency. Critics argue that Cardano can only support one transaction per block and that the protocol is heading for centralization. Whether this is true or not, we shall see.

Parting Shot

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There’s no denying that unspent transaction outputs are essential in any blockchain transaction.  The UTXO model increases transparency and ensures cryptocurrencies are more auditable than traditional financial assets. The UTXO model does not compromise reliability over auditing, as is the case with the accounts model. Thus, UTXO remains to be a better option for blockchains.

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