- Inputs and Outputs
- What is the Bitcoin UTXO model?
- Bitcoin dust
- Pros and cons of the UTXO model
- How to manage UTXO?
The Bitcoin blockchain, despite the fact that the first cryptocurrency is often compared to fiat, is organized quite differently from a conventional bank. There is no single structure in the blockchain where each address is matched with its current balance. Instead, it looks at the history of all transactions that are recorded on the blockchain. That is, if you analyze the entire blockchain, you can count how many coins “belong” to a particular address. Does this mean that every time you open a wallet, the program “reads” the blockchain and calculates the total amount? Of course not, and let’s see how the blockchain actually works below.
Inputs and Outputs
Transactions in the Bitcoin network are based on the concepts of inputs and outputs.
Inputs are the transactions that we “reference” when we generate a new “transfer”.
Outputs are the point from which funds are sent to the receiving party. There can be multiple outputs, each assigned with a different amount.
The ability to specify several outputs at once is very important, because a transaction (or more precisely, its output) can be used as an input only once and only in its entirety. When the input has more funds than the transaction value, the excess funds are returned as change to a newly generated address (different from the one from which it was sent). This is called the change address.
Once a new transaction is entered into the blockchain, its outputs can be used as inputs. There is a special name for such unspent transaction outputs – UTXO (unspent transaction output). Each output can only be used as an input once, so only unspent outputs really matter.
What is the Bitcoin UTXO model?
As we have already realized, the cryptocurrency itself is not physically stored in a wallet. Instead, the wallet simply acts as a tool to access and manage the funds associated with the user’s Bitcoin address. The Bitcoin blockchain breaks down the payment process into inputs and outputs to properly track Bitcoin transactions. Nodes track the outputs through which funds can be sent in transactions, or outputs that have not yet been used in a subsequent transaction. These are known as unspent transaction outputs (UTXO).
So, to calculate the address balance, you don’t need to traverse the entire blockchain, but only need to get by with a UTXO enumeration, which is obviously faster.
Bitcoin dust
Just as a Bitcoin wallet represents funds, UTXO is a representation of the unspent outputs of the wallet’s transactions. Keep in mind that transactions can result in the purchase of UTXOs that cannot be spent. Small Bitcoin transactions result in even smaller UTXOs. Outputs that are too small can cost more than they are worth in transaction fees, rendering them useless. Therefore, it is important to manage UTXO to prevent the accumulation of so-called Bitcoin dust.
Pros and cons of the UTXO model
The first blockchain protocol was originally created with the ability to track UTXO.
Pros of the UTXO model
Security
The UTXO model tracks Bitcoin ownership by verifying that previous transactions have sent coins to a specific wallet. Ultimately, the input data contains information about the publicly available wallet of the user who sent it. Using transaction input and output scripts, the network can trace Bitcoin back to the wallet that mined it. This prevents the double-spending method.
Tracking protection
ТTransactions do not reveal the entire balance of the wallet. Users can configure the Bitcoin wallet to create new addresses with each transaction, making it even harder to track the total amount of Bitcoins.
Cons of the UTXO model
Traceability
While the UTXO security model ensures that transactions are spread across the network, if desired a user can trace every transaction back to a single wallet and see their spending habits. While UTXO’s lack of pruning is not inherently threatening, some users may prefer a confidential token or confuse their transactions by receiving change to different addresses.
Cost
Sending any amount of Bitcoins will cost a transaction fee proportional to the amount sent. Higher amounts result in higher transaction fees. Additionally, if a user has multiple UTXOs on multiple wallet addresses, they will pay even higher fees due to the number of transactions taking place to create the inputs.
Bitcoin dust
Mismanagement of UTXOs can lead to the accumulation of Bitcoin dust. Bitcoin dust is a common byproduct of receiving many small Bitcoin transactions over time. Dusty UTXOs increase the size of the Bitcoin blockchain.
Because miners prioritize transactions based on fee size, dusty UTXOs contribute to network congestion, potentially hindering efficient confirmation times. However, some wallets and exchanges offer tools to consolidate small UTXOs into larger ones, reducing their impact on the Bitcoin blockchain.
How to manage UTXOs?
Avoiding high transaction fees and Bitcoin dust can be avoided with proper wallet management.
Wallet consolidation
UTXO consolidation is the process of taking a wallet’s UXTOs and sending them back to itself to create one unified UTXO. This prevents small transactions from accumulating and creating Bitcoin dust. Additionally, if a wallet has groups of UXTOs scattered across multiple addresses, consolidation prevents additional fees resulting from sending multiple transactions at the same time.
Market timing
Bitcoin transaction fees are constantly changing. It is important to make transactions when fees are low. Similarly, to do UTXO sizing optimization, you should wait until commissions are low enough to save money in the long run.
