The power of unspent transaction output in blockchain
The term "Unspent transaction output" (UTXO) is used in the context of blockchain technology to describe the record of funds received by users which remain unutilized.
This may refer to the sum you transferred from a cryptocurrency exchange to your wallet. It may also refer to the residual amount obtained after executing a transaction with another address.
UTXO finds its application on the Bitcoin blockchain, as well as hard forks such as Bitcoin Cash and Litecoin. It is also utilized in other distributed ledgers where transactions are composed of input and output data.
Input data refers to the amount the user sends or spends, which is deducted from their account, while output data is the received funds, the remaining balance on the account that serves as input for future transactions. In this case, each cryptocurrency wallet balance consists of indivisible UTXOs.
UTXOs are utilized for calculation and tracking digital assets, providing valuable information about the location and quantity of cryptocurrencies as well as enabling transaction origin tracing. Additionally, this component facilitates the identification of the beginning and end of each transaction on the blockchain.
All UTXOs recorded on the blockchain are compiled together to provide nodes with information about where unspent outputs are available. These outputs can be used as transaction inputs. These details are stored in full nodes of the chain and help process only the output data to avoid analyzing the entire blockchain.
Upon adding another block to the chain, the system's state is updated. This reveals which UTXOs have become input data, what new balances have been created, and which addresses they belong to.
The Account Model is another approach to track cryptocurrencies on the blockchain, used on the Ethereum network. Unlike UTXO, this model counts tokens on network nodes instead of transactions.
How does UTXO work?
This mechanism is best understood through an example. Let us assume that the balance in your Bitcoin wallet is 0.7 BTC, which consists of indivisible remains from previous transactions, such as 0.6 BTC and 0.1 BTC.
If you need to send 0.4 BTC to another address, the wallet automatically uses the UTXO in the amount of 0.6 BTC as the input for the transaction. Once the transaction is complete, the 0.6 BTC is deducted from your wallet, and two new unspent transaction outputs are generated - 0.4 BTC and 0.2 BTC. The former amount is assigned to the new user, while the latter is returned to you after subtracting the mining fee.
The benefits of UTXO
The use of unspent transaction outputs to count funds promotes decentralization. By tracking digital currencies in this way, peer-to-peer transfers become possible, removing the need for third parties. As a result, the need for contracts and centralized accounts is obviated.
The UTXO model is capable of protecting the blockchain from double-spend attacks, which are more common in networks that do not utilize this transaction component.
In addition, UTXO enables transaction transparency without revealing identity. This is because it contains the public key of the cryptocurrency, which indicates the Bitcoin address where the funds are held.
Last but not least, the UTXO mechanism ensures privacy and security by generating new addresses every time UTXO is utilized.
UTXO drawbacks
Aggregating several unspent transaction outputs into a new transaction results in higher fees because each UTXO needs a separate signature from its proprietor.
UTXOs can accumulate small amounts of coins that cannot be spent due to the minimum transaction size limit, resulting in "dust" outputs. These outputs can be used by cybercriminals for "dust attacks." However, some cryptocurrency wallets automatically consolidate small UTXOs into a single sum to prevent such scenarios.
A multitude of UTXOs can occupy substantial space on the blockchain. Nevertheless, this concern can be surmounted by transferring certain data to a hard drive or SSD storage device.
A number of developers are presently working towards refining the UTXO mechanism. For example, the Cardano team has introduced the Extended UTXO (EUTXO) model, which leverages smart contracts to meticulously monitor unspent transaction outputs and overcome traditional fund accounting issues.
