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Despite the rapid growth rates in crypto adoption, many of the essential terms sound like jargon to many investors. That is quite unfortunate since several of them may serve as crucial indicators for various aspects of the respective coin. It is only fair that these terms are explained in depth. UTXO is one such term. Read to understand more about that terminology as used in crypto.
A Brief on UTXO
UTXO is an abbreviation of Unspent Transaction Output. It is a more technical wording for the amount of crypto left behind after a transaction is executed. One can link it to the pocket change they get after purchasing a good using a higher note value. However, a key difference is that, unlike change, UTXO is not in a lower denomination value. What it represents is a blockchain network-generated, database-based transaction output. It plays the primary role of enabling non-exact transactions, transactions that aren't in whole numbers of a crypto coin. In simpler words, all UTXO amounts are recorded in a database as reusable inputs for new transactions.
Explanation Using a Sample Transaction
The assumption used for this sample transaction is that the price of 1BTC is $40,000. If a transaction involving goods worth $30,000 is executed and the buyer prefers to pay via BTC, only 0.75BTC will be required. Assuming the buyer does not need more BTC, They will buy the exact 0.75BTC needed from the network and transfer it to the seller's account. However, the process of mining Bitcoin only results in non-decimal units of BTC being mined. The network will send 1BTC to cover the transaction, but only 0.75BTC will be spent. The 0.25BTC that is left as an unspent transaction output (UTXO) will be sent back and stored within the Bitcoin network's database. It is made available for allocation to other subsequent transactions that don't require whole BTC units.
The View of UTXO Transaction by Different Parties
An important point to note is that there are two separate ways to look at UTXO transactions. The first is the crypto developer or network way, while the other is the crypto trader or user way.
The Crypto Developer/Network View
A crypto transaction is represented as an information transfer to different ledgers and nodes within the network's database within the blockchain. The nature of most transactions is such that the spending of whole units of cryptos is quite rare. Most crypto transactions thus generate UTXO. In order for a miner to avoid a situation where the network is constantly mining cryptos but has a considerable volume of UTXO, spending won't happen as a single data byte. The network constantly retrieves multiple UTXO residues to fulfil a transaction request. Most crypto reserves in people's wallets are in the form of UTXOs. Once a user requests a transaction spending via their wallet, UTXOs with the user's information are located and unlocked. The new recipient of the cryptos being transacted gets their information attached to the UTXOs, after which they have locked again. When the new user decides to spend the said cryptos, the process is repeated. Because transactions are constantly occurring, the blockchain database accumulates a vast number of ownership change records over time. Their recording in the database is in the form of fractional inputs of crypto.
The Crypto Trader/User View
For the crypto trader, their perception is quite different and a lot simpler. It is primarily influenced by what is seen on one's crypto wallet before and after a transaction. When a user initiates a transaction to spend their crypto, what is seen is the amount that has been spent is deducted from one's crypto savings. What is left is the balance, represented either in cryptos (inclusive of decimals) or as Fiat money equivalent. The same is applicable when being paid in cryptos. The details on what UXTOs have been transferred aren't available. So if someone with a $2.75BTC wallet balance and knows the UTXO definition is asked what their UTXO is, the expected answer is $0.75BTC.
The Aims and Repercussion of the UTXO model
Aims
The main aim of the UTXO model is to solve the lack of subdivision of cryptos within the blockchain network into smaller denominations. Since mining only results in a unit of crypto produced. The model ensures residual cryptos in the network are mopped up. It is worth noting that smaller subdivisions can define many cryptos for transaction purposes. Examples are Satoshis for Bitcoin and Gwei for Ethereum. The model serves as a way of increasing mining efficiency within cryptos. By constantly allocating UTXOs to meet the needs of non-exact transactions, no unnecessary coins are mined. It also plays a crucial role in tracking the ownership of all crypto portions. Their association with public addresses, which are visible all over the network, is done with anonymity maintained. Transparency of transactions is assured, enabling the creation of a trustless system.
Repercussions
The process of constantly allocating UTXOs comes with some drawbacks. It takes considerable effort over time and thus comes with cost disadvantages. It makes on-chain transactions very unsuitable for small-figure spending needs. Transaction costs can easily be higher than a small transaction volume, especially for older and busier blockchains with lots of UTXOs. The second drawback is that the process may come at a detriment of speed to the blockchain. It is evident in older chains with high valued coins and huge transaction volumes.
Take Away
UTXO is a widespread blockchain phenomenon with an intimidating name. While grasping its concept may appear daunting, the model becomes easy to master once one understands the key concepts. The model is viewed quite differently by the network and developers compared to the trader's view. However, the main thing to note is that UTXOs are the small chunks of unspent cryptos after non-exact transactions are executed. The UTXO model enables ownership tracking, increases mining efficiency, and solves the lack of a defined crypto subdivision within the blockchain network. The detriment is increased transaction costs and lower speeds.