UTXO Concept Explained
A UTXO refers to a chunk of Bitcoin a person has received but not utilized yet. Specifically, it involves holding various denominations of dollars in the physical wallet, meaning each Bitcoin transaction sent comprises one or more of the concealed UTXOs.
Thus, the balance is the blend of all the UTXOs a person holds in their wallet. A simple example is demonstrated below:
Understanding Single UTXO Setting
One can imagine a scenario where they just mined a block and acquired recently generated Bitcoin directly from the network. In case the reward is 3.5 BTC, comprising the transaction fees and block reward, the amount comprises a single UTXO.
In case one intends to send a BTC to a friend, the network will take the 3.5 BTC and divide it into three UTXOs, including:
- A minute amount, for instance, 0.0000002 BTC, to be utilized to pay the network fee.
- 2.5 BTC will be returned to the wallet as change.
- 1 BTC to be sent to the friend.
Only the fee will be considered if a person plans to send the remaining 2.5 to someone else. This will entail 2.5 BTC being sent to the recipient and 0.0000001 BTC being used as a network fee.
The fee will be lower since Bitcoin transaction costs are determined by the transaction data size rather than the amount being sent. Hence, with less UTXOs in the wallet, transactions are more straightforward and cheaper for the network to process.
What is Multiple UTXO Setting?
One can consider a scenario where a person intends to send 1.2 BTC, meaning they have several small, medium, and large UTXOs in their wallet. Hence, the network must form a bigger transaction from several smaller UTXOs.
In case a person has 10 BTC in multiple UTXOs, the transaction can be split as follows:
- Network fees of nearly 0.000009 BTC
- 8.8 BTC being sent back to the wallet as change.
- UTXOs to be sent to the recipient as part of the 1.2 BTC transaction. This is split into the following:
- Payment 1: 0.9 BTC
- Payment 2: 0.15 BTC
- Payment 3: 0.10 BTC
- Payment 4: 0.05 BTC
What is Consolidating UTXOs?
The process entails sending several smaller UTXOs to oneself as a single larger UTXO. This minimizes the number of future transaction inputs.
The steps involved include:
- Opening Sparrow Wallet and acquiring a receiving address.
- Picking the UTXOs for consolidation
- Creating the consolidation transaction
- Finalizing and signing the transaction
- Verifying the transaction
How the UTXO Model Averts Double-Spending?
The model prevents double spending in three major ways:
- Every transaction input must reference an earlier transaction output.
- The sum of inputs equals the sum of outputs.
- The UTXO is updated following a transaction’s confirmation.
How Does UTXO Differ From the Account Model?
The UTXO model eases the verification of the blockchain’s integrity by offering a vivid trail of funds. This reduces the intricacy of double-spending prevention and boosts privacy via the utilization of several addresses.
The strategy comes with the trade-off of more intricate transaction structures and greater transaction sizes with restricted smart contract support. Hence, the ‘account model’ was suggested with the development of the Ethereum blockchain, which became live in 2015.
The account model is easier to comprehend since it resembles conventional bank accounts. When one initiates a transaction to move a stated amount from their account to another, the bank confirms it and updates the balances in its ledger.
Despite being efficient and simple, the account model has scalability problems, privacy concerns, and security risks. Thus, the account and UTXO models are not the sole approaches in blockchain.
Final Thoughts
It is critical to remember that the UTXO model powers Bitcoin, the globe’s biggest and most famous blockchain. Besides, the industry is continuously changing.
New models, such as, Iota’s Tange and Cardano’s EUTXO, are coming up, providing innovative solutions to the problems encountered by conventional models such as Ethereum’s account model.
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