What it means
Think of cash in a physical wallet. You might hold a $20 note, a $10 note and some coins, and your total is the sum of the pieces.
A UTXO system works in the same way, with every piece being a record on the blockchain (a shared digital ledger) that says an amount belongs to a particular owner and has not been spent yet. When you make a payment, your wallet picks one or more of your unspent outputs as inputs to the new transaction.
The transaction then creates new outputs, one for the person you are paying and, usually, one that returns the change to you. The old outputs are marked as spent and cannot be used again, which is how double spending is prevented.
Because outputs cannot be split, a wallet may need to combine several small ones to make a larger payment. This increases the size of the transaction and therefore the network fee, since fees depend on the data size and not on the value being moved.
A wallet with hundreds of tiny outputs can find that it costs more to spend them than they are worth, a problem known as dust. The model differs from the account system used by banks and by some other blockchains such as Ethereum, where a single balance is updated as money moves.
Supporters of UTXO point to its transparency and the ease of checking each transaction independently. Critics note that it is less natural for complex programmes that need to keep a running state.
For businesses that accept or hold Bitcoin, the practical issues are fees, privacy and record keeping. Finance teams should manage the pool of outputs, for example by consolidating small ones when network fees are low.
Each output also has a cost basis for tax purposes, so careful records are needed to calculate gains and losses. In accounting terms, the total of all unspent outputs controlled by the company's keys is what the company holds, much as a bank statement shows cash.
Auditors will want proof that the company controls the keys to those outputs. Because control of the keys is control of the asset, key management is a core financial control.
In practice
Real-world examples.
Example
An online retailer accepts Bitcoin and receives 300 small payments in a month. Its treasurer consolidates them into a few larger outputs during a quiet period, when network fees are low, so later payments cost less to send.
Example
An exchange operator reconciles its customer balances by adding up the unspent outputs controlled by its wallets. The finance team compares the total with its ledger every day.
Example
A freelance developer receives a $1,000 payment in several pieces. When she pays a $350 invoice, her wallet spends one output worth $400 and returns the $50 of change, less a fee, as a new output.
Formula
Calculation
Change returned to sender = total value of inputs - payment amount - network fee
Suppose a wallet holds two unspent outputs worth $700 and $500, and the owner wants to pay a supplier $900 with a network fee of $4. The wallet uses both outputs as inputs, so the total input is 700 + 500 = $1,200. The change is 1,200 - 900 - 4 = $296, which is returned to the owner as a new unspent output. The $700 and $500 outputs are now spent, and the wallet's balance is $296.Case study
Seen in the real world.
Copperline Exchange is an illustrative, fictional business that holds customer deposits in digital currency. Over a year its wallets collect thousands of small deposits, and the number of unspent outputs grows to 40,000.
The finance director finds that a large withdrawal now needs hundreds of inputs, and the network fee for such a transaction is far higher than for a normal one. Staff estimate that a typical large withdrawal costs $180 in fees, against $15 if the outputs had been consolidated.
In this illustrative story the company schedules a monthly consolidation when fees are low and sets a policy for the number of outputs it will hold. Average withdrawal fees fall by about 80% and the finance team gains a clearer reconciliation of customer funds.
Watch out
Common mistakes.
- Thinking a wallet has a single balance stored somewhere, when the balance is the total of separate unspent outputs.
- Forgetting to include change in a calculation, when the change comes back as a new output that must be tracked.
- Ignoring the number of outputs, when many small ones raise the size and cost of future transactions.
Questions
People also ask.
Is UTXO used by every cryptocurrency?
No, Bitcoin and several others use it, while others such as Ethereum use an account model with a running balance.
What is dust?
It is an output so small that the fee needed to spend it is close to or more than its value.
Why does the change go to a new output?
Because an output must be spent whole, so any amount left after the payment and fee is sent back to the sender as a fresh output.
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