What is Bitcoin’s UTXO model, and how to manage UTCXs?

What is the Bitcoin UTXO model?

Before getting into UTXOs, defining the Bitcoin transaction lifecycle is important. Technically, Bitcoin transactions are a little more complicated than fiat transactions. Cash transactions typically occur in whole dollar increments like $5 or $10, while Bitcoin transactions can be as small as to the eighth decimal point, known as a satoshi, showcasing its high level of divisibility.

When initiating a Bitcoin transaction, it’s important to understand that the cryptocurrency itself is not physically stored in the wallet. Instead, the wallet merely acts as a tool to access and manage the funds associated with the user’s Bitcoin address.

The blockchain serves as a public ledger that records all transactions made on the network, including those involving the user’s funds. When someone makes a new transaction, Bitcoin nodes initiate a transaction validation process. Valid transactions then enter the mempool where miners select them to include in a new block.

Miners compete to solve a complex puzzle, and the winner adds the block to the blockchain. Other nodes verify the block’s transactions. If valid, the block becomes a permanent part of the ledger, and the winning miner receives newly mined Bitcoin.

The Bitcoin blockchain breaks the payment process into blockchain inputs and outputs to properly track Bitcoin transactions. An output is the wallet that initiates a transaction, as it is “outputting” funds to create an “input” for the receiving wallet. However, the network can’t make an output if there wasn’t an input to that wallet beforehand. And those inputs are what make up a Bitcoin wallet balance.

An input can be anything from a few satoshis to multiple Bitcoin. These inputs are accumulated in a wallet through various transactions. For example, let’s say Bob’s wallet received 3.75 Bitcoin in three separate transactions, resulting in three unspent UTXOs.

When Bob wishes to spend 0.50 BTC, the Bitcoin network will look for suitable UTXOs in his wallet to use as inputs for this new transaction. Since Bitcoin transactions require spending the entire amount of an input, if Bob uses the 0.75 BTC UTXO, the excess 0.25 BTC will be sent back to his wallet as a new UTXO, often referred to as “change.”

Here’s one way Bob’s wallet’s funds may be broken up:

This process is somewhat analogous to using cash. If Bob’s physical wallet had $100 in various bills and he needed to pay $27, he would use a combination of bills that covers the amount, say a $10 bill and a $20 bill, and receive $3 back as change.

However, it’s possible to acquire Bitcoin dust, which is unspendable Bitcoin that accumulates in a wallet. Small Bitcoin transactions result in even smaller UTXOs. Outputs that run too small may cost more than they’re worth in transaction fees, making them unspendable. It’s important to manage UTXOs to prevent Bitcoin dust accumulation.

How does a Bitcoin wallet decide which transaction outputs to spend?

The Bitcoin UTXO model typically utilizes the first in, first out (FIFO) method when categorizing UTXOs to spend. This coin selection process means it will automatically spend the oldest Bitcoin in a wallet to initiate a transaction. That said, most Bitcoin wallets offer ways around FIFO for more experienced spenders.

Privacy within the UTXO model

Just as a Bitcoin wallet is a representation of funds, a UTXO is a representation of a wallet’s unspent transaction outputs.

Every Bitcoin wallet has a wallet address used to send and receive funds. That said, users can configure their Bitcoin wallet to generate a new address to enhance their privacy with every transaction. Over time, users may hold Bitcoin across various addresses tied to one wallet.

The Bitcoin network distributes UTXOs across these addresses and may generate a new address whenever a user receives funds. As a result, it is quite difficult for others to track a wallet’s transaction history without access to all of its addresses. If Bob transacts with another user, they’ll only see the address generated for that transaction.

Pros and cons of the UTXO model

While different networks use various models for tracking transactions, the Bitcoin protocol was built with UTXO tracking capabilities. Here are some of the model’s pros and cons:

Pros of the UTXO model

Secure

The UTXO model tracks ownership of Bitcoin by verifying that previous transactions sent coins to a specific wallet. After all, an input carries the public wallet information of the user who sent it. Using a transaction’s input and output scripts, the network can track Bitcoin back to the wallet that mined it. This clear point of history prevents the double-spend method.

Considerate

Transactions do not reveal an entire wallet balance. Users can configure a Bitcoin wallet to create new addresses with every transaction, making tracing their total Bitcoin holdings even harder.

Cons of the UTXO model

Traceable

Since the Bitcoin blockchain is a public ledger of transactions, a wallet’s transactions are only so private. While the UTXO security model ensures transactions are spread among the network, a dedicated user could trace every transaction back to one wallet and see its spending habits. While this lack of UTXO pruning isn’t inherently threatening, some users may prefer a privacy coin to avoid this.

Expensive

Sending any amount of Bitcoin will cost a transaction fee relative to the sent amount. Higher amounts result in higher transaction fees. Also, if a user has multiple UTXOs across multiple wallet addresses, they’d pay even more fees due to the number of transactions occurring to create an input.

Bitcoin dust

Improper UTXO management can result in Bitcoin dust accumulation. Bitcoin dust is a common byproduct of receiving many small Bitcoin transactions over time. Dust UTXOs increase the size of the Bitcoin blockchain.

Since miners prioritize transactions based on fee size, dust 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 footprint on the blockchain.

How to best manage UTXOs?

Avoiding high transaction fees and Bitcoin dust is possible with some wallet management. Here are a few Bitcoin UTXO management tips to keep the transacting experience as clean as possible:

Wallet consolidation

UTXO consolidation is the act of taking a wallet’s UXTOs and sending them back to itself to create one unified UTXO. This prevents smaller transactions from accumulating and creating Bitcoin dust. Also, if a wallet has groups of UXTOs spread across multiple addresses, consolidation prevents the additional fees as a result of sending multiple transactions at once.

Timing the market

Regular crypto traders understand that Bitcoin transaction fees are constantly in flux. It’s important to make transactions when fees are low. Similarly, wait to conduct UTXO size optimization until fees are low enough, saving money in the long run. There’s no time limit on UTXO consolidation.

Disclaimer：

1. This article is reprinted from [cointelegraph], Forward the Original Title‘What is Bitcoin’s UTXO model, and how to manage UTCXs?’, All copyrights belong to the original author [Maxwell Moeller]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.

2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.

3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.