0.6 UTXO based model

Now that we understand how Bitcoin transactions work, we need to explore the fundamental concept that powers Bitcoin’s accounting system: UTXOs (Unspent Transaction Outputs). Unlike traditional banking systems that maintain account balances, Bitcoin operates using a UTXO model, which keeps track of spendable outputs from previous transactions.

What Are UTXOs?

A UTXO is a unit of Bitcoin that has been received but not yet spent. Each Bitcoin transaction consists of inputs and outputs, and the outputs that remain unspent become UTXOs. These UTXOs act as the available balance for a Bitcoin address.

To understand UTXOs, consider the following example:

1. Alice receives 0.5 BTC from Bob.

2. Alice receives 0.8 BTC from Charlie.

3. Alice now has two UTXOs totaling 1.3 BTC.

When Alice wants to send 0.7 BTC to Dave:

• She must use one or more UTXOs as inputs.

• Suppose she chooses the 0.8 BTC UTXO.

• The transaction will generate two outputs:

  • 0.7 BTC to Dave (spent output).

  • 0.1 BTC in change back to Alice (new UTXO).

This process ensures that no partial UTXOs exist - each transaction consumes full UTXOs and creates new ones as change.

How UTXOs Prevent Double-Spending

Bitcoin nodes maintain a UTXO set, a global database of all unspent transaction outputs. Before confirming a transaction, nodes check whether the inputs being used are still unspent in the UTXO set. If an input has already been spent in a previous transaction, the transaction is rejected. This mechanism ensures double-spending is impossible.

Challenges of the UTXO Model

Despite its advantages, the UTXO model also introduces challenges:

• Managing UTXOs requires users and wallets to track individual outputs instead of a single balance.

• Since each input references a previous UTXO, transactions can become large when multiple inputs are needed.

• Small leftover UTXOs, often called "dust," can accumulate over time and become uneconomical to spend due to transaction fees.

UTXOs are the foundation of Bitcoin’s transaction model. Unlike traditional account-based systems, Bitcoin’s UTXO model offers security, decentralization, and privacy benefits while preventing double-spending. However, it also requires careful management of outputs and transaction fees.

In the next chapter, we will explore how Bitcoin’s wallets manage UTXOs and how fee optimization strategies help users minimize transaction costs.