UTXO Model and Transaction Fees
What is the UTXO model?
An unspent transaction output (UTXO) is the technical term for the amount of digital currency that remains after a cryptocurrency transaction. You can think of it as the change you receive after buying an item, but it is not a lower denomination of the currency — it is a transaction output in the database generated by the network to allow for non-exact change transactions.
The portion of the whole cryptocurrency not spent in a transaction is used as an accounting measure. Like double-entry accounting, each transaction has an input and an output.
For example, imagine that one BTC is a bucket full of coins. Each coin represents a UTXO. If you purchase something from Bob for .5 BTC, the network will give Bob the entire bucket of coins and send back the .5 BTC you're owed in "change". You now have a UTXO worth .5 BTC that cannot be divided into smaller amounts.
What the networks sees
A cryptocurrency transaction is a transfer of information within a database. Cryptocurrency is divided into small chunks, which are stored throughout the entire database and called unspent transaction outputs. Nearly all transactions create UTXOs because most are not in increments of whole numbers.
This means spending does not take place using a single data byte. Instead, multiple fractions of cryptocurrency are retrieved to fulfill a spending request.
Fast Fact: UTXOs are not cryptocurrency denominations, like satoshi for Bitcoin (BTC) or gwei for ether (ETH); however, UTXOs can be measured in these denominations.
When you initiate a transaction through your wallet, UTXOs with your information are located, unlocked, and the new owner's information is associated with the UTXO you transferred to them. They are locked once again, and that user can use them in transactions via the same process.
As transactions continue, the database becomes populated with records of ownership changes. The outputs are fractions of cryptocurrency you sent to someone that aren't spent. They are recorded into the database as inputs in fractions of cryptocurrency.
What a user sees
When you decide to spend your bitcoin, you only see the amount you've spent deducted and the amount leftover in your wallet. For you, it's similar to using a $1 bill on a $.50 item — you're given change, you put it in your pocket and go about your day.
Goals of the UTXO model
The UTXO model is used in many cryptocurrencies because it allows users to track ownership of all portions of that cryptocurrency. Because cryptocurrencies were created with anonymity in mind, UTXOs are associated with the public addresses visible to the entire network.
Users cannot be identified from their ownership — unless they advertise their address — but the model allows for transparency through the addresses.
Downfalls of the UTXO model
The profusion of small coins within a cryptocurrency's network makes certain transactions uneconomic. This is because it may cost more to transact than the actual cost of the product being purchased with cryptocurrency. For example, it doesn't make sense to buy a $2 cup of coffee if the transaction fee on bitcoin’s network is greater than the price of the coffee.
Is Bitcoin a UTXO?
Unspent transaction outputs are part of the distributed database technology behind Bitcoin and other cryptocurrencies. Bitcoin uses UTXOs, but it is not a UTXO.
Is Ethereum a UTXO?
Ethereum is a cryptocurrency, so it is not a UTXO. Additionally, Ethereum uses an account-based approach with account balances, so there are no UTXOs in the Ethereum Virtual Machine.
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