What Is UTXO?
The term UTXO refers to the amount of digital currency someone has left remaining after executing a cryptocurrency transaction such as bitcoin. The letters stand for unspent transaction output. Each bitcoin transaction begins with coins used to balance the ledger. UTXOs are processed continuously and are responsible for beginning and ending each transaction. Although confirmation of transaction results in the removal of spent coins from the UTXO database, a record of the spent coins still exists on the ledger.
- A UTXO is the amount of digital currency remaining after a cryptocurrency transaction is executed.
- UTXOs are processed continuously and are responsible for beginning and ending each transaction.
- When a transaction is completed, any unspent outputs are deposited back into a database as inputs which can be used at a later date for a new transaction.
How a UTXO Works
UTXO transactions sound complicated, but they really are fairly simple. UTXO or unspent transaction outputs are used in cryptocurrency transactions. These are the transactions that are left unspent after someone completes a transaction, similar to the change someone receives after conducting a cash transaction at the store.
Here's how it works. A UTXO database is used to store change from cryptocurrency transactions. This database or ledger is initially set to empty or zero. As transactions multiply, the database becomes populated with change records from various transactions. When a transaction is completed and there are outputs that aren't spent, they are deposited back into a database as inputs which can be used at a later date for a new transaction. Cryptocurrency transactions—such as those used for bitcoins—are similar to cashier checks. You cannot exchange them for custom amounts and must spend the entire amount stored in that data byte.
But cryptocurrencies like bitcoin are also unique in that transactions can be conducted using fractions of the cryptocurrency. This means spending does not take place using a single data byte. Instead, multiple fractions of bitcoin are retrieved by the algorithm to fulfill a spending request. For example, a purchase worth 1 bitcoin may retrieve 0.6 BTC from one byte and 0.4 BTC from another. Change from each of these fractions is then sent to the UTXO database to be spent at a later date.
The profusion of small coins within bitcoin’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 bitcoin. For example, it doesn't make sense to purchase a $2 cup of coffee if the transaction fee on bitcoin’s network is greater than the price of the coffee. According to research by prominent bitcoin developer Jimmy Song, 13 million coins have marginal costs greater than their worth at 50 Satoshi/bit.
Keep in mind that some transactions may be uneconomic because it may actually cost more to do the transaction than the actual cost of the product being purchased.
But that's not all. There is another problem with increasing UTXO. The change in equipment cost required for processing UTXOs has not kept pace with its increase. In fact, the cost of data mining rigs for fully validating nodes, for example, has not kept pace. “Allowing more transactions with no other changes would very likely accelerate the UTXO set growth making it more expensive to run a full validating node," according to software developer Gavin Andreesen who was a major part of the development of bitcoin.