You Can Understand UTXOs Too

When I started to study Bitcoin after I made my first $5 purchase I was awash in a sea of new information, but I was absorbing as much information as I could until it started to make sense. I was buying satoshis to hodl, and I knew that there was something special about Bitcoin, but I couldn’t explain how SHA-256 worked, or what hashing was. However, one of the first concepts I could understand and explain to others was the UTXO, or Unspent transaction (TX) Output). I was really proud of this. UTXOs can be confusing, but by the end of this article, the whole concept will not only be easily understood, but you should also be able to clearly explain to your family, friends, and the servers at your local restaurant what a UTXO is and how it is an important part of the Bitcoin protocol.

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Imagine you enter a record store on a Saturday afternoon. In your pocket or beltbag are likely your keys, cellphone, and wallet. After some careful shopping, you decide to purchase a pretty mint copy of your favorite band’s first album. You take the record up to the cashier to check out. The price of the album is $26.85. You are faced with a decision.

In your possession are various bills, including a $50 dollar bill, several $20 dollar bills, a $10 dollar bill, a few $5 dollar bills, and three $1 dollar bills. The bills themselves are not divisible any further without using the bills in a transaction (this includes making change at the arcade). So, How will you pay for the album? Various external circumstances and your own personal preference will guide you to a decision. Do you like to have large bills or small bills in your wallet? Are you going somewhere later in the day that you may want more small bills for? Who knows. The point is, you have a decision to make. You pull out your wallet, open it up, and… remove a $20 dollar bill, a $5 dollar bill, and two $1 dollar bills. You receive a small amount of chance in return, which you place back into your wallet. After receiving your receipt, the transaction is complete and you leave the store to go have lunch.

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Though it is pseudonymous, the Bitcoin ledger is truly a public system of accounting which anyone can audit. Because users are not required to link personal information to public addresses where they receive inputs, hold UTXOs and send outputs, they are able to obscure their identity on the block chain. However, there are several ways to trace identities back to specific addresses. When you receive bitcoin in a transaction, your wallet’s private keys are actually gaining control over a specific amount of bitcoin on the public ledger in the form of a UTXO. The UTXO can be compared to one of the bills in your wallet to an extent. On the block chain, you hold the right to transfer control of bitcoins (or fractions of) to another public address of your choice by having the private keys that control the UTXO. When you need to make a payment over the Bitcoin network, your wallet (or you) will decide which UTXO or UTXOs to use in the transaction, and any extra bitcoin will be returned to your wallet as a new UTXO.

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Keep in mind that it is impossible to spend a fraction of a UTXO, just as it is impossible to spend a fraction of a $10 bill without making change with someone (a transaction). Every UTXO has to be be spent as a whole. The change is returned to another address in the sender’s wallet. A wallet automatically generates a ‘change address’ to which the balance from the transaction will be returned after the required amount is deducted from the output. The change becomes a new UTXO that can be spent later.

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In this scenario, the cashier’s role is completed by the bitcoin network, powered and secured by miners and node operators around the world. The network verifies that the UTXOs (the bills in your wallet) are in fact authentic. The UTXO acts as a receipt as well, which can be used to trace the source and validity of the funds back to their inception when they were payed out to a miner as a reward for verifying transactions and permanently adding them to the block chain. This is because UTXO patterns make it possible to track a single bitcoin unit (satoshi) all the way back to the block in which it was first mined.

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The unspent transaction output (UTXO) is a significant part of the Bitcoin protocol. Next time you are orange-pilling a friend, explain this concept to them and see if it helps them to understand the beauty of Bitcoin.