What Is Unspent Transaction Output (UTXO)?

Unspent Transaction Output (UTXO) is a feature of the Bitcoin (BTC) blockchain, and a large subsection of blockchains. A UTXO represents the amount of cryptocurrency remaining after a transaction, which can then be used in future transactions. 

In the UTXO model, each Bitcoin transaction mimics the characteristics of a cash transaction in real life. For example, if you buy a $10 item with a $50 bill, you hand over the $50 bill and receive $40 in change, such as four $10 bills. The $40 in cash you have will now remain as four $10 bills until the next transaction, where they may be divided further.

Account-Based Model vs UTXO Model

In the account-based model used by Ethereum, balances are tracked as credits and debits in each account. If Alice has 1 ETH and sends Bob 0.1 ETH, 0.1 ETH is deducted from Alice’s balance, and 0.1 ETH is added to Bob’s balance. The balances are updated directly without breaking them down into smaller units.

In the UTXO model, if Alice has 1 BTC and chooses to send Bob 0.1 BTC, the Bitcoin network would take one of Alice’s UTXOs, create a new output for Bob for 0.1 BTC, and create a new output returning 0.9 BTC (as change) back to Alice. The transaction outputs are tracked, and the unspent ones become the UTXOs available for future transactions.

In an account-based model, the balances on each address are updated directly after each state change. However in a UTXO-based network such as Bitcoin, the total balance of each address is actually made up of a set of UTXOs associated with the address. For instance, if Alice owns 1 BTC, it might be composed of two 0.5 BTC UTXOs or ten 0.1 BTC UTXOs from previous transactions. 

Pros of the UTXO Model

Improved Privacy

The UTXO model enhances privacy by making transactions harder to trace. Each transaction can involve multiple UTXOs from different addresses, making it more difficult to link specific transactions to individuals. To determine the full balance of an address, a person would have to scan the entire blockchain to sum up all UTXOs associated with an address. As a result, UTXO transactions offer better privacy compared to an account-based model.

Parallel Processing

The UTXO model allows for more effective parallel processing. Since transactions can be processed independently, because a Bitcoin transaction describes the state changes, multiple transactions can be verified simultaneously, improving the overall efficiency of the blockchain.

Inscriptions (Runes, Ordinals, BRC-20 and more!)

In 2023, developers discovered a way to inscribe data onto individual Satoshis (the smallest unit of Bitcoin) within UTXOs using the Ordinals Protocol. This innovation allows data, such as digital content or metadata, to be stored directly on the Bitcoin blockchain. As a result, new token standards, including Ordinals (Bitcoin NFTs), BRC-20, Runes, and others, have emerged, enabling a variety of digital assets to exist natively on Bitcoin.

Cons of the UTXO Model

Higher Transaction Fees

Transactions in the UTXO model can become larger due to the need to reference multiple inputs and outputs, leading to higher transaction fees and more space required on the blockchain.

Lack of Smart Contract Flexibility

The UTXO model is less suited for complex smart contracts compared to the account-based model. Each transaction must fully consume its inputs, which can make implementing certain types of smart contracts more cumbersome.