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How the Digital Currency Model Works

Digital Currency

Digital Currency Model Works. Many digital currencies use an unspent transaction output (UTXO) model rather than relying on the typical account model traditional banks use. In this sort of arrangement, people use digital coins as hard currency rather than as something fungible. Learn more about UTXO models.

What Is a UTXO?

A UTXO is an unspent transaction output buyers and sellers have access to after a cryptocurrency transaction. In other words, it’s the amount of “change” left over from any new transaction on a blockchain. Each transaction records a new amount of unspent money for both the buyer and seller in cryptography.

For crypto users and exchanges that use this model, there are no traditional account balances, so these UTXOs are necessary to keep track of transactions. Digital Currency Cryptocurrencies like Bitcoin and Cardano use the UTXO model, while Ether coins on the Ethereum exchange system rely on more traditional account models.

Why Are UTXOs Important in Crypto?

UTXOs have an essential role to play in many types of blockchain transactions. Here are just a few reasons why UTXOs are important in crypto:

  • The blockchain ledger: UTXOs provide transaction inputs and outputs for the blockchain in general. These nodes help represent how much cryptocurrency individual users have without anyone needing to make a bank account. Theoretically, this model allows for infinite scalability.
  • The lack of an account model: There are plenty of differences between cryptocurrency and more typical forms of money, but one of the most notable is the lack of an account model for many exchanges. Public and private keys on a blockchain supplant the need for individualized accounts. UTXOs help keep track of an individual’s total balance of crypto.
  • The nature of cryptocurrency: As opposed to account-based and fiat currency, crypto doesn’t break down easily into different denominations. For example, when you hold dollars in a bank, you can transfer any amount at any given time. For crypto, the goods you exchange are more like literal coins. A literal quarter cut in half has no value, and the same goes for many types of cryptocurrency. UTXOs allow you to “make change” in a digital sense within these parameters.

Benefits of UTXOs

Unspent transaction amounts ensure cryptocurrency exchanges remain functional for everyone. These are just a few of the UTXO model’s benefits:

  • Improved transparency: One of the premier benefits of blockchain technology is its transparency. Each time a crypto transaction occurs, a new block appears so everyone can see how the digital money is circulating. These transactions also create new UTXO sets for both buyers and sellers. Keep in mind: The nature of these transactions and the identity of those involved in them remains private.
  • Increased privacy: All virtual coinbase transactions maximize transparency and privacy at the same time. While a public key displays transaction information to all users, private keys help guard each person who is involved in the transaction’s identity. You can only access these transactions with a unique digital signature. This keeps all the crypto (as well as your UTXOs left over from transactions) in your crypto wallet safe from hacking.
  • Mitigation of double-spending: Without UTXOs, cryptocurrency users would be at a higher risk of double-spending. There must be some validation of the transaction fees to create a new output for buyers and sellers; otherwise, it’s theoretically possible someone could keep spending the same coins in perpetuity.

UTXO Example

Imagine you have one Bitcoin (BTC) and want to purchase some goods or services for three-quarters that amount. In other words, you need to spend 0.75 BTC on the transaction. Your one BTC is not the same as one dollar in your bank account. You can’t send the 0.75 BTC on its own. Instead, you’ll send the one BTC to the vendor and a new node will appear on the blockchain signifying 0.25 in unspent output from this Bitcoin transaction. Now you have a Bitcoin UTXO worth 0.25 BTC you can use for future transactions.