Bitcoin is a digital money form and payment system at the same time. How does the protocol define the ownership of certain BTCs? How does Bitcoin ensure that only the owners are able to transfer satoshis? The answer is an abbreviation of four letters: UTXO.
UTXOs: The Bitcoins Core
UTXO stands for Unspent Transaction Output and describes the core of the Bitcoin protocol. After all, if you install a copy of the Bitcoin blockchain on your home full node, you have the entire transaction history of the Bitcoin network at your disposal. Each transaction can thus be traced back. Bitcoin is therefore nothing more than a logical sequence of legitimate transactions that have been executed in accordance with the network rule.
In addition to transactions already made, Bitcoiner can also view the current UTXO set. This is the current sum of all possible outputs that have not been made in the network, i.e. satoshis that can be transferred using the corresponding private keys. If the owner of a certain UTXO decides on a BTC transfer, the status of the Bitcoin blockchain changes visibly for all network participants. Each transaction is therefore a transparent change of the status quo of the UTXO set.
What happens during a transaction?
Whoever speaks of “issuing” Bitcoin actually means the transfer of the right to be able to transfer a certain UTXO. Once the Bitcoin transfer is complete, the recipient’s wallet recognizes a new UTXO that can be issued using the private keys controlled by this wallet. As a result, the total amount of BTC on the digital wallet is just the amount of UTXOs that users can spend using the wallet.
UTXOs are indivisible
When you instruct your wallet to transfer a certain amount of BTC to a destination address, the wallet searches for a matching UTXO and creates the transaction using the corresponding private key. However, the settlement of the available UTXO set is not trivial. The wallet cannot simply use any UTXO, deduct the desired amount from it and send it to the recipient. Rather, the wallet creates a transaction that contains two components. The output, i.e. an available UTXO, and the so-called change, i.e. the UTXO minus the surplus Satoshis. The change then goes back into the possession of the transferor.
In other words: Whoever controls a single UTXO via 2 BTC, but only wants to spend 1 BTC of it, has to transfer the entire output and then receives a new UTXO via 1 BTC as “change”. This settlement usually remains hidden. Wallets browse the available set for possible outputs and independently build a transaction from them.
One can imagine the whole thing as payment transactions with cash: After all, a five-euro note cannot be cut in two. If you pay four euros for expensive goods with a five-euro note, you get one euro change. This is exactly how Bitcoin transactions work.
And so the Bitcoin blockchain is at its core merely the sequence of issued outputs that make up the current set. Each UTXO is therefore the consistent sequence of a preceding output. Exceptions, however, are the so-called coinbase transactions, which miners can create out of nothing and send to a wallet of their choice.