A lot of people think Bitcoin works like a big ledger of accounts and balances. It doesn't.
Bitcoin doesn't track account balances, rather it tracks something called UTXOs (Unspent Transaction Outputs)
A UTXO is simply a chunk of Bitcoin locked to a specific address. It could be any amount, from a single satoshi to multiple BTC.
The easiest way to understand UTXOs is to compare them to physical cash.
Imagine you have a penny, a $1 bill, and a $5 bill in your wallet. Together, you know you have $6.01. Each piece of cash is its own distinct unit. If you buy something for $5.98, you hand over your $5 bill and your $1 bill. The cashier gives you two pennies back. Your original bills are now "spent," and you walk away with new change.
Bitcoin works similarly...
Suppose your Bitcoin wallet holds three UTXOs:
0.01 BTC
1 BTC
5 BTC
Your wallet totals this as 6.01 BTC.
You buy something that costs 5.98 BTC. To pay, your wallet selects your 1 BTC UTXO and your 5 BTC UTXO as the "inputs" to the transaction.
The seller receives a 5.98 BTC output. Meanwhile, you get a new 0.01 BTC UTXO as your change.
Your original 1 BTC and 5 BTC UTXOs are now spent, they're history.
Two new UTXOs are created:
5.98 BTC (owned by the seller)
0.01 BTC (your change)
Unlike cash, Bitcoin UTXOs aren't stuck in fixed denominations like a penny, $1 or $5. They can represent any value, so long as it's 1 satoshi or more
Summary...
a UTXO = a discrete amount of Bitcoin tied to an address.
Your wallet balance = the sum of your UTXOs.
When you spend Bitcoin, you're spending specific UTXOs as transaction inputs.
New UTXOs are created as outputs, including your change.
UTXOs aren't fixed sizes, they can be any amount.
Fun fact.
If you add up every UTXO in the Bitcoin network, you can independently verify the total circulating supply of Bitcoin.
That's radical transparency.
Try doing that with dollars. You can't.
In my next post I'll cover why consolidating your UTXOs is crucial, and how ignoring it could cost you big time later. Speaking from a painful personal experience.
Please feel free to leave your thoughts, or add something I might have missed ^^,