Learn how Bitcoin transactions work through asymmetric encryption and UTXO
- Bitcoin Keys and Addresses
- The Bitcoin Transaction: Input, Output and UTXO
- Privacy and Fees in Bitcoin Transactions
Bitcoin Keys and Addresses
The effectiveness of Bitcoin transactions is largely due to asymmetric cryptography. The private key is the only means of spending the bitcoins in one’s possession. Once created, the public key can be obtained by elliptic curve multiplication. To obtain the addresses, two hashing functions must be applied to the public key. This type of cryptography is called asymmetric because it consists of a one-way process: one can easily obtain the public key by knowing the private key, but the reverse process is almost impossible.
The Bitcoin transaction: input, output and UTXO
Every Bitcoin transaction contains two main elements: input and output. Suppose we need to pay 35 euros but only have a 50 note. The inputs and outputs behave similarly. UTXO stands for Unspent Transaction Output and consists of an amount received and not yet spent, like a cashed banknote waiting to be spent in the wallet. If Alice wants to send Bob 0.5 BTC and only has a 3 BTC UTXO, she will have to take the latter and turn it into a payment input to Bob. Two outputs will be created: one of 0.5 BTC to Bob and one of 2.5 BTC which will return to Alice as change.
Privacy and fees in Bitcoin transactions
a) How transaction fees work
Transaction fees in Bitcoin are not calculated based on the amount sent, but on the amount of data required to register the payment on the blockchain. What is paid is the block space, i.e. the space occupied within a block. The unit of measurement is the sat/vB, i.e. satoshi per byte.
All other things being equal, therefore, it is more expensive to send multiple UTXOs instead of just one. For example, if you have to pay 0.5 BTC and you have 0.5, 0.3, and 0.2 BTC UTXOs, your fees will be lower if you choose to send only the 0.5 BTC one instead of combining the two 0.3 and 0.2 BTC ones.
b) UTXO: difference between KYC and NON-KYC and the importance of privacy
The Bitcoin blockchain, being a public ledger, makes it possible to trace the history of UTXOs, i.e. to understand the path taken by a specific note and through which hands it has passed. This traceability varies according to the origin of the UTXOs and can be divided into two categories: KYC (Know Your Customer) and non-KYC.
UTXO KYC: refers to bitcoins purchased on a centralised exchange that requires personal documents and data. If transferred to one’s own wallet address, it is very easy to trace the identity behind the UTXOs thanks to the documents provided to the exchange;
NON-KYC UTXO: concerns bitcoins purchased on peer-to-peer exchanges, whose link to a specific identity is very complex;
Conclusion
The management of UTXOs is not only an interest for experts, but could become part of everyday life for many. Understanding the differences between KYC and NON-KYC UTXOs and transaction fees is vital to the effective and responsible use of Bitcoin, ensuring both economic efficiency and user privacy.
