Lost and hodled – understanding Bitcoin’s ‘Unspent Transactions’

A new report by Delphi Digital is shedding light on the state of the bitcoin economy. Specifically, the report quantifies the number of bitcoin units that are actively in circulation as well as those which are lying dormant, unused in wallets. This is referred to as UTXO.

Understanding UTXO

UTXO is an acronym for Unspent Transaction Outputs. To understand what these are it is essential to grasp how transactions take place on the Bitcoin blockchain as bitcoin transactions do not function in the same way as fiat currency transactions.

Say you would like to pay for an item at a store. With fiat currency, you retrieve the amount needed for the payment and leave the rest in your wallet untouched. However, if you were to pay for the same item using bitcoin, the transaction would work differently.

On the Bitcoin blockchain, it is not possible to make partial payments. What this means is when you are making a transaction, you retrieve the entire amount on your wallet. The payment is deducted and sent to the recipient’s wallet while your remaining balance is sent to a new address. The difference is that the new address is still under your control. This new address is referred to as a change address.

In simpler terms, UTXO signifies the amount of bitcoin one owns. Every bitcoin transaction has a spent output and unspent output. If there is no UTXO at the end of a transaction, it means there is no more bitcoin in that particular address.

In the early days of bitcoin, users were required to manually input the recipients of their transactions. This includes the recipient’s address as well as the change address. If the user made a mistake and sent the unspent bitcoins to an address not under their control, they would lose access to the UTXO.

Currently, however, the evolution of technology has led to the rise of deterministic wallets which handle transactions in a much more user-friendly manner. Now, users do not need to input a change address when conducting a transaction, only the recipient’s address. Deterministic wallets have simplified the transaction process and lessened the percentage of losses that would likely occur due to erroneous change addresses.

Bitcoin UTXO distribution

Bitcoin has been coded in a manner that allows for only a total of 21 million units in circulation once all coins have been mined, Additionally, using the data viewable on the Bitcoin blockchain, we know that the number of bitcoins currently in circulation comes to around 17.4 million.

While these are indisputable facts, there have been speculations or questions regarding the number of bitcoin that are actually being used in transactions as opposed to laying dormant in wallets.

As of December 2018, Delphi Digital stated in its report: "By analyzing the Bitcoin UTXO age distribution, as seen below, we can observe that roughly 1/3 of the Bitcoin in circulation have not moved in at least 3 years."

In other words, roughly 5.8 million BTC has not been moved from their addresses for at least three years. At current market prices, this figure equates to about $18 billion. At bitcoin’s all-time-high, the 5.8 million bitcoin would have been worth significantly more.

Analyzing the findings

Considering the significant amount of value that is held in UTXOs, it raises the question of why users would keep these holdings. The first plausible explanation would be that the units are inaccessible to their owners due to errors in inputting the relevant transaction data. As explained earlier, this scenario was commonplace in the early days of bitcoin.

Delphi Digital states: "The private keys that access these bitcoins have been lost and will remain lost indefinitely. Chainalysis completed a thorough analysis of bitcoins that are likely lost and came to an estimate ranging from 2.78-3.79 million coins."

While this is an unfortunate reality for the owners of lost bitcoin, it does present an advantage for the bitcoin economy. Bitcoin is designed to have a scarce supply. Scarcity is an important feature for something that can effectively be used as a store of value. Bitcoin’s digital scarcity has been one of its key price drivers and has led to its comparison to gold.

Therefore, if the findings are to be believed, then there are ultimately fewer units of bitcoin in circulation, which should help the price of bitcoin in the long run.

However, according to the research conducted by Delphi Digital, this number accounts for only roughly half of the total UTXO. Therefore, there must be another reason for the rest of the unspent units held in the addresses.

The second plausible reason is that there is a significant portion of the users who are using their bitcoin holding as a long-term investment. Delphi Digital explains: "There are long term holders with a strong enough conviction in Bitcoin that they were not interested in liquidating at these historically high levels."

These long-term ‘hodlers’ signify substantial belief in the future of bitcoin. This can be seen as a de facto vote of confidence and an endorsement of the robust nature of the technology underlying bitcoin as well as its potential to achieve higher prices than we have witnessed in 2017.

While the large number of UTXO in the Bitcoin blockchain may seem worrying at face value, it ultimately points towards a bright future for bitcoin investors.