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Smart Contracts in the UTXO Model

Bitcoin’s Unspent Transaction Output (UTXO) model differs fundamentally from the account-based model used in platforms like Ethereum. This difference creates both challenges and opportunities for smart contract development. Arkade builds upon Bitcoin’s UTXO model to enable powerful smart contracts while maintaining Bitcoin’s security properties.

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The UTXO Paradigm

In the UTXO model:

• Each transaction consumes one or more UTXOs as inputs
• Each transaction creates one or more new UTXOs as outputs
• Each UTXO can only be spent once
• Each UTXO has an associated script that defines the conditions for spending it

This model provides excellent security and scalability but creates challenges for stateful applications. Traditional smart contract platforms use an account model where contract state is stored directly in accounts, but in Bitcoin, we must think differently.

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Commit-Reveal Pattern

The classic approach to smart contracts in Bitcoin uses a commit-reveal pattern:

1. Commit Phase: Participants commit to certain values by locking funds in a transaction output with specific spending conditions
2. Reveal Phase: Participants reveal the committed values when spending the output, satisfying the script conditions

Here’s a simple example of a hash time-locked contract (HTLC) using the commit-reveal pattern:

# Commit Phase - Lock funds with this script
OP_IF
    # Reveal preimage to claim
    OP_SHA256 <hash> OP_EQUALVERIFY
    <receiver_pubkey> OP_CHECKSIG
OP_ELSE
    # Timeout path
    <timeout> OP_CHECKLOCKTIMEVERIFY OP_DROP
    <sender_pubkey> OP_CHECKSIG
OP_ENDIF

In this pattern:

• The commit phase locks funds that can be claimed by revealing a preimage to a hash
• The reveal phase occurs when the receiver spends the output by providing the preimage

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State Transitions in UTXO

Traditional Bitcoin script has limited ability to enforce state transitions. When a UTXO is spent, its script can only verify the spending conditions, but cannot directly enforce conditions on the outputs being created.

This limitation makes it difficult to implement contracts that need to maintain state across multiple transactions, such as:

• Decentralized exchanges
• Payment channels
• Automated market makers
• Lending protocols

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Advancing Beyond Commit-Reveal

Arkade Script introduces two key innovations that enable more powerful smart contracts in the UTXO model:

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1. Transaction Introspection

Transaction introspection allows a script to examine properties of the transaction that’s spending it, including the outputs being created. This enables:

• Verification that outputs maintain certain properties
• Enforcement of state transitions
• Implementation of covenants (restrictions on how funds can be spent)

Instead of just revealing values during spending, contracts can verify the entire state transition:

// Verify that output 0 maintains the contract with updated state
require(tx.outputs[0].scriptPubKey == updatedContractScript, "Invalid state transition");
require(tx.outputs[0].value >= minValue, "Insufficient value in next state");

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2. Taproot and Key Tweaking

Taproot enables more complex script conditions while maintaining privacy. Combined with key tweaking, it allows:

• Verification that outputs commit to specific contract terms
• Complex spending conditions hidden in Taproot trees
• Efficient verification of contract continuation

Example of verifying continuation through key tweaking:

// Verify that output 0 contains a Taproot output with the expected tweaked key
bytes expectedTweakedKey = tweakKey(internalKey, contractHash);
require(tx.outputs[0].scriptPubKey == new P2TR(expectedTweakedKey), "Invalid continuation");

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State-Carrying Contract Primitives

With introspection and Taproot, Arkade enables true stateful contracts in the UTXO model through:

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Token Support

Tokens can represent state and ownership within contracts:

• Fungible tokens for value representation
• Non-fungible tokens for unique assets
• Token transfers as state transitions

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Recursive Covenants

Recursive covenants allow contracts to enforce conditions on their future spending:

• Self-replicating contract logic
• Enforced state machine transitions
• Preservation of invariants across transactions

Example of a recursive covenant:

function updateState(int newValue, signature userSig, pubkey user) {
  // Verify current state
  int currentValue = tx.input.current.value;
  
  // Verify state transition is valid
  require(newValue > currentValue, "New value must be greater than current value");
  
  // Verify output maintains the same contract with updated state
  require(tx.outputs[0].scriptPubKey == tx.input.current.scriptPubKey, "Contract script must be preserved");
  require(tx.outputs[0].value == newValue, "Output must contain new value");
  
  // Verify user signature
  require(checkSig(userSig, user), "Invalid user signature");
}

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The VTXO Paradigm

Arkade introduces the Virtual Transaction Output (VTXO) paradigm, which combines the security of Bitcoin’s UTXO model with the flexibility needed for complex applications:

• Immediate Execution Path: Cooperative execution with server co-signature for instant finality
• Timelock Unilateral Path: Fallback mechanism for onchain redemption with timelock constraints

This dual-path approach enables efficient offchain execution while maintaining Bitcoin’s security guarantees.

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Conclusion

Smart contracts in the UTXO model require different design patterns than account-based systems, but with Arkade Script’s innovations, they can achieve comparable functionality with Bitcoin’s security advantages. The following sections will explore the Arkade Language in detail, showing how to build powerful applications using these principles.