How to consolidate previous outputs in transaction (transaction size problem?)

[swilly]

Take this transaction for example:
http://blockchain.info/tx-index/10949621/c4a0c86c955ba357de698ec5d7aea20a471e2185d5ebd4463eca55c7e1776388

Is it possible to consolidate all the "previous" outputs so that your transaction size isn't enormous like this? It seems that if each transaction is a summation of the largest previous outputs, transaction size/fees will only continue to grow in the future.

eg.

1) 1 BTC (address A) -> [ 0.5 BTC (B), 0.5 BTC (A) ]    - 0.5 BTC from A to B
2) 1 BTC (C) -> [ 0.5 BTC (B), 0.5 BTC (C) ]    - 0.5 BTC from C to B

3) [ 0.5 BTC (B), 0.5 BTC (B) ] -> 1 BTC (D)    - 1 BTC from B to D
4) [ 0.5 BTC (D), 0.5 BTC (D) ] -> 1 BTC (E)    - 1 BTC from D to E

Both transactions 3 and 4 require 2 previous outputs, whereas 1 and 2 only require 1. How can 3 and 4 be consolidated to prevent all prior transaction BTC amounts from being very tiny in the future?

Thanks!

[Foxpup]

Your example is incorrect. Transaction 4 requires only 1 previous output, since D received BTC1 in a single transaction (transaction 3) from B. The fact that transaction 3 used multiple inputs makes no difference, since it consolidated them into a single output. In your actual transaction, you sent BTC6 to 12yEB7J93XtgXVM343fPdzYw38ZLgE5U2t, and now the owner of that address has a single BTC6 output that he can spend without creating an enormous transaction. In this way, as bitcoins change hands, they consolidate themselves into whatever amounts people are spending them in. It is not true that they just keep getting split into smaller and smaller pieces as time goes on.

As for your situation, if you really wanted to, you could send all your bitcoins to yourself in one huge transaction, after which your future transactions will be smaller, but that would incur an even greater fee than if you just spent your bitcoins normally, so there's no point in doing this. You just have to get used to the fact that Bitcoin simply isn't meant for microtransactions, and anyone who insists on using it for that purpose just has to accept the higher fees that this usage requires.

[swilly]

Ah - thanks so much! This makes much more sense. The protocol is taking some time to wrap my head around, but it's absolutely incredible!