What are UTXOs?
UTXOs (Unspent Transaction Outputs) are discrete and indivisible bitcoin amounts. When someone sends you bitcoin, you get new UTXOs in your wallet.
With a bitcoin transaction, you must spend the entire value of the selected UTXO and may receive exchange UTXOs back.
An example:
Let's say someone sends you 3 bitcoin. You now have a UTXO worth 3 bitcoin. If you want to spend 1 bitcoin later, the recipient receives 1 bitcoin and you get a new UTXO worth 2 BTC as change. This creates various UTXOs in your wallet.
The UTXO system prevents the “double spend problem” (bitcoin cannot be spent twice) because each UTXO has a unique identifier. During a transaction, the UTXOs are consumed and used as input to the new transaction, temporarily turning them into “inputs.” The new outputs, including exchange money, are fresh UTXOs that overwrite previous ones and can now be used in new transactions.
The UTXO model allows all network nodes to determine the total amount of bitcoin in existence at any time by calculating the value of all UTXOs on the blockchain (the so-called “UTXO set”).
What is UTXO management?
UTXO management refers to the strategic management of Unspent Transaction Outputs (UTXOs) to enable smooth and efficient use of bitcoin in practice.
Effects of UTXO management on transaction fees
If a transaction contains many small UTXOs, it gets bigger in terms of the amount of data. Since bitcoin transaction fees are usually charged per byte, a larger transaction results in higher fees. Conversely, using fewer larger UTXOs in a transaction results in a smaller amount of data and therefore lower fees.
By cleverly selecting UTXOs, transaction fees can therefore be reduced and transaction times accelerated. This is particularly important in times of high workload to ensure smooth transactions.
At the same time, an uncontrolled accumulation of small UTXOs can result in inefficient payments and, in the worst case, render individual UTXOs unusable (UTXOs < 250 sats) because their value is less than the fee, the fee to be paid for issuing them.
Impacts of UTXO Management on Security and Privacy
UTXO management not only affects the cost and speed of transactions, but also has an impact on your security and privacy.
Bitcoin is a “pseudonymous” blockchain, so transaction patterns could allow conclusions to be drawn about the identity and activities of users. Distinctive transaction patterns can be avoided through careful UTXO management.
In addition, unexpected payments from small UTXOs, so-called “dusting attacks,” can pose a security risk. With good UTXO management, you can minimize such risks by not issuing these small UTXOs.
3 Tips for successful UTXO Management
Consolidation in Times of low Fees
Consolidating UTXOs into a wallet can be useful to reduce transaction costs. By combining smaller UTXOs into larger ones, you can carry out transactions more efficiently and cheaply in the future.
Consolidation combines several small UTXOs in one wallet to form a larger UTXO.
Performing a consolidation is relatively easy. To do this, you simply have to initiate a bitcoin transaction, in which you select all desired UTXOs from your wallet and combine them into a new UTXO.
It's important to note that consolidation results in a new transaction that requires you to pay transaction fees. Therefore, consolidation should be carried out with caution, particularly when transaction fees are high. If fees are low or there is low demand for transactions, it may be worthwhile to consolidate.
Maximize Security and Privacy
Use a new bitcoin address for every new transaction. This prevents different transactions from being linked together and protects your privacy.
Make sure that you don't get large amounts back as change when you send bitcoin. This could allow conclusions to be drawn about your bitcoin balance. Instead, use UTXOs that are as appropriate as possible for transactions.
If you receive very small amounts of UTXOs (also known as Dust) unsolicited, they could come from attackers who want to collect information about you in order to track your wallet. Ignore such Dust UTXOs to protect your privacy.
Avoid the Accumulation of small UTXOs with 21bitcoin
Let's say someone takes custody of their bitcoin themselves every time they buy $10 worth of BTC (currently ~30k Sats). And he does it every day, for years. All of that BTC becomes virtually worthless in a high-fee environment.
— @BitcoinIsaia
In contrast to other providers who offer a bitcoin savings plan, which sends the bitcoin directly to a wallet after every purchase, 21bitcoin gives you the option to keep your purchased bitcoin in the app up to a limit set by you.
You can decide for yourself when you want to automatically send your bitcoin to your own wallet. A good guideline is to only send a transaction to your own wallet after 1,000,000 sats in order to generate sufficiently large UTXOs. If you already know that you want to trade even at times of high fees, it can be an advantage to keep your own UTXOs even bigger.
Conclusion
UTXOs are an important part of bitcoin and well-thought-out UTXO management saves you fees, time and increases privacy.
In order to be able to use bitcoin efficiently in times of high fees, you should be careful not to accumulate too many small UTXOs and consolidate them if necessary.
If you stack with 21bitcoin, you enjoy full flexibility and can avoid small UTXOs from the outset:
In order to manage UTXOs efficiently and not be surprised by high transaction fees in the future, you can collect bitcoin in your 21bitcoin app and have it automatically paid out to your external wallet when a sufficiently large amount is reached.
Note: 21bitcoin also offers you the option to use bitcoin non-custodially. If you want to be on the safe side, after every bitcoin purchase, you can immediately make an automated payout to your external wallet in the next block for just 1,000 sats.
