Understanding UTXOs is crucial for managing your bitcoin held in self-custody — they’re a crucial building block in bitcoin transactions.
In recent years, market demand for blockspace has resulted in increased transaction fees on the base layer of the bitcoin network. If you’re bullish on bitcoin and believe it’s an exponential opportunity, smart UTXO management can help you maximize that potential.
Properly managing UTXOs can help you avoid overpaying on transaction fees, keep track of your holdings, and improve overall transaction efficiency.
What are UTXOs and why do they matter?
Bitcoin only exists on the internet. It gets reassigned from place to place with each transaction on a public ledger called a blockchain.
A UTXO (unspent transaction output) is a deposit that has been made into your wallet. Every time you receive bitcoin, a new UTXO is created that will later need to be spent. You can think of UTXOs as individual data entries written on the bitcoin blockchain.
Each UTXO lists an amount of bitcoin tied to an address, and an address can have multiple UTXOs. When you spend bitcoin, your UTXOs (outputs) become inputs in your transactions.
Why are UTXOs important?
There’s no free lunch in bitcoin. Each transaction has a cost, either in BTC or energy used to mine a block.
It costs BTC to write data to the blockchain, which includes UTXOs. Each incremental UTXO you add to an address becomes a sliver of data you’ll have to pay to move in a later transaction.
Accumulating too many UTXOs in your wallet can lead to various challenges, especially when using certain hardware wallets. These challenges arise due to memory and processing limitations, which can affect the efficiency of your wallet and increase transaction fees.
Imagine you have many small coins in your piggy bank, like pennies and nickels. It’s fun to collect them, but when you want to buy something big, you might need to use lots of those small coins. It can get heavy and take a lot of time and energy to count them all. There’s little economic value in filling your piggy bank with pennies when you can trade them in for dimes and quarters.
UTXOs work in a similar way. If you have too many small UTXOs in your bitcoin wallet, it can become a bit unwieldy and cost you more to transact with than it’s worth.
UTXOs should contain at least 0.01 BTC
With a little forethought, you can avoid having your wallet bogged down with dust and excessive UTXOs. It’s best to create UTXOs with at least 0.01 BTC for viable spending in the future, and ideally much larger than that amount. This means you should be a bit strategic about how you acquire your bitcoin and send it to self-custody.
How spendable a UTXO has to do with transaction fees, which fluctuate according to market demand. It’s hard to know what the transaction fee market will look like in the future. If you create data entries with not enough BTC, there’s a possibility that BTC may not be spendable in the future because the transaction would cost more BTC than the UTXO contains. This is especially true to UTXOs containing less than 0.0001 BTC, also known as dust. Avoid creating dust at all costs to keep your bitcoin worth your while.
It’s easy to create dust if you send unnecessary transactions. For instance, if you purchase $10 of bitcoin a month, it may be a few months, perhaps years before you acquire an amount that is reasonable to send to self-custody and back. Mining rewards are similar. If you only earn $25 from mining a block, it may not be a distribution you want sent to an address on the bitcoin base layer.
In many cases, it can make sense to postpone sending bitcoin to self-custody until you have a large enough amount to justify creating a UTXO.
Keep your piggy bank neat with UTXO consolidation
To save on fees and make things easier, we suggest you keep your piggy bank neat and tidy and combine smaller UTXOs into bigger coins. This is like trading all your small coins for a few shiny, big ones. It makes spending your bitcoin faster and simpler.
To ensure your wallet continues to operate smoothly and to optimize your transaction experience, we recommend keeping the number of UTXOs in your wallet below 100 UTXOs. When your UTXO count approaches this threshold, it’s essential to consider consolidating your UTXOs into fewer, larger ones. This process, known as UTXO consolidation, helps streamline your wallet and reduces the strain on wallet memory and processing power.
UTXO consolidation is a straightforward process that involves creating a new transaction that combines multiple UTXOs (inputs) into a new UTXO (output). Once this transaction is sent and confirmed on the bitcoin network, the consolidation is complete. Through UTXO consolidation, you can maintain a healthy bitcoin wallet.
Why consolidate UTXOs? Save on transaction fees
The advantage of UTXO consolidation lies in preserving value and optionality. A reality of markets is, sometimes, investors sell assets not because they want to but because they’re compelled to for financial reasons. If you’re ever in a situation where you have to sell bitcoin immediately, you won’t have control over the transaction fee market, but an already consolidated UTXO maximizes the value of your holdings.
Timing is key for consolidating UTXOs. If you watch the transaction fee market, you can send a transaction when fees are low and reduce the fees you might otherwise pay in the future. What constitutes a low fee is subjective, but you can easily monitor fee markets with a block explorer such as Mempool.space. Transaction fees are assessed in satoshis per virtual byte.
Monitoring fees is especially important for multisig wallets like the Casa vault because multisig wallets are “heavier” and process more data on the network, resulting in higher fees than single-signature transactions. For this reason, the stronger security model of multisig is better suited for long-term holdings.
If this process sounds technical, don’t worry. Our team is here to assist you with this process and provide guidance every step of the way. If you’re a Casa member and would like assistance, please reach out to our advisors at email@example.com and we’ll be happy to help you consolidate your UTXOs efficiently.
Consider privacy before consolidating UTXOs
Because bitcoin transactions are public, it’s worth giving thought to each individual UTXO before proceeding with a consolidation. If you’ve intentionally kept your coins separate for privacy reasons, combining them into larger UTXOs can reduce that privacy.
It’s a bit like putting all your different coins together in one glass jar instead of keeping them in separate pockets. While this can improve efficiency, it might make it easier for others to see how much bitcoin you have. If privacy is a top concern for you, please reach out to our support team. We can provide guidance on how to balance privacy with the need for efficient UTXO management, ensuring you make the best choice for your unique needs.
Let’s review. Why take action?
By managing your UTXOs proactively, you can:
- Minimize transaction fees
- Ensure the optimal performance of your wallet
- Simplify your bitcoin holdings for easier tracking
- Avoid creating unnecessary data on the bitcoin network
Casa is committed to providing you with the best possible bitcoin experience, and effective UTXO management is a crucial part of that journey. Think ahead and you can master your UTXOs and make the most of your bitcoin.
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