Don’t get stuck: The 2024 Guide To Bitcoin’s UTXOs

This comprehensive guide covers everything you need to know about UTXOs, including their definition, functionality, management techniques, and additional insights

Don’t get stuck: The 2024 Guide To Bitcoin’s UTXOs
March 4, 2024
Eduardo Prospero

Did you know wallets do NOT contain Bitcoin or even Sats? UTXOs are all there is in there. These “Unspent Transaction Outputs” are the building blocks of Bitcoin’s main chain. In the following article, you’ll learn what those are and why keeping them “fat” is usually a good idea. Plus, you’ll get a 101 lesson on UTXO consolidation, management, and coin control. An important class for everyone interested in self-custodying Bitcoin; especially for those who use the DCA or dollar-cost averaging technique to accumulate precious coins.

Investopedia defines DCA as “investing the same amount of money in a target security at regular intervals over a certain period of time, regardless of price. By using dollar-cost averaging, investors may lower their average cost per share and reduce the impact of volatility on their portfolios.” That may be positive, but the technique could generate a high number of skinny UTXOs that could in turn increase the transaction fees of future transactions. 

The solution is UTXO consolidation and management. There’s no denying it, on-chain transactions continue to get more expensive, and the phenomenon will not stop if we want to bring Bitcoin to the next billion people. UTXO management can help users cut fees, organize and label their stash, and increase the privacy of their transactions.

To make sure we’re on the same page, let’s back up the truck and start at the beginning.But before we do that, let’s make one thing clear: Blink is a Lightning Network wallet and UTXOs are the accounting system of Bitcoin’s main chain. What you’ll read has little to do with Blink, but keep reading until the end to learn how you can use the Lightning Network to generate fat UTXOs.

What Exactly Is An Unspent Transaction Output? 

So, wallets contain “Unspent Transaction Outputs” or UTXOs and not Bitcoin or Sats. Each UTXO is unique, it specifies the amount of Sats that a wallet received in a specific transaction and has not spent yet. The concept is elusive, we know. Here are a few facts about UTXOs that will help paint a clearer picture:

  • Each transaction in the Bitcoin blockchain is made up of inputs and outputs. The inputs can consist of many UTXOs if the Sats sent can’t be covered by a single one. The miners get a fee, and the rest of the funds arrive at the other person’s wallet in UTXO form.
  • If it has never sent funds, an unmanaged wallet would contain as many UTXOs as transactions it has received.
  • Outputs remain in UTXO form until they’re used as inputs in a new transaction, which restarts the cycle.
  • Every outbound transaction destroys the old UTXOs and, if the balance is not entirely spent, creates a new one that reflects the change. 
  • Most modern wallets let you see the content of each of the user’s UTXOs and select which one he or she wants to use for the next transaction.
  • Older and simpler wallets abstract UTXOs altogether, and show just a balance to users. For each transaction, these wallets pick the lesser number of UTXOs possible. The objective is to get the cheapest fee available.   
  • A Bitcoin address’s balance is known as an Xpub or an extended public key.

What Is the UTXO Set?

Another relevant concept, the UTXO set is the aggregate amount of all UTXOs that the whole Bitcoin network is hosting at any moment in time. Since UTXOs are created and destroyed in every transaction, the UTXO set is always changing. The fewer UTXOs exist, the lighter the blockchain is, and the cheaper it is for users to run nodes.

https://studio.glassnode.com/workbench/6df238d5-b09c-4b81-5044-cee6cd278327

Now, speaking about cheaper…

Without UTXO Management, Fees Are Higher. Here’s Why

At any given time, the average fees of the Bitcoin network depend on the activity and the size of the transaction. The first factor is easy to understand. It’s a free market out there, and the miners will logically pick the transactions that offer higher fees to go on their blocks. The users will only feel this in times of high network activity because that’s when the competition gets fierce. The second factor may seem counterintuitive at first.

When it comes to fees, the amount of Sats a user sends is not relevant at all. What’s important is the size of the transaction. Thanks to the brave fighters in The Blocksize War, each block contains a maximum of 4Mbs of data. The heavier a transaction is, the higher the fees. And, what determines the size of a transaction? You guessed it: the amount of UTXOs used in said transaction! Remember, network congestion is still a factor, but a transaction that consists of several UTXOs is always going to be more expensive than a transaction that only contains one. 

Now, think about the future for a second. We already established that the activity of the Bitcoin network affects the fees and there’s a high probability that the amount of users will grow exponentially. The blocks will be the same size, so the competition to get into those blocks will surely intensify. The fees will increase and the size of the UTXOs in each wallet will be even more important. 

Are you starting to see why UTXO management, consolidation, and coin control are critical, anon? We want those UTXOs fat, sure, but, exactly how fat?

What Is UTXO Consolidation?

To merge multiple UTXOs into a single one is called UTXO consolidation. The technique is incredibly simple: send a transaction that contains several UTXOs to yourself. The funds will arrive in a single fat UTXO. Of course, you’ll have to pay a fee for that transaction, so it’s important to be strategic. A congested network is an expensive network. Consult sites like mempool.space for the current average fees - measured in 140 vBytes chunks - and wait for the right time to consolidate your UTXOs… but wait, there are also privacy considerations.

This is important and only logical. A UTXO consolidation operation links all of those UTXOs together. The blockchain is a public ledger, so spy companies like Chainalysis, governments around the world, and basically everyone able to consult it will get confirmation that all of those UTXOs belong to the same person. Take that into account, but there’s more.

Remember what happens when a UTXO contains more Sats than the transaction requires? A new UTXO containing the change is created and goes to the user’s wallet. Well, the whole transaction is in the public domain. That means that Chainalysis, governments, and anyone with access to the transaction hash will know how many Sats went back to the wallet. And, if the user only has one uber-fat UTXO, those people will know exactly how much Bitcoin he or she has!

How Fat Should They Be, Then?

Look, we can’t predict the future. 

We can prepare for everything, however. 

The best course of action is to divide your stash into spendable UTXOs and savings UTXOs. The second kind can be as fat as you can make them, just take into account the privacy considerations if you ever have to spend from them. Which we hope you never have to do. Now, “stacking sats” is not the only strategy available. A new mantra of the Bitcoin community is “spend and replace,” because it’s the only way to grow circular economies and Bitcoin businesses. That’s what the spendable UTXOs are for, and, generally speaking, those could be around the one million Sats mark. That’s enough to pay future fees, send value, and not reveal a significant part of your stash if you receive change.

Of course, that’s just a general recommendation. By all means, adjust the fatness of those UTXOs to your spending needs.

https://studio.glassnode.com/workbench/e0438f9e-9a39-4ff8-758d-17649af130d3

What Is Coin Control?

The ability to choose exactly which UTXO you want to transact with is called “coin control.” In the recent past, in the name of making usage simpler, wallets hid this functionality and made every decision automatically. They aimed to get the lowest possible fee, but, what about privacy and other concerns? Nah, coin control is better left in the hands of each user. 

A few wallets with coin control features available are Sparrow, Wasabi, Trezor, Electrum, and Bluewallet.

What is a Coin-Join?

For people with extra privacy concerns, there’s a possible extra step. The process known as Bitcoin mixing or Coin-Join consists of exchanging UTXOs with other anonymous users of the network. It would be like a lot of people putting bills in a big jar, mixing them up, and then everybody taking exactly the amount they contributed - minus fees - but receiving different bills. 

Of course, in reality, the Coin-Join process is much more complex than that and has the following characteristics:

  • Every user can contribute different input sizes, but all outputs look the same. 
  • The randomness of the process makes each UTXO more difficult to track for government and Chainalysis or similar companies, but it comes with a huge tradeoff.
  • It will be obvious and noticeable in the blockchain that your funds went through a Coin-Join process. At the time of writing, some institutions, exchanges, and services don’t accept coin-joined Bitcoin.

Other Fun Facts About UTXOs

  • How are UTXOs first created? Though “coinbase transactions.” At the moment, through these types of transactions, miners get paid a 6.25 BTC reward for each block they get to mine. These coinbase transactions have no input and generate a UTXO without history. 
  • What happens if a UTXO is so skinny that it’s not enough to pay the transaction fee? It becomes what we call “Bitcoin dust.” Merge the dust with other UTXOs or lose those Sats forever.
  • The UTXO model is what makes Bitcoin completely auditable at any moment in time. Every transaction is connected to a specific UTXO, so, if the blockchain is functioning properly, invalid transactions are impossible.

We can’t close this article without explaining the Lightning Network method that we promised at the beginning. You can perform this magic trick through Blink. The Lightning Network is a Layer 2 solution in which you can execute a virtually unlimited amount of transactions without touching the main chain. However, when you want finally to send funds on-chain, that transaction will generate a single UTXO. So, you can use the Lightning Network and Blink to DCA or accumulate Bitcoin by any means you prefer, and, when ready, consolidate UTXOs directly with that one transaction. 

This trick works like a charm. Use it wisely. 

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