🪙 Mastering UTXO Management for Bitcoin: Optimize Fees and Maintain Privacy

UTXO management is one of the most important and least talked about topics in Bitcoin

It's important because if you don't do it right, you're going to end up unable to ever spend your Bitcoin

And it's not talked about because it's super confusing

Luckily, I'm a genius and a man of the people so I'm going to break this down to be as simple as possible

But first, if you don't know what a UTXO is - watch this video

The Framework

Everyone is different. Instead of giving you advice on how big your UTXOs should be - I'll be showing you how to think about the problem.

That way you can tailor this advice to your specific situation

The problem to solve is: How can I future proof my UTXOs so they are easy to spend while maintaining my privacy

Think of UTXOs as dollar bills

If your UTXO is too small (say $5 or 0.0001 BTC as of this writing):

It could cost you more than $5 to spend that Bitcoin in the future making it useless

If your UTXO is too big (say you put your whole $250,000 retirement stack into 1 UTXO):

If you make a $50 payment for drinks the bartender will know you paid with a $250,000 bill and got $245,950 in change (bad privacy)

So how do you strike a balance?

The good news is you're already doing this balancing in another part of your life

The Traditional Finance Model

If you're well versed in personal finance you're not saving for retirement in a checking account

Instead you have different accounts for different time preferences

A checking account for daily operations

A savings account for short term savings

A brokerage account for medium term savings

And tax advantaged retirement accounts for long term savings

Depending on your age and upcoming expenses you will have:

1) Different percentages of your money in these different accounts

2) Different time thresholds for the accounts

I'm 30 years old and here are my breakdowns and time thresholds for the accounts

Long Term Savings (70%) - 20+ years

Medium Term Savings (20%) - 5-20 years

Short Term Savings (9%) - 1-5 years

Daily Operations (1%) - Less than 1 Year

These numbers can change over time and the definitions of the buckets can change too

Maybe next year I decide that in the next 1-5 years I want to buy a house.

I can start to move my medium term savings (larger UTXOs) into more short term savings (smaller UTXOs)

Or I'm getting close to retirement and no longer want to have a 20+ year time horizon for my long term savings

I decide to move half that money into the medium term savings and change the time horizons to 10+ years and 5-10 years

This framework is as flexible as you need it to be and you should update it over time

UXTO Sizing

Now that you have a framework for understanding how often you'll be moving money you can start to size your UTXOs

Think about how many times you're likely to move the money in each of these buckets

This is how I'm thinking about each of my buckets:

Long Term UTXOs (70%) - 20+ years

I'm unlikely to move this money any time soon.

1-2 large UTXOs will help me optimize fees when I need this money.

Medium Term UTXOs (20%) - 5-20 years

I'm also unlikely to move this money any time soon.

When I do move this money it will be to supplement a large purchase or rebalance into short term savings

2-5 UTXOs is enough to optimize fees and give me the flexibility to rebalance into short term savings

Short Term UTXOs (9%) - 1-5 years

This is Bitcoin that I plan to sell/spend in the next 1-5 years to finance a large purchase

These large purchases will be more than $1000 so that will be the smallest amount I hold in this category of UTXOs

I doubt I would make more than 10 of these large purchases over a 5 year period so 10 UTXOs is the high end for this category

Daily Operation UTXOs (1%) - Less than 1 Year

I am unlikely to spend much if any on chain Bitcoin in a year

This Bitcoin belongs in a lightning wallet or a mobile wallet with UTXOs around $50-$100 (amounts I'd spend)

As time goes on, it seems less likely that I'll be holding much on chain Bitcoin for payments

These are my numbers and my reasoning, you should come up with your own for your situation

Think about:

1) What amount of Bitcoin you're likely to spend in those time ranges (UTXO size)

2) How often you'll spend Bitcoin in those time ranges (UTXO quantity)

Once you've gone through this exercise you're ready to start consolidating.

Consolidation

Wait for low fees by checking out mempool.space and watch this video to learn how to consolidate your UTXOs

Consolidation isn't the end!

You're likely going to spend or sell portions of that Bitcoin over time

Your time preference buckets are also likely to change over time as things change in your life

Go through this exercise on a yearly basis and consolidate your UTXOs so they are healthy and future proofed

Bookmark this page for those future exercises and DM me on Twitter/X if you have any questions

See you guys next week