Best practices for UTXO management and privacy
Understanding UTXOs
In Bitcoin, your balance is actually made up of discrete chunks called Unspent Transaction Outputs (UTXOs). When you receive bitcoin, a UTXO is created as an output of the transaction. When you spend bitcoin, you are really spending UTXOs as the inputs to a new transaction.
Definition snippet:
UTXO: An Unspent Transaction Output that can be spent as an input in a new transaction.
Understanding UTXOs is important because how you manage them affects your privacy and the efficiency and cost of your transactions. Some key UTXO considerations:
Privacy: Spending multiple UTXOs in one transaction can link these UTXOs together as belonging to the same owner. This reduces your privacy.
Efficiency: A transaction with many small UTXOs as inputs will be larger in size and thus more expensive in mining fees than one with fewer, larger UTXOs.
Dusting: Dusting is a tactic used by attackers to try and deanonymize Bitcoin users. Small, insignificant amounts of Bitcoin (known as "dust") are sent to many addresses, usually below the threshold required for a transaction fee to be economically viable. These dust UTXOs, once received, can potentially be linked to your identity if you later spend them. In practice, you should avoid spending dust UTXOs, as doing so could reveal links between transactions, reducing your privacy. Many wallets will automatically recognize these small UTXOs and warn users, suggesting that they remain unspent to avoid exposure.
Proper UTXO management is an important aspect of being a sovereign Bitcoiner.
UTXO management
Good UTXO management involves being conscious of how you structure your transactions. Some best practices:
Minimize inputs: Where possible, use fewer, larger UTXOs as inputs to your transactions rather than many small ones. This keeps your transactions smaller and fees lower.
Avoid address reuse: Generate a new address for each transaction you receive. This makes it harder to link your UTXOs together.
Label UTXOs: Some wallets allow you to label your UTXOs. This can help you track which UTXOs came from where and make decisions about which to spend.
Consolidate when fees are low: If you have a lot of small UTXOs, you can consolidate them into a larger one when network fees are low. This makes future transactions more efficient.
Identify small, scattered UTXOs in your wallet and create a transaction with Coin Control, using them as inputs, and sending them to a single address (preferably your own).
Some more advanced UTXO management techniques:
Coin control: Advanced wallets let you choose which specific UTXOs to spend in a transaction. This allows fine grained control.
UTXO splitting: Intentionally splitting your UTXOs into set denominations for better privacy and fungibility.
Coinjoin: Trustlessly mixing your UTXOs with others to break the link between them and your identity. More on this in the privacy section.
Personal recommendation: Make UTXO management a regular habit. Periodically consolidate small UTXOs, and always think before spending to avoid linking addresses unnecessarily. UTXO management is like going to the gym, if you don’t do it, your bitcoin wallet will get fat and sloppy!
Privacy considerations
One of Bitcoin's superpowers is that it's a neutral, global money that can be used without asking anyone's permission. However, Bitcoin is also radically transparent. All transactions are public on the blockchain. Therefore, if your Bitcoin addresses become tied to your identity, you can lose much of that financial freedom.
Some common ways your addresses may become linked to your identity:
Purchasing bitcoin on a KYC exchange tied to your bank account.
Posting an address online under your real name, or using it to receive funds from known accounts.
Reusing addresses or keeping funds consolidated into a single address.
This can compromise privacy, as it links all transactions to one address, making it easier to trace the source and destination of funds. This reduces anonymity and can expose patterns of spending.
Exposing your network information while transacting.
While it's hard to maintain perfect privacy with Bitcoin, there are many tools and techniques to preserve your transactional freedom. The key principle is to avoid creating links between your addresses and your identity, and between your different addresses with each other.
Some privacy best practices:
Never reuse addresses - generate a new one for each transaction.
Avoid consolidating your funds into a single address. Spread them across multiple.
Be careful about what information you share about your bitcoin usage. Avoid telling people what addresses are yours.
Consider using the Tor network or a VPN when transacting for added network-level privacy.
Remember, your financial privacy is a human right but also your responsibility. Take it seriously.
Personal recommendation: Make privacy a priority in your Bitcoin journey from day one. It's much harder to claw back privacy than to maintain it from the start. Your future self will thank you.
Mixing techniques
Bitcoin mixing, also known as CoinJoin, is an advanced technique for enhancing the privacy of your transactions. At a high level, it involves combining your transactions with those of other users so that it's very difficult to determine which inputs and outputs belong to which user.
Definition snippet:
CoinJoin: A privacy technique that trustlessly combines multiple users' transactions into a single large transaction, making it difficult to determine which inputs and outputs belong together.
Some popular mixing implementations include:
Wasabi Wallet: A desktop Bitcoin wallet with a built-in CoinJoin implementation called ZeroLink. Easy to use for beginners. Just select which coordinator you want to use and off you go!
JoinMarket: A decentralized CoinJoin implementation where users enroll as market makers and takers. More technical than other options.
Mixing comes with some trade-offs:
Mixed UTXOs can stand out as unusual on the blockchain, potentially flagging you for extra scrutiny.
Mixing services often require extra fees.
Improperly mixed coins can still be traced, giving a false sense of privacy.
There may be legal or tax implications depending on your jurisdiction.
Do your own research before using any mixing service. Understand the risks and benefits given your threat model.
Personal recommendation: If you have a strong need for privacy, mixing can be a useful tool. But use it carefully and with a full understanding of the implications. For most users, basic privacy best practices will be sufficient.
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