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Consolidation, UTXO management, and CIOH

Privacy on Bitcoin

Consolidation, UTXO management, and CIOH

  • What is consolidation?
  • What's the minimum size for your UTXOs?
  • Consolidation and CIOH
One of the most complicated aspects of running a self-custody wallet is consolidation. Should you consolidate? What's the point? What size of UTXO should be respected? What are the compromises in terms of confidentiality? That's what we're going to look at in this section.

What is consolidation?

Bitcoin operates like an auction market, with miners giving preference to transactions offering the best fees. However, each block has a maximum weight, which limits the number of transactions that can be included within it. As a block is produced on average every 10 minutes, the space available in each block is a scarce resource.
Miners, whose activities generate significant costs in terms of electricity, fixed assets, and maintenance, naturally seek to maximize their profitability. They therefore tend to favour transactions that generate the highest fees relative to their weight.
Not all Bitcoin transactions carry the same weight. Those with more inputs and outputs will weigh more. For example, let's imagine 2 transactions:
  • Transaction A comprises 1 input and 1 output. It allocates 1,994 sats of fees and has a weight of 141 vB;
  • Transaction B, a more complex transaction with 2 inputs and 2 outputs, allocates 2,640 sats in fees for a weight of 220 vB.
In this example, although transaction B offers a higher total fee, miners will prefer transaction A, as it provides a better fee-to-weight ratio. Here's the calculation for each transaction, expressed in sats per virtual byte (sat/vB):
TXA: 1994 / 141 = 14 sats/vB
TXB: 2640 / 220 = 12 sats/vB
This means that for each unit of weight, transaction A offers more costs than transaction B, even though transaction B offers more costs in absolute terms.
It is therefore always more interesting for the user to consume as little input as possible in their transactions. However, you need to consume sufficient amounts to meet the output payment. When managing your wallet, you need to have sufficiently large UTXOs.
The principle of consolidation is precisely to take advantage of periods when fees are low on Bitcoin to merge its smaller UTXOs into a single larger one. This way, when fees rise on Bitcoin, you'll be able to make transactions with a minimum of inputs, and therefore spend less on fees in absolute terms. The aim is therefore to anticipate the compulsory transactions to be carried out during periods of high fees.
In addition to saving on transaction costs, consolidating UTXOs helps prevent the formation of "dust". "Dust" refers to UTXOs whose value in sats is so low that it is insufficient to cover the transaction costs required to spend them. This makes these UTXOs economically irrational to use for as long as the transaction costs remain high. By proactively pooling your UTXOs, you prevent them from being lost, ensuring that all your funds remain usable.

What's the minimum size for your UTXOs?

I'm sometimes asked what the recommended minimum value for a UTXO is. Unfortunately, there's no universal answer, as it depends on your preferences and the conditions of the fee market. However, here's a formula that may help you determine a threshold suited to your needs:
Where:
  • is the transaction weight;
  • represents the maximum charge rate in satoshis per vbyte (sats/vB) against which you hedge;
  • is the percentage of the transaction fee you are willing to pay in relation to the total value of the UTXO;
  • is the minimum amount in satoshis for each UTXO.
Let's assume that you plan to cover the fees for a standard SegWit transaction with 1 input and 2 outputs, weighing 141 vB. If you're hedging up to 800 sats/vB, and you're willing to spend up to 12% of the UTXO value in fees at most, then the calculation would be:
In this example, it would therefore be wise to keep a minimum value of 940,000 sats for UTXOs in your wallet.

Consolidation and CIOH

One of the most widely used heuristics in blockchain analysis is the CIOH (Common Input Ownership Heuristic), which assumes that all inputs to a Bitcoin transaction belong to the same entity. The very principle of consolidation is to consume several UTXOs as inputs and create a single UTXO as an output. Consolidation thus enables the application of the ICOH.
In practice, this means that an outside observer can deduce that all the consolidated UTXOs probably belong to the same person, and that the unique output generated also belongs to him or her. This situation can jeopardize your confidentiality by associating different transaction histories. For example, let's say I consolidate 3 UTXOs acquired via P2P with one UTXO obtained via a platform that requires KYC:
By doing so, any entity with access to the exchange platform's data, potentially including government agencies, will be able to identify that I own other amounts of BTC. Previously, these UTXOs were not directly linked to my identity; now they are. What's more, it reveals to all sources that I'm in possession of a certain amount of bitcoins.
When it comes to managing UTXOs, economic considerations, which drive consolidation to reduce costs, come into conflict with good privacy practice, which would recommend never merging UTXOs. The choice between economy and confidentiality, therefore, depends on the priorities of each user.
If you can avoid consolidation while maintaining substantial UTXOs, that's ideal. To do this, optimize your acquisition methods. If you buy your bitcoins in DCA, try to space out your one-off purchases as much as possible to consolidate value over fewer UTXOs. It will be easier to manage a one-off purchase of €1,000 every 2 months, rather than a purchase of €120 every week. This minimizes the number of UTXOs generated and simplifies wallet management, preserving your confidentiality.
If you need to consolidate your bitcoins, prioritize consolidating UTXOs from the same source first. For example, merging 10 UTXOs from a single platform will affect your confidentiality less than mixing 5 UTXOs from platform A with 5 UTXOs from platform B. If consolidation of various sources is unavoidable, try to separate them according to their characteristics. For example, group together UTXOs acquired via KYC in one transaction, and those obtained via P2P in another.
In any case, don't forget that any consolidation inevitably entails a loss of confidentiality. Carefully assess the need for this operation and its potential impact on your privacy, taking into account the CIOH.
Quiz
Quiz1/5
How can we minimize the impacts of COIH when consolidating UTXOs?