What Are Transaction Fees?

To the people who have never used cryptocurrencies, these networks may seem somewhat mysterious. Unlike traditional payment methods, using Bitcoin or other assets requires the sender to pay the transaction fees. It is a slightly unusual situation, although one that works rather well for all network participants. 

Most consumers are not used to paying transaction fees for everyday purchases. Although people will pay a fee for wire transfers or remittances, a purchase at a store usually doesn’t involve a tangible transaction fee. Instead, the recipient will often have to spend money to keep cash safe or accept payment cards. A fee of 3.5% per transaction is not unusual in the latter case, yet it isn’t something the consumer will ever notice. 

With cryptocurrencies, that situation becomes very different. The one sending money will pay for the transaction fee, ensuring the recipient gets the full amount of money being sent. It is a fair system, as the one receiving money should never have to pay for this “privilege”. But why do these fees exist, and what is their exact purpose?

The Purpose Of Transaction Fees

No one is ever able to move value around the globe free of charge. Somehow, there is always a cost to pay, although that cost can come in many different formats. For Bitcoin and other cryptocurrencies, it is essential to pay a transaction fee whenever value moves across the network. This fee is created by default on every blockchain network, although its value at the transaction time can differ. We will talk more about why this difference exists later on. 

Blockchain ecosystems will always require an incentive for users to validate transactions and include them in future network blocks. For Bitcoin, those transactions are processed by miners, who spend money on hardware and electricity to keep the network operational. In exchange for including transactions, they receive a share of the overall transaction fees in the network blocks. 

On other networks, such as the ones using proof-of-stake, the transaction fee will go to node operators or validators in charge of processing and validating transactions. There will always be a cost to pay for sending money, yet most networks keep these costs under control. No one should pay an arm and a leg to send someone else $50 in crypto, after all. 

Why Do They Exist?

There are other reasons why blockchains and cryptocurrency networks rely on transaction fees. One could argue this is a “necessary evil” of sorts to protect ecosystems from spam attacks. A spam attack aims to flood the network with low-cost transactions, preventing other users from seeing their transfers confirmed by the miners or nodes. A spam attack doesn’t happen often, yet it is not entirely uncommon in this industry either.

Moreover, as mentioned earlier, the fees are an incentive for users who support the network by validating transactions. Although users can tackle these processes via special software, users still need to run the hardware side manually. Additionally, there is a bit of maintenance and upkeep for providing 24/7 network support – either via mining or running a validator node – making some reward warranted. 

Bitcoin Transaction Fees In A Nutshell

As the world’s leading cryptocurrency, most people look at Bitcoin and its network fees. under most circumstances, users can complete transactions on the network for $5 or less, depending on how quickly they want it to be picked up by miners. During times of congestion – when many transactions hit the network simultaneously – those fees can spike to $15 or more. Such amounts make the network slightly too expensive to use, even though it has a global reach.

When completing a Bitcoin transaction, there are often three types of fees one can include. A “normal” fee will see transactions picked up by the network in 10-30 minutes. A “high” fee can expedite this process to 10 minutes or less. Using the “economic” fee can delay transaction confirmations by an hour or more. Depending on the current situation, a different fee type may apply. 

There is no reason to constantly transmit the highest fee possible if the situation doesn’t require it. Bitcoin’s mempool – the pool of pending transactions waiting for confirmation – is often a short queue. There have been times when people waited days for transactions to get picked up, but that is no longer the case today, for the most part. Including a very low fee can still cause a significant delay, however.

Calculating Bitcoin TX Fees

Now that everyone knows why these fees exist, it is essential to understand how they are calculated. It may seem random at first sight, but there is always a reason why the economic, normal, and high fees represent the value you will see in your wallet. As users can customize these fees by increments in most wallets, there is clearly room for customization. However, there is only so much deviation from the “norm” to choose from.

Contrary to some people’s assumptions, the amount of Bitcoin being sent does not affect the transaction fee. You can send $5 in BTC or $5 million with both transactions having the same fee at the same time. Instead, the network looks at the transaction size – expressed in bytes – to determine the possible fees for having miners include it in a future network block. 

The transaction fees on the Bitcoin network can be calculated in Satoshis – the smallest unit of a Bitcoin – per byte. If the average is 40 satoshis per byte – or 0.00000040 BTC per byte – and your transaction is 200 bytes in size, your fee will be 0.00008 BTC. More specifically, this fee would give you a fair chance of getting a transaction included in the next Bitcoin network blocks. On average, new blocks are found on the network every ten minutes. 

When the network traffic increases, however, so will the overall fees. More demand for Bitcoin transactions will eventually increase the transaction cost, although its dollar-based value can vary greatly. Such unexpected increases in transaction costs are part of why very few people buy coffee with Bitcoin, for example. However, some network solutions can alleviate high fees.

Can Bitcoin Become Cheaper?

One of the pressing questions is whether these transaction fees for Bitcoin will ever be lower than they are today. Finding an answer to that question isn’t necessarily difficult, although implementing a viable solution has proven difficult.

Two significant network upgrades have been launched over the years to bring down transaction costs.

First of all, there is Segregated Witness or SegWit. Through this upgrade, the Bitcoin network operates more efficiently, allowing more transactions to be processed quicker. In theory, this should result in much lower network costs, but that isn’t always the case. It is still common to pay over $13 for a transaction even if your wallet supports SegWit transactions by default. Although this is an improvement over the situation prior to SegWit, it isn’t necessarily ideal all the time.

The second upgrade is the Lightning Network. Users pay a flat fee per transaction through this layer – depending on the node – and the fee-based on liquidity used. The base fee is determined by the node processing the transaction – but can be a slow as $0.01 – whereas the liquidity fee depends on channel bandwidth. Both fees are often much lower than standard network charges. 

Then What Is The Problem?

There currently isn’t sufficient liquidity on the Lightning Network to facilitate large volumes. More specifically, there is currently 1,203.81 BTC in liquidity on the network. That isn’t sufficient to facilitate too many transactions today. Until this number rises spectacularly, the LN will remain a bit of a niche solution. That is unfortunate, as it is much faster and cheaper to use.

One also has to keep in mind the Lightning Network is still under development. It is a complex infrastructure to test properly and ensure no mishaps can take place. Moreover, using the LN isn’t as intuitive as using Bitcoin, which already requires a minor learning curve. 

Until the UI, UX, and liquidity of the Lightning Network improve, it will not solve the transaction fee issue. However, some networks are off far worse compared to Bitcoin.

Ethereum TX Fees Are A Mess

Anyone who has used the Ethereum blockchain over the years will know its transaction costs are variable. More specifically, you may pay $15 one day and $130 the next. Tgere is too much variation in the network costs, primarily due to scalability concerns. The current iteration of Ethereum is incapable of handling all of the data and transactions.

As Ethereum is developer-oriented, these high fees pose numerous problems. Using DeFi solutions or decentralized exchanges can become incredibly expensive very quickly. Although that network uses a different calculation method, the gas limit for Ethereum can make things unsustainable. Not long ago, a gas limit of 21,000 was enough. Today, a setting of over 400,000 isn’t uncommon. Rising gwei prices are slowly killing the network.

Thankfully, Ethereum has its own set of solutions. Users can experiment with the many layer-two network solutions or wait for Ethereum 2.0 to come around. This latter upgrade will introduce sharding and parallel processing, significantly reducing transaction fees. That is the plan, at least, yet the technology is still under development. Its release will prove crucial for the future of the Ethereum network.

Cheaper Options Exist

Looking beyond Bitcoin and Ethereum, there are multiple networks capable of processing transactions at much lower fees. Litecoin, Binance Smart Chain, and even XRP or Dogecoin are just a few examples. However, these are not “mainstream” networks like Ethereum or Bitcoin. To use these ecosystems for value transfers, suers will need to do ample preparation and setup, which may not appeal to everyone.

For cryptocurrency and blockchain networks, it isn’t sufficient to just be cheaper or more efficient. Competing with the two industry kings is challenging for anyone, regardless of which benefits their technology may provide. Competing on transaction fees is viable, as it pushes competitors to step up their game. However, it may not be a significant selling point for most alternative networks in existence today. 

Closing Thoughts

Although the potential cryptocurrencies can bring to the table, there is much room for improvement. Innate lack of scalability pushes transaction fees higher, which is far from ideal for users. If these currencies aim to become mainstream, those costs will need to be reduced significantly. Until that happens, there will be little or no everyday use for Bitcoin or Ethereum. 

To some, it may seem better to remove all transaction fees entirely. An intriguing idea on paper, but one that may not necessarily prove viable. Users require incentives for processing transactions, as these fees are an integral part of blockchain network economics. Taking that aspect away will lead to more centralization and control by specific users or groups. Finding a technological solution to bring fees down remains the main priority for Bitcoin and Ethereum. 

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