Introduction to cryptocurrency transaction fees
Introduction to cryptocurrency transaction fees
Like most things in life, there’s a fee attached to cryptocurrency transactions. Every time you send any cryptocurrency, from your address to another, you incur a network transaction fee.
This fee is either added on top of the value of crypto you are sending, or deducted from the end cryptocurrency, depending on the wallet or exchange you are using.
The actual fee you pay will vary according to the network you use. A Bitcoin transaction will warrant a different fee to transactions placed on the Bitcoin Cash, Ethereum or Litecoin network – and so on and so forth.
Crucially, the fee you pay is not a consistent figure – it can fluctuate depending on market demand and network capacity for confirmations. Average transaction fees on the Bitcoin network, have been progressively increasing since the cryptocurrency’s inception in 2009 due to transaction capacity becoming an artificially scarce resource.
Why are there fees? Who benefits?
The fees are received by miners. More specifically, the fee is received by the miner who verifies the block on the network which contains your particular transaction.
Miners receive the fees because they use their computing power to verify transactions and uphold the security of the network. Miners receive these fees in addition to the new cryptocurrency that is released when a new block is mined. In other words, they are doubly incentivised to do the work they do because they receive both fees and the ‘block reward’.
How are fees calculated?
The amount you pay per transaction is determined by how much you’re willing to spend. There is often a degree of outbidding involved – the more you pay, the more people you outbid and the faster your transaction is processed. The transactions of those people you’ve outbid are deprioritised.
Outbidding makes sense for larger transactions that are worth thousands or even millions of pounds worth of Bitcoin. Most people who are sending transactions of this size won’t mind paying a fee which is minimal by comparison. Of course, there is no point paying a fee of five pounds worth of Bitcoin if your transaction involves buying a coffee that amounts to two pounds worth of Bitcoin!
This isn’t to say smaller transactions aren’t processed at all - however, they’re likely to be processed slower, should the network be congested, as people are less likely to pay higher fees on them.
Sometimes the digital wallet software that you use will give you a suggested bid – but it’s worth doing your own research instead of simply going along with what you are told. There are resources available that allow you to track the average fees that are being paid for transactions of different sizes (in bytes). Brushing up on this information may save you money in fees.
Why have fees increased?
Fees typically increase in accordance with the growing usage and popularity of cryptocurrency networks. Bitcoin is the best example of this. As Bitcoin has surged in popularity, more people are seeking to place transactions within the network, and the pressure on the network is increasing as resource is scarce.
Making matters worse is Bitcoin’s scalability problem. Its block sizes are limited to 1MB each, which restricts the number of transactions Bitcoin can process to approximately 7 per second. . More and more transactions are occurring, due to increased demand, yet the block size remains the same. The result is that transactions are taking more time to process, and people are paying higher fees to get their transactions processed first.
Solutions to the problem of increased fees
The simplest way to tackle the problem of increased fees on the Bitcoin network (and other networks for that matter) is to make it possible for more transactions to be processed faster. Solutions are currently in the works to address these scalability issues – the SegWit soft fork (we covered soft forks and hard forks in a previous lesson) is a good example. In short, SegWit aims to free up more space in the block for transactions by removing signature data and moving it elsewhere.
Another example of a solution is the Bitcoin Cash hard fork. This has increased the block size to 8MB, and in doing so, has created its own separate blockchain and corresponding cryptocurrency. As solutions are being worked on, newcomers in the cryptoverse should be made aware of transaction fees. Before initiating a transaction, consider the fees as well as the time involved to process your transfer. If you’re diligent and dedicate the right time and effort to doing the necessary research, you can be more cost-efficient with regards to the fees you pay on your crypto transactions – and save money in the process.