Blockchain Transaction Fees Explained 2021
Why do blockchains need transaction fees? Where do Bitcoin transaction fees go? How to calculate Bitcoin transaction fees and why are Bitcoin fees so high?
Blockchain Transaction Fees Explained
When we speak about a transaction in cryptocurrency, we cannot leave without paying attention to transaction fees. The blockchain fee is a fee collected to process your transaction. It is used for two purposes:
- To reward stakers or miners if the coin can be mined;
- To protect the coin network from spam.
The blockchain fee is applied to all the transactions in a specific blockchain. Different blockchains have different principles on how to charge such fees.
What Are Bitcoin Transaction Fees?
Let us check how blockchain fees work and how they are determined using the example of Bitcoin, the most expensive cryptocurrency.
The fees in the Bitcoin blockchain are not high. You can even try to transfer Bitcoins with a zero fee. However, we don’t recommend doing so.
The thing is that transactions in Bitcoin are confirmed by miners. When miners mine a block, they get a reward and transaction fees contained in the block. Miners aren`t assigned blocks randomly or in a specific order. Miners choose the blocks that they want to mine on their own. It means that the blocks with the highest transaction fees will be mined first. And if you have chosen to send coins with a zero fee, most likely, your transaction will be ignored by miners.
Why Do Blockchain Transaction Fees Exist?
Coins can be mined or staked. Miners get blockchain fees and a fixed reward when they mine a block. Stakers receive only transaction fees. It looks that for miners, fees do not constitute a significant part of the income. But in the case of Bitcoin, the reward is decreasing. It will come to the point once when miners will not get any reward but their efforts will be paid with fees only.
So, transaction fees are used to pay rewards to those who take care of registering transactions in a blockchain. This is not the only function of transaction fees though.
They reduce the possibility of spam in the network. In other words, their function is also in increasing network security. Large scam attacks become too costly to implement, and thus, the possibility that one might do it is reduced significantly.
How Are Blockchain Fees Calculated?
Different blockchains calculate their fees differently. On some of them, fees are static, while on the others, they are dynamic. So, we again need an example to show how the fees are calculated.
Bitcoin Fees Explained
The Bitcoin blockchain has dynamic fees. The fee is calculated for every single transaction, and some wallets even allow users to set their own fees.
The fee depends on the transaction size. For example, you send a transaction with the size of 600 bytes. If the average fee is 80 Satoshis per byte, you will need to pay 600 x 80 = 48,000 Satoshis.
This fee is not fixed. When the market volatility is high, the fee might increase.
Ethereum Fees Explained
The Ethereum blockchain applies static fees. It considers the computing power that is needed to process a transaction. The fees in the Ethereum blockchain are paid in gas. For a specific translation, the amount of gas is the same. However, the gas price itself might fluctuate, like the price of any cryptocurrency.
Is a Network Fee the Same as a Fee Charged by an Exchange?
No, these are two completely different types of fees. A network fee is charged by the network. This fee type is used for the inner purposes of the network:
- To motivate miners;
- To award stakers;
- To perform transactions;
- To protect the network, and similar.
Fees charged by cryptocurrency exchanges are the funds that an exchange charges for its services. You pay it in addition to the network free.
What Factors Contribute to Transaction Fees?
Two main factors influence transaction fees:
- The transaction size;
- The demand for block space.
Some blockchains have blocks of limited size. Miners can include in a block a specific number of transactions only. When many users want to send funds via the blockchain, the demand for block space increases drastically. More and more transactions are waiting for confirmation. In such time periods, transaction fees might grow. Sometimes, so many unconfirmed transactions are accumulated that the network experiences congestion. The fees might surge to a level that might be not sustainable for a transaction.
Then, the transaction size: bigger transactions take longer to be processed and the fees are usually higher.
How Expensive Are Bitcoin Transaction Fees?
Normally, Bitcoin fees are not high. On average, a transaction fee is 0.30 USD. But in the Bitcoin network, fees are dynamic. Every Bitcoin transaction fee is calculated depending on the transaction size.
Also, some wallets allow users to set up a transaction fee manually. We don’t recommend doing so though. Miners pick the transactions they want to include in a block on their own. They prioritize transactions with higher fees. If you don’t set any fee or it is lower than the fees set by other users, your transaction might be simply ignored.
Reducing Bitcoin Transaction Fees
If you transfer considerable amounts of funds, you don’t mind paying 30 cents or even more as a fee. However, what about sending small amounts? For example, if you want to buy a cup of coffee with Bitcoin, the fee of 30 cents will be already too high for the transaction.
Is there a solution to reduce fees for micro-transactions? Yes, there is a solution that reduces the blockchain transaction fee if you are transferring a small amount. This solution is called the Lightning Network. It is a second-layer protocol built on top of the Bitcoin blockchain. The Lightning Network allows nodes to open a channel between them and process an unlimited number of transactions. After the transactions are performed, the channel is closed. Only the transaction that is opening and closing the channel is registered on the blockchain while all those transactions that are sent between, are performed off-chain, and the network fees are not charged on them.
The main drawback of the Lightning Network is the lack of security for those transactions that are performed off-chain. They are not on the blockchain, and they are not protected.
How Bitcoin Wallets Deal with Fees
We have mentioned that some wallets allow you to set up your own fees. You also know that if your fee is lower than the average, your transactions will be processed in the last turn.
How can you learn what fee is suitable at the moment when you want to transfer your funds?
The most advanced wallets not only allow you to set up any fee you want. They also monitor the market conditions, including fees, and suggest a fee that is more suitable at the moment.
Where Do Bitcoin Transaction Fees Go?
Transactions on the Bitcoin blockchain are confirmed by miners. Fees are given to miners to motivate them to process transactions.
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