Blockchain Transaction Fees: Why It Matters?

In 1998, Chinese engineer Wei Dai first introduced the concept of “cryptocurrency”. Unlike regular currency, digital currency exists only on the Internet. Users can exchange cryptocurrencies online after purchasing tokens using “real”, i.e. traditional or fiat, currency. Cryptocurrency eliminates the need for a central controlling body such as a financial institution or government office and instead creates a fast, simple and efficient way to exchange money for people all over the world.

About ten years after the idea of ​​cryptocurrency was first described, an innovator under the pseudonym “Satoshi Nakamoto” revealed concept Bitcoin. Bitcoin (or BTC) is one of the most popular forms of cryptocurrency today. While bitcoin has eliminated the need for a central authority, it has not eliminated the costs associated with the technology behind cryptocurrencies. Knowing how this technology works will help you better understand transaction fees – and how to minimize your costs when using cryptocurrencies.

Blockchain, databases and bitcoin

All verified bitcoin transactions are stored on a blockchain, a type of database that stores data electronically. The main difference is that databases use tables to structure data, while blockchain stores data in blocks. When a block is filled, it is added, marked with time, and “clings” to the previous one. This creates a record with easily accessible data and an unchanging timeline.

Like databases, blockchain requires multiple computers to manage and store data. However, databases use servers that are usually owned by a specific person or organization, whereas a blockchain stores data across multiple computers belonging to multiple people or organizations.

The Bitcoin network includes thousands of computers called nodes that work together to validate transactions, fill in blocks, and keep the system running.

Blockchain trilemma

For a blockchain to function at its best, it must be secure, decentralized, and scalable. Blockchain trilemma, a concept introduced by a programmer (and founder of Ethereum) Vitalik Buterin, refers to the idea that blockchain projects attempt to meet all three ideals.

Blockchain developers use the concept of trilemma to further improve networks and create tools to achieve optimal functionality.

Security

Blockchain is designed to be democratic and immutable. Blockchain security is maintained through encryption as well as consensus algorithms that dictate the number of network nodes required to confirm transactions before completing them. And because the blockchain is made up of a series of blocks that write data to a time-stamped hash function, it has proven to be resistant to data falsification and hacking.

Decentralization

One of the tasks of central agencies is to prevent double spending and similar problems. However, they are vulnerable to DDoS attacks and other security issues. The idea of ​​a decentralized blockchain network stands for an environment where no one needs to know anyone, as each node is fed the same information in a distributed ledger.

Decentralized systems like Bitcoin are inherently immune to these problems, and algorithms or consensus mechanisms provide additional system security by preventing double spending and ensuring peer equality. If someone tries to change or mess up the ledger, most of the network must come to a consensus to do so.

Scalability

During periods of heavy use, congestion can occur, slowing transaction processing and increasing user costs. Blockchain scalability is essential to maintain a competitive edge over centralized networks.

To overcome and solve the blockchain trilemma, some developers recommend making direct changes to the network—layer XNUMX solutions such as Ethereum. Others propose developing secondary networks, or second-layer solutions designed to work alongside the blockchain, such as Lightning Network in Bitcoin or Litecoin. It is important to note that blockchain technology is still in its infancy, and as it matures, potential solutions to the blockchain trilemma will emerge.

Why are there transaction fees in Bitcoin?

In the early days of Bitcoin, miners worked quickly to confirm transactions. With the rise in popularity of digital currency, transactions have become more numerous and complex. Bitcoin transaction fees were introduced to speed up the verification of Bitcoin transactions.

The commission is tied to the size of the transaction and the age of the entry. In other words, a transaction with more bytes, occupying more block data, will have a higher transaction fee. Additional fees can speed up the passage of a transaction through the system, essentially putting it in a priority queue. In other words, you can pay more to get transactions confirmed faster.

The collected fees go to miners who confirm and record Bitcoin transactions and help keep the system running:

  • support transaction processing
  • pay miners who confirm transactions
  • elimination of spam transactions.

In other words, Bitcoin transaction fees protect and preserve the integrity of the Bitcoin network.

Understanding Bitcoin Transaction Fees

Conceptually, Bitcoin transaction fees represent the rate at which a user wants their transaction to be confirmed on the blockchain. Although the decentralized nature of Bitcoin makes it easy for anyone to participate as a miner – which means verifying and recording transactions that form a block and are combined into a chain. However, the process of mining Bitcoin, or BTC, is complex and expensive. Mining rigs are expensive and often consume huge amounts of electricity, and the blockchain subsidy and transaction fees help offset these costs and incentivize miners every time a new block is confirmed.

Miners receive transaction fees and block subsidies as “block rewards” every time they successfully add a block to the blockchain. The block subsidy is fixed every time Bitcoin is mined and is halved (Bitcoin halving), which will happen every four years or every 210 blocks. In 000, you could get 2009 BTC for mined bitcoin, in 50 - 2012 BTC, but over the years the reward has halved, and in 50, when the last decrease occurs, the reward will be 2020 BTC.

Reducing by half leads to a decrease in the hash rate, which increases the processing power and energy required to mine new blocks. However, rising transaction fees are encouraging miners to keep the network safe and healthy. Transaction fees are determined based on several factors:

  • how congested the cryptocurrency network is at present
  • the amount of data contained in a particular Bitcoin transaction
  • transaction priority. \

The last point is under the control of the user. If you need your Bitcoin transaction to be processed urgently, you can pay a higher priority fee. If your transaction is less urgent, you can opt for a lower fee. In this case, the transaction will remain in the memory pool (or mempool) until the traffic slows down.

A memory pool can be thought of as a queue. When you initiate a transaction, it gets into the mempool. Pending transactions remain in the mempool until miner will not approve and add them to the block. When the mempool fills up, miners choose higher fee Bitcoin transactions first.

Such a system can provide smoother transaction flow, but it can also lead to a kind of rate war. Many people using cryptocurrencies are willing to pay to have their transactions completed first. However, this tactic can backfire, especially during periods of heavy use. Some users end up overpaying, forcing other miners to raise fees as well.

Transaction Fees: Bitcoin vs Ethereum

The biggest cryptocurrencies are Bitcoin (BTC) and Ethereum (ETH) and understanding how fees are calculated can ensure that you pay a fair amount for executing a transaction without getting into a bidding war or staying in the mempool unnecessarily.

Calculating transaction fees in bitcoins

To calculate your bitcoin transaction fees, you have several options. Some wallets can automate this process, allowing you to choose how quickly you want to complete the transaction and pay accordingly.

Check first current ratesand then multiply them based on the size of your transaction. Bitcoins are divided into satoshi, which make up one hundred millionth (or 0,00000001) BTC. If your transaction size is 225 bytes and you choose 100 satoshi per byte, then you will have to pay about 22 satoshi, since 500 x 100 = 225. Currently, this is just over $ 22, given that 500 satoshi is equal to $ 14 , 1 or $ 0,00056666 BTC as of October 0,00000001.

Calculating transaction fees in Ethereum

Until 2021, all transactions on the Ethereum network were based on “gas”. Gas is a unit related to the amount of computing power needed to complete a particular transaction. The properly named gas refers to the energy used to keep the Ethereum network running.

In this payment system, everything is connected with gas. A simple addition problem may require as little as 5 units of gas, while a real transaction may require 20 to complete. To determine the transaction fee, the user needs to know the gas price, which is measured in gwei, or the equivalent of 000 (one billionth) ETH.

To calculate, you will need to multiply the gas price by the gas price. For example, you might have a transaction that costs 20 units of gas, and the gas price is 000 gvei.
Gwei is the denomination of Ether (ETH), a cryptocurrency that is used to pay for goods and services on Ethereum bl…
... The total cost of this transaction is two million gweys, because 20 x 000 = 100 million. This is a little more than $ 2 if we assume that 7 gvey is equivalent to $ 1.

Users can set “gas limit
A gas limit can be defined as the maximum amount of gas that someone will pay for an operation to be performed on ...
“, which meant a spending limit, or how much gas you want to use for a particular operation. Complex operations required more work, so gas limits for them were necessarily higher than for simpler operations.

However, this system proved cumbersome and many users underpaid, which could result in a transaction being rejected or having to overpay. (Think of this as putting too many stamps on an envelope you want to mail instead of risking the letter being returned due to insufficient postage.) The EIP-1559 update has changed the way we pay for transactions. Instead, ETH users will pay a base fee for specific transactions. A portion of each fee collected is “burned”, which takes the coins out of circulation, while the rest goes to the miners. ETH users also have the ability to “tip” miners, which can speed up the processing and recording of their transactions.

Average transaction fees

Transaction fees are a necessary fee for conducting financial transactions in the 21st century, and cryptocurrency transactions are no exception. Both Bitcoin and Ethereum tie the cost of a transaction to its size, and users can pay more to speed up the process. The average cost of a bitcoin transaction fluctuates from day to day, depending on traffic volume and other factors. The same applies to the Ethereum network.

Now average bitcoin transaction fee is from 2 to 5 US dollars, which in translation means from 3 700 to 9 170 satoshi. Average transaction fees on the ETH network ranges from 2 to 7 dollars, or from 0,00056 to 0,002 ETH.

Average number of transactions per day

The BTC and ETH networks are thriving, with a huge number of transactions being made and verified every day. About 200 - 000 transactions are made daily on the Bitcoin network. On the Ethereum network, by contrast, more than 300 million transactions are made every day.

Completing transactions on a day when traffic is low can reduce transaction speed without forcing you to compromise on verification speed.

Alternatives

Bitcoin's high transaction fees are attractive to miners, but may not be as popular with users. The fee structure may be such that some users pay a fee equivalent to the amount of the transaction, especially when it comes to small transactions.

Transaction fees are not the only problem with bitcoin. Scalability also turns out to be a kind of “Achilles heel”. The Bitcoin protocol clearly defines the block size and its generation, which limits Bitcoin to about seven transactions per second.
Transactions per second (GST) is the number of transactions that the blockchain network can process every second, or the number of ...
or TPS. This led Bitcoin to fork into additional forks such as Bitcoin Gold (BTG) and Bitcoin Cash (BCH). Ethereum, on the other hand, has larger blockchains and can handle around 20 TPS, while ETH 2.0 paves the way for a more scalable solution.

To change the Bitcoin protocol, all its users must agree and choose specific software. The Lightning Network offers an alternative that is designed as a Layer XNUMX payment protocol, which means it sits on top of the blockchain. With the Lightning Network, many transactions can be made before closing the payment channel and making the final settlement with the blockchain.

Lightning Network

Lightning Network is an off-chain solution that sits on top of the blockchain, not just on the Bitcoin network, and helps process payments on the blockchain quickly and securely without potentially long block confirmation times. It even allows users to perform cross-chain atomic swaps instantly without relying on third parties.

One of the main advantages of the Lightning Network is the ability to make small payments, even less than one satoshi. The process is more private, which allows many separate transactions to be carried out without being broadcast over the blockchain. As the name suggests, the Lightning Network is fast too, with virtually no TPS caps. Settlement times are also fast: an average transaction takes about a minute or less. The commissions are also lower.

For those looking for privacy, speed, and accessibility, the Lightning Network offers a great alternative.

More scalable consensus mechanism

A consensus mechanism or algorithm is a specific protocol designed to allow computer networks to work together efficiently while maintaining security. The algorithm is often used to ensure the efficient functioning of the crypto network and prevent certain types of system attacks.

If the main disadvantage of Bitcoin is its scalability, then a more scalable consensus mechanism could help reduce costs. Bitcoin currently operates on a Proof of Work (PoW) consensus, which requires each node to solve complex mathematical problems in order to validate a transaction. The one who is the first to solve the problem can add the next block to the chain. Then the block is verified and the data is entered into the blockchain.

Protocol proof-of-stake (PoS) is more scalable and sustainable than PoW. PoS links mining power to ownership. Miners do not need to waste energy on solving math problems, instead they are limited to mining a certain number of transactions associated with their share of ownership. A miner with a one percent ownership can mine one percent of the blocks.

PoS systems are also less vulnerable to certain types of economic attacks. A miner must own more than half of the digital coins on the network in order to launch a systemic attack, which would be disadvantageous to his interests.

Ultimately, a PoS system is more scalable, energy efficient, and secure than PoW systems.

Breakdown for a smaller congestion

Just as traffic congestion causes congestion, more transactions pending on the network lead to slower traffic and higher fees. Consequently, during periods of peak usage, fees tend to increase.

If your bitcoin transaction is not urgent, you can pitch a tent and wait for the opening, similar to how you can choose to check out later in the day to avoid rush hour traffic. Blockchain tends to have predictable peaks and valleys as businesses make larger transactions. Waiting until the weekend to complete your transaction could mean less traffic, faster transaction clearing, and lower fees. This is one of the advantages of markets that never close.

While custom fees are possible, miners prioritize and process transactions based on several factors, including fees. Larger transactions may take a little longer to process, but they will be added to the blockchain usually when traffic slows down.

Сonclusion

Higher or lower fees can significantly reduce your bottom line and affect capital gains or losses. While these fees are a necessary part of digital asset transactions, you can take steps to lower overall costs and reduce the risk of overpayment, whether it is choosing an alternative system for small transactions like the Lightning Network or waiting for the perfect time to process your transactions. Researching options and finding the best one for your needs can help you save on both the cost of your transactions and the cost of running a business.

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