Fundament of the week: Transaction fees on the blockchain

Why do we need transaction fees?

Transaction fees do exist also in the realm of defi more specifically in blockchain transactions and have been an essential part of most blockchain systems since their inception. You have most likely stumbled upon them while you were sending, depositing, or withdrawing cryptocurrencies.

Most cryptocurrencies use transaction fees for two main reasons.

First of all, charges reduce the amount of spam on the network. That is because implementing large-scale spam attacks is costly which is something “spammers” will think twice about.

Second, transaction fees act as an incentive for users to help verify transactions. You can perceive it as a reward for helping the network.

With most blockchains, transaction fees are reasonably cheap but depending on network traffic, they can be quite expensive. As a user, the amount you choose to pay in fees determines the priority of your transaction when you add it to the next block. The higher the fee paid, the faster the confirmation process.

Bitcoin transaction fees

As the world's first blockchain network, Bitcoin has set the standard for transaction fees used by many cryptocurrencies today. Satoshi Nakamoto realized that transaction fee can protect the network from large-scale spam attacks and stimulate good behavior.

Bitcoin miners receive transaction fees as part of the process of committing transactions to a new block. A group of unconfirmed transactions is called a mempool . Miners will naturally prefer transactions with higher fees that users have agreed to pay when sending their BTCs to another bitcoin wallet.

Criminal entities wishing to slow down the network must therefore pay a fee associated with each transaction. If they set the fee too low, miners are likely to ignore their transactions. If they put them on the right level, they will incur high economic costs. Transaction fees therefore also function as a simple but effective spam filter.

How are BTC transaction fees calculated?

In a bitcoin network, certain crypto wallets allow users to manually set transaction fees. It is also possible to send BTCs with zero fees, but miners are most likely to ignore such transactions, which means these transactions will not be verified.

BTC transaction fees do not depend on the amount sent, but on the size of the transaction (in bytes).

For example, imagine that the size of your transaction is 400 bytes and the average transaction fee is now 80 satoshi per byte. In that case, you would have to pay around 32,000 satoshis (or 0.00032 BTC ) to have a good chance of adding your transaction to the next block.

When network traffic is high and there is a high demand for sending BTCs, the transaction fee required for fast transaction confirmation increases when other Bitcoin users try to have it confirmed too. This can happen during periods of high market volatility.

High fees as such can therefore make it difficult to use BTC in everyday situations. Buying a cup of coffee for $ 3 may not be practical if the fees are even higher.

Only a certain number of transactions can be included in a block with a limit of 1 MB (i.e. block size). Miners add these blocks to the blockchain as quickly as possible, but there is still a limit to how fast they can go.

The scalability of cryptocurrency networks is a crucial issue when setting the network fees. Blockchain developers are constantly working to resolve this issue. Previous network updates have helped to improve scalability. These were updates such as the implementation of SegWit and Lightning Network .

ETH transaction fees

Transaction fees on Ethereum work differently from those of BTC. The fee takes into account the amount of computing power required to process a transaction referred to as gas. Gas also has a variable price measured in ETH, the network's native token.

While the gas needed for a particular transaction may remain the same, its price may differ. That is because this price is directly related to network traffic. If you pay a higher gas price, the miners are likely to prefer your transaction.

How are Ethereum transaction fees calculated?

The total gas fee is simply the price that covers the costs, plus the incentive to process your transaction. However, you should also consider the gas limit, which defines the maximum price paid for a given transaction or task.

In other words, the gas price represents the amount of work required and the price for "every hour" of work. The relationship between these two prices and the gas limit defines the total fee for an Ethereum transaction or for a smart contract operation.

As an example, let's choose a random transaction on the Etherscan.io website. The transaction cost 21,000 gas and its price was 71 Gwei. Thus, the total transaction fee was 1,491,000 Gwei or 0.001491 ETH.

When Ethereum gets to the Proof of Stake model, gas charges can be expected to fall. The amount of gas needed to confirm the transaction will be lower, as the network will only need a fraction of the computing power to verify the transactions. However, network transmission can still affect transaction fees, as validators prefer higher-paying transactions.

Binance Chain transaction fees

Binance Chain is a blockchain network that allows users to trade BNBs and other BEP-2 tokens. Apart from that, users can also create and distribute their own tokens. Binance Chain adopts a consensus mechanism called Delegated Proof of Stake. So instead of miners, we have validators.

Binance Chain also powers Binance DEX (decentralized exchange), where users can trade crypto assets directly from their wallets. Transaction fees for Binance Chain and DEX are paid in the BNB. Binance Chain and Binance Smart Chain are two different blockchains.

How are Binance Chain transaction fees calculated?

Depending on the action you intend to make, the fee structure in the BNB applies. Binance DEX distinguishes between transaction fees, such as BNB sending, and fees for trading. The total transaction price may also fluctuate depending on the market price of the BNB.

For non-trade-related transactions, such as the withdrawal or deposit of a BNB in a wallet, the fees are paid in BNB only. Fees for trading on Binance DEX are payable in the traded token. However, there is a discount for payment in BNB. This scheme helps to stimulate the adoption of the BNB token and build its user base.

Transaction fees in Binance Smart Chain

Binance Smart Chain (BSC) is another blockchain built by Binance that runs in parallel with Binance Chain (i.e. two separate networks). While the BNB running on the Binance Chain is a BEP-2 token, the BNB on the BSC is a BEP-20 token.

The Binance smart chain allows you to create smart contracts, making it more customizable. The fee structure on the BSC is not as rigid as on the Binance Chain. Instead, a gas system (similar to the Ethereum system) is used, which reflects the computing power required to perform transactions and operate with smart contracts.

The BSC uses the Proof of Authority consensus mechanism. Network users must use the BNB to become a validator and will receive transaction fees after successful block validation has been completed.

How are transaction fees calculated in Binance Smart Chain?

As already mentioned, the structure of the BSC fees is very similar to the structure found on Ethereum. Transaction fees are calculated in Gwei, which is a small nominal value of BNB equal to 0.000000001 . Users can set their gas prices to prioritize their transactions added to the block.

To find out the current and historical average gas price, BscScan provides the daily average along with the lowest and highest price paid. Since March 2021, the average BSC fee has been around 13 Gwei.

In the example below (taken from Bscscan.com), the price of gas was 10 Gwei. The gas limit was set at 622,732 Gwei, but only 352,755 (52.31%) Gwei was used in this transaction, resulting in a transaction fee of BNB 0.00325755 .

BSC fees are usually very low, but if you try to send tokens without having a BNB on your account, the network will alert you that you do not have enough funds. That is why you should not forget to leave some other BNBs in your wallet so that you can pay for the transaction fees.

In conclusion

Transaction fees are an integral part of the crypto-economics of blockchain networks. They are part of the incentives provided to users who keep the network up and running. Fees also provide a certain layer of protection against malicious behavior and spam.

However, the volume of traffic received by some networks has led to significantly higher fees being charged. The decentralized nature of most blockchains makes it difficult for them to scale. It is true that some networks provide high scalability and throughput of transactions, but this often comes with a certain trade-off in terms of security or decentralization.

There are still several researchers and developers working on improvements that will hopefully bring more inclusion when it comes to the use of cryptocurrencies in the developing world.