update 14 September 2021

The Correlation Between Blockchain Activity and Transaction Fees

Miners and validators are essential cogs in any crypto project. They’re the ones who process transactions on a blockchain (BC) activity. For their efforts, crypto projects compensate them for their efforts from transaction fees. A transaction is only valid when it has undergone validation. The process ends in the validators adding it to the BC. Mining consumes a lot of computing power. As such, it’s an energy-intensive exercise. The motivation for the miners is the block reward that consists of two variables. First is the block subsidy, and the second is the transaction fees. For the Bitcoin (BTC) network, every block added to the BC attracts a block reward of 6.25 BTC and transaction fees sent with them.

What are Transaction Fees?

Transaction fees are charges that users pay for crypto transactions between wallets. These fees are flexible and fluctuate based on the activities on how dynamic the BC network is. When you want binding confirmation of your payments, you incentivize the miners. You pay higher fees so that miners can fast-track your transactions. 

The fee that you pay depends on several factors. One, there’s the data size of the transactions you wish to make. Also, there’s the network condition at the time of the transactions.

Without the miner’s reward, verification would stall. Eventually, it would cease altogether. Catering for the mining resources is a costly affair. Thus, the only incentive to go on is the compensation that it attracts. 

As fees influence the pace of transactions, it’s crucial to pay the right amount. Higher fees mean faster confirmations. Conversely, low fees lead to longer processing times and, in some instances, cancellations. 

The Reason for Transaction Fees

BTC introduced the fees initially as an anti-spam tool. It was to prevent overloading of its network due to malicious actors. During that time, these transaction fees didn’t seem like much of a big deal. 

As time went by, they increased as the block sizes, and BTC’s value increased. They became expensive for users who wanted to send small amounts of cryptocurrencies.

Bitcoin’s increase in block sizes was a result of its SegWit2x upgrade. That action made transaction fees an integral part of the platform, with costs lower than 0.01 BTC. Ethereum (ETH) and Ripple (XRP) have since followed suit.

How do the Fees Work?

On Bitcoin, all pending transactions reach a mempool where they await picking by miners. Once the mempool fills, miners choose transactions with high fees while leaving the rest for the following block. This way, they force the users to increase the transaction fees.

Transaction fees are equally crucial for the Ethereum network. They enable the provision of sophisticated features like decentralized applications (dApps) and smart contracts. On ETH, the fees go under the name of “gas.” And one major challenge the network faces is crypto users failing to include adequate gas in their transactions.

In Ripple’s case, transaction validation doesn’t generate new XRP coins. As a result, the network charges low to negligible transaction fees are.

How Do You Determine Transaction Fees?

Earlier on, we saw that network congestion and data volumes affect transaction fees. A block on BTC contains up to 1 MB of data. This limitation influences the number of transactions to process on a block. Large transactions pay more fees on a per-byte basis.

If you’re transacting from a BTC Wallet, it’ll calculate and give you the fees rates. The fee rate totals as satoshis per unit of transaction data (sats/vByte). This rate multiplies by the size of your transaction to get the total transaction fees.

Factors that affect transaction fees

Transaction fees gradually fluctuate depending on several factors. Two significant reasons for this variation are: 

Network conditions

Only a few transactions are part of any block. One bitcoin block can accommodate up to 1 MB of information. During congestion, many users are sending funds, and there is little space in the block. Users, therefore, have to wait longer for confirmation of their transactions.

When a user decides to send funds, they broadcast it first. It goes into a mempool before adding it into the block. If the mempool fills, the fee market turns into a competition. The users include higher fees to get their transactions into the block. Finally, the transaction fees will reach an equilibrium that the users are willing to pay. The miners will now work in an orderly way through the entire mempool. Once the traffic subsides, the fee falls back to normal.

Transaction size

The size of a transaction is essential for the miners. It’s easy to confirm small transactions, but it takes longer to validate more significant transactions. Substantial transactions take up more space in the block. Large transactions require higher fees to process.

It is not easy to calculate the transaction fees manually. If you’re using a Blockchain Wallet, an in-built dynamic fee structure will calculate the ideal transaction fees. 

When are Transaction Fees High?

The transaction fees rise when more people use a blockchain network,

During a Bull Run

Transaction fees escalate during a bull run. During a bull run, traders are willing to pay high prices to process their transactions quickly. There is high demand for these services with a few miners. An increased supply of miners these days has eased the burden of transaction fees on a blockchain network.

Exchange Fees

Some exchanges charge high fees to cover the network fees associated with cryptocurrencies. They also fix withdrawal fees to cover their transaction fees. They depend on the number of transactions on the network. The exchanges may add trading fees to cover the services.

Final Word

No one owns a blockchain network. Transaction fees help to pay miners for confirming transactions. Otherwise, they would be doing free work, and no one in this world likes to work for free. Transaction fees have also facilitated quick and secure transactions. Payment of these fees is necessary to eliminate several digital issues.  

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However, with the growing blockchain activity, the fees tend to rise. The decentralized nature of BC makes them hard to scale. Developers and researchers are working on upgrades that will bring more updates to the networks.  

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