As a matter of fact, the past year has been a really exciting one for Bitcoin and all other cryptocurrencies. Cryptocurrency has become a trending topic in the general public but it is often condensed to a mere small talk.
On the other hand, crypto aficionados and experts alike have been faced with a series of arising problems and heated debates within the community. We have borne witness to the rise of altcoins and new regulations followed by numerous reports of hacks all over the world, and the problem with the so-called “hard forks”.
This translates into a hefty package, full of intricate technicalities with a pinch of drama. Of course, no such big phenomena goes unnoticed, and the media’s attention was caught by the buzzing discussions within the crypto-community.
In a broader sense, 2017 has really been the year for Bitcoin, but there seems to have been an underlying problem waiting to unravel all along. Because of Bitcoin’s architecture design, the sheer amount of rising transactions was inevitably followed by an exponential rise in the transaction fees.
The average Bitcoin transaction catapulted to a mind-boggling $32.5 in January 2018 from $0.4 per transaction in January 2017. The situation got worse to a degree where big companies like Bitspark and Steam started refusing Bitcoin payments and moved onto other alternatives i.e altcoins.
Table of Contents:
Even though the situation appears to be a bit absurd at the moment, and it looks like Bitcoin has lost one of its most valued features which is the “low transaction cost”, the adoption rate is still growing at an extraordinary, upward progression.
Moving further down in this article, I will try to shed light on the importance of transaction fees and touch upon the abrupt rising in prices, which will hopefully give valuable information to present and future investors alike.
Bitcoin Mining
Mining is one of the fundamental elements of the Bitcoin protocol and simply put, it is the process where the Bitcoin network issues new bitcoins and reaches emergent consensus on the state of the blockchain.
One must first understand how mining works before getting into detail about the transaction fees. Expanding on the topic of mining, we come across specialized nodes called miners who run a computerized hardware called the “mining rig”, and because of Satoshi Nakamoto’s ingenious solution of removing the need for third trusted parties (TTP), the clearing and settlement of transactions is done within the network by the miners themselves.
Initially, all of the miners compete in solving a complex mathematical problem and whoever comes up with the solution first, will have their “block” integrated into the decentralized ledger and ultimately have their transaction validated. This is widely known as the proof-of-work algorithm or PoW.
Those who tend to follow the rules will be encouraged to do so even more because they will receive the benefit of the newly mined bitcoins from the coinbase transaction, and all of the fees that the users of the Bitcoin network will integrate into their transactions. However, if the miner decides to bypass the rules and cheat the system, not only will he be left with an astronomical electricity bill, but more importantly, he will have all of his blocks discarded as invalid.
Yep, that’s the beauty of it. This means even hackers will have to play the game fair and square.
Bitcoin Transaction Fees
Considering transaction fees, we must understand that they are not a part of Bitcoin’s policy, nor an imperative duty, but because of the widespread adoption which resulted in a high volume of transactions, they have become a functional necessity.
In fact, the miners are made aware that the blocks have limited capacity of 1 Mb data averaging 2000 unique transactions per block, and taking in consideration that one block gets mined every 10 minutes on average, what follows through is that if the number exceeds more than 2000 transactions in 10 minutes, the miners will have to choose which transactions will be included in the blocks that they’re mining.
The higher the fee goes, the faster it will be processed, so it comes down to a game of profit and the smartest move would be to prioritize the transaction with the highest fees. Users of the protocol are essentially bidding to have their transactions validated and embedded into the blockchain in the fastest manner possible, by offering the miners a bigger reward for the work done.
Nonetheless, block rewards are halving every four years until all of them are mined by 2140, according to the projections, so the ultimate goal is to make transaction fees the primary incentive for mining.
Determining the price of the transaction fees
The price is determined by the market for block space, or to be more precise, the price is set at the point where the supply and demand curves meet. The transactions can be processed without fees, but trying to send free transactions can take several days, or even up to several weeks.
Naturally, when it comes to demand, spenders have different needs and some will want faster confirmations, while others will choose to wait. When determining the fees, you can either use a variety of wallets with the option of dynamic fee estimation, or you can do the estimation manually.
On the supply side of things, we already know that the protocol is limiting the maximum block size to 1mb of data and that it takes 10 minutes on average to mine it.
How does one decide on the payment fees?
In the realm of a distributed network like Bitcoin, the rules are set in code and there is no need for a centralized authority figure to control it all. But what do you think makes Bitcoin a non-controllable, decentralized network?
Let’s get started, now.
There is three types of decentralization: political, architectural and logical decentralization, which are independent of each other, but together, they are the elements that make a truly decentralized network.
Higher the fees, higher the priority of the transaction, which translates into faster confirmation time.
The size, on the other hand, is the structure of the transaction, which consists of metadata, and all the inputs and outputs, expressed in kilobytes.
Finally, the case with the parameter of age is pretty simple, the older the inputs of a transaction are, the higher the priority of the transaction.
Although you can play around with the parameters of age and size when constructing your transaction, there’s a high possibility that you will do worse than the online wallet software, so the fees remain the only reliable parameter you can use to exert influence over the priority of your transaction. Before we go deeper into choosing what fees to pay, you must ask yourself how important the speed of confirmation for your transaction really is.
Therefore, a faster confirmation means that the fees will be higher, but you if you are able to wait out a few hours, maybe even a few days, you would minimize your expense for the fees, better yet, make it non-existent.
The Automatic way
An online wallet will give you the option tо choose between two kinds of transactions. A prioritized one, with estimated confirmation time less than one hour, or a regular one where the estimated time needed for a confirmation is more than one hour.
This is the most practical and effective way of calculating how much fees you need to pay in order to validate the transaction in a sensible and acceptable amount of time. The transaction fee you chose to pay is completely up to you.
The Manual way
If you have enough spare time and decide to set the fees manually, you ought to start by using this calculator. The metrics of the site are expressed in the form of satoshis per byte, and your only concern should be the total fee of the transaction, which is determined by the size of it, measured in bytes, rather than the funds that it contains.
So, it doesn’t make a difference if you send 100 Bitcoin or 100 satoshis, as a 300-byte transaction, per se, will still cost you the same amount of fees.
Although there is no common method to see the size of your transaction before you send it, there’s one clever tactic you can use. You can set the manual fee per KB at 9 satoshis/byte which equates to 0.0009/KB (just as an example) in your online wallet.
Now, use the recommended fee from the wallet calculator to make a deduction on the size of your transaction by dividing the recommended fee by your fee per KB and then multiply it by 1000.
So, how does this work? If your wallet recommends 0.000250 and your fee per kb is 0.0009 that’s 0.000250/0.0009 x 1000 = 277.7 bytes transaction.
The above clearly indicates the recommended satoshi per byte fee, and the time you can choose to wait in minutes. However, the chart won’t help you decide whether you have the time to calculate the bytes yourself by using the previously explained method, that’s left for you to decide.
Instead of this, you can presume that your transaction is approximately between 260 and 500 bytes, the first having median size, and the latter a bit larger.
How will Bitcoin solve this problem and are there any workarounds?
There is no bypassing the rules under the circumstances which the Bitcoin protocol imposes, but there are certain ways to minimize the cost of your transactions. Before you move on from Bitcoin and start looking for alternatives in other cryptocurrencies, you can try batching multiple payments together or try dodging the times with highest transaction volumes.
Likewise, waiting a few hours might be the best thing to do, as most of your transactions are probably not that urgent. If you do decide to start using alternative coins(alt-coins) such as Monero, Dash, Litecoin, Bitcoin Cash or others, a point often overlooked is that despite the possibility of making a low fee, fast payment, there actually aren’t many merchants that accept them as a payment method.
This is the point where Segregated Witness comes into play, as an alternative technology for halving the transaction fees. As of now, only 12 % of the network is using the technology of SegWit and there is no particular reasoning behind this.
Another key point worth mentioning is that the exchanges and wallets like Blockchain.info and Coinbase haven’t utilized SegWit as of yet, making the use of it very inconvenient. Be that as it may, there are some online wallets that support the Segregated Witness technology like BTC.com, and a few hards wallets like Ledger Nano S and Trezor.
How does Bitcoin deal with this problem?
The community shares different viewpoints regarding the block size limit. One group believes that increasing storage room of the blocks to 8MB will enable more transactions per second resulting in a healthier market.
They believe that the current off-chain solutions are not ready to take offload from the main blockchain. However, other community members fear that block size increases with the storage and the bandwidth requirements for the running of a “full node”, resulting in fewer users to verify the transactions, hence a more centralized network.
As we know, the legacy Bitcoin code has a limit of 1mb of data per block, and even though it’s simple to raise the limit, the community members couldn’t reach an agreement, so the members who wanted bigger storage room forked the Bitcoin blockchain on August 1, 2017, thus Bitcoin Cash (BCH) was born.
Lightning Network
Did someone mention zero fees? Not so long ago the community was introduced to an off-chain solution called the Lightning Network which is capable of reducing the fees by taking the load off from the Bitcoin protocol, essentially solving the scalability problem without having to worry about the time it takes to confirm a block.
The Lightning Network is a powerful tool and with it, users are able to create a separate payment channel between each other and engage in a prompt conduct of many micro and macro transactions. Granted, what we are dealing with is a bidirectional payment channel which uses Bitcoin’s smart-contract scripting language in order to generate a ledger entry on the blockchain which is to be signed by both parties at any point in time.
Lastly, only the latest version of the final balance is considered valid and broadcasted into the network. The alpha version of Lightning network went live on the 10th of January and its testing phase went smoothly as the first off-chain purchases were a success.
The Future Awaits
The implementation of the Lightning network as an upgrade of Bitcoin might be able to prevent this currency from going down the drains, yet we cannot be sure of anything as there are so many randomly determined sequences happening on a daily basis when it comes to Bitcoin’s future.
The ins and outs of the cryptocurrency world are a complex matter but many think that we will eventually see it incorporated in the everyday life of our society. The modern day world is beginning to grasp on the fact the classical and centralized way of payment is becoming an outdated model.
The winds of change have started blowing, and the cryptocurrency which will propose the most simple, yet brilliant and applicable solutions, will be the rightful heir to the throne in the thriving kingdom of decentralized networks.
If you’re only getting started with Bitcoin it’s best to know a little background so click the link to learn a few things about Bitcoin and cryptocurrency.
Featured Image by D Alex