Cryptocurrency analyst. Founder and editor at btcpeers.com
If you have a quick read-through of the original Bitcoin whitepaper, you will find that part of Satoshi's 'sales pitch' was about the 'ultimate reduction of the cost incurred from financial intermediation' that Bitcoin made possible.
In the exact words used by Satoshi: “The cost of mediation increases transaction costs, limiting the minimum practical transaction size.”
This was written while explaining the inherent cost found in traditional transaction systems as opposed to what Bitcoin offered.
Sadly, in reality, transactions across Proof of Work (PoW) networks --like Bitcoin as well as Ethereum -- are still trapped in a quagmire of high transaction fees. This is quite ironic considering the case Satoshi originally made.
For those new to blockchain investing, high transaction fees are something you probably have been confronted with already.
That being said, this was not the case in the earlier days of cryptocurrencies, across pioneering networks like Bitcoin and Ethereum.
As you may know, one of the flaws of pioneering blockchain protocols is that miners have the liberty to select transactions they validated based on the fee size of those transactions.
Even more, with huge transactions piled up in the memory pools of networks like Bitcoin and Ethereum, the laws of supply and demand almost always skyrocket the network fees or 'gas fees' for Ethereum.
For instance, when one takes a look at Ethereum's network activities --while comparing network traffic and transaction fees-- it's easy to see this playing out.
This is similar to when scarcity and high demand for a particular concert ticket push ticket prices through the roof.
Now that we have had a brief background of the state of cryptocurrency fees, it’s time we look at some of the 'fee types' we all confront when dealing with cryptocurrencies.
In August 2020, the average fee per transaction on the Ethereum network rallied to an all-time high of $6.04.
This was the highest we had seen since 2015. According to experts, the surge in fees coincided with the skyrocketing activities of decentralized financial protocols like Uniswap.
As if that wasn’t enough, Ethereum network fees increased by a staggering 470%, reaching a new record high on May 11.
According to various reports, a single swap transaction went for as high as $300.
As you may know, every single time you send crypto assets from your wallet to another receiving wallet address, you incur a transaction fee or a 'network fee' as many choose to call it. This is assuming the wallet is not on some centralized exchange like Binance or Coinbase, which technically is done off-chain.
That being said, the exact fee you end up paying for every cryptocurrency transaction depends on the consensuship protocol of the network you’re using and the traffic on that network.
For instance, a Bitcoin or Ethereum transaction (which uses PoW for consensuship) will have a totally different fee from let’s say Cardano or the Binance Smart Chain (which uses Proof of Stake (PoS) for consensuship).
While PoW networks have higher fees -- especially as the network gains volume -- PoS networks have lower fees.
However, most earlier networks were not built this way and are having a hard time switching. For Ethereum a full switch to its 2.0 version (which uses PoS) is going to take approximately two years.
For the most part, the most-used networks like Ethereum will continue to have the network fee problems, which begs for a practical solution.
While we crave fully autonomous self-sovereign decentralized finance products, the cost that comes with such on-chain level transactions is hard to process.
Following the astronomical rise in DeFi and NFT adoption -- and the effect on fee prices -- answers are emerging for this problem.
Some of these answers include the introduction of entirely new blockchains, like the Binance Smart Chain, Polkadot and so on, which have also had quite a huge reception.
That being said, there still remains the question of isolation, network security, true decentralization, and backward compatibility with existing decentralized services already built on the Ethereum network. They intertwine heavily with the existing economy.
On an optimistic glance, the implementation of Ethereum 2.0 -- although still unfolding-- will soon make the transaction fee enigma a thing of the past.
Already there are a few ETH2.0 solutions optimizing for a feeless environment, both for DeFi and NFT products.
For example: Cryption Network is already building an exchange that allows for gasless DeFi transactions across the Ethereum network.
This will allow DeFi traders to finally trade without gas fees.
Anytime you decide to buy a crypto asset, you have to buy it from someone who is ready to sell.
Since exchanges (either centralized or decentralized) facilitate these markets, they are the entry point for cryptocurrency purchases.
Regardless of whether you want to trade your crypto portfolio for other assets, or convert your fiat currencies to digital assets, an exchange is the cheaper and more convenient way to trade cryptocurrencies.
Unlike trading directly, exchanges offer the users the supervision of an escrow system and also liquidity that you won't find trading Peer-to-Peer across chains. However, that comes at the price of losing the control of your funds.
You know what they say about private keys: “Not your key not your funds.”
It is also worth noting here that DeFi exchanges afford you the privilege of full sovereignty and some liquidity. However, since they are on-chain the fees are still high.
That being said, exchange services aren’t provided for free by exchanges. So to generate some sort of income, they charge users fees on every trade executed on their exchange.
These fees are what make operating an exchange profitable for the owners.
Also, with centralized exchanges (CEX) every transaction is done off-chain on an exchanges order book. This is pretty much superficial and is technically not a blockchain transaction, as it leaves the traders exposed to all of the counterparty risk involved with trusting a third party.
Transaction fees at their core aren't such a bad thing -- especially when you factor in the need for security on a decentralized platform. These types of incentives keep miners working.
But with the skyrocketing prices of transaction fees, especially on the Ethereum network, this space craves alternatives (which we are already seeing).
Currently, the Ethereum decentralized network is the most expensive chain out there to transact and build on, with regards to gas fees. Fortunately, with the implementation of PoS, fee problems will be reduced significantly.
Also, there is the rising adoption of on-chain bridge technology, which allows for cross-chain interoperation of DeFi projects.
With this technology, we will be seeing a more harmonious, liquid and efficient space, rather than isolated blockchain technologies trapped in their separate worlds.
The author does not have any vested interest in the projects mentioned above.
The opinions in this article belong to the author alone. Nothing in this article constitutes investment advice. Please conduct your own thorough research before making any investment decisions.
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