When users transfer coins from their wallet to someone else’s wallet, they pay certain transaction fees. Initially created to prevent malicious activity, transaction fees are required for transactions to be recorded in the blockchain. The amount of the transaction fee depends on various factors, including different coins, exchanges, and network congestion.
Why Do Transaction Fees Exist?
Cryptocurrency transactions are executed on top of the blockchain networks, which are maintained by the participants of the network (nodes) rather than a central authority overseeing the transactions, as in the case of a bank.
These participants assume the responsibility of verifying and authenticating the transactions, ensuring that every transaction occurring is genuine and bad agents can perform double-spending.
Nodes are incentivized by reward systems as per their consensus mechanisms, most notably PoW and PoS, for maintaining the network, which to the end-user, are reflected as transaction fees. Transaction fees are instrumental to maintain the decentralization of security and the growth of a network.
These fees are subject to fluctuation as they depend on several factors, and are not the only types of fees associated with cryptocurrency transactions. This guide explains how transaction fees work, the different types of fees, and how to minimize them.
How Do Transaction Fees Work: Types and Affecting Factors
Cryptocurrency transaction fees are typically divided into two main categories, miner/validator fees also called network fee, and service fees.
Miner/Validator Fees
As said before, for nodes in a blockchain network to perform transaction validation work they are incentivized by rewarding a certain amount of native tokens. This process is followed by pretty much every blockchain and ensures that nodes are encouraged to participate in maintaining the network. To outline, network fee as such serve three main requirements;
Performing transaction processing,
Preventing incorrect transactions,
Paying validators for their services.
These fees depend on how much work a transaction requires to be verified, the demand at the given time, and the supply of validators.
A large-sized transaction or a transaction that includes more bytes and therefore accounts for more block space will have higher transaction fees. Traders are welcome to include additional fees to speed up their transactions.
In Bitcoin, for example, transactions awaiting verification are stored in mempools. At times when there’s a large number of transaction requests, miners tend to prioritize the transactions with higher fees, and those who wish to settle their transactions quickly may add higher transaction fees to end up higher in a queue.
Ethereum follows a similar model, where transaction fees are referred to as gas fees. The transaction fees are determined by the gas limit, the maximum amount of work the user estimates the validator will spend on a transaction, and the gas price, the price per unit of work done, and is determined by the demand. The transaction fee becomes the gas limit multiplied by the gas price, and much like in Bitcoin, higher limits tend to get picked quicker.
Service Fees
Centralized cryptocurrency exchanges, or CEX, facilitate most crypto-based transactions, hosting about 95% of all trading volume in September 2020. Besides the network fees, they extra charge transaction fees for their services.
Much like regular stock exchange platforms, cryptocurrency exchanges tend to cut a commission on every trade done through their platform. While the transaction fees are the main costs associated with exchanges, some may also pose withdrawal fees.
The fee structure varies depending on the service of choice, but most exchanges follow the trend of a tiered-level structure that charges a percentage based on the trading volume executed in the last 30 days
Fee Schedules
Most markets follow the maker-and-taker structure, and fee schedules are designed accordingly. According to the system, there are two parties involved in the market: those who create the offers, and those who keep those offers either by buying or selling.
Makers can create an offer or market by setting out a limit order that wouldn’t be executed right away, and therefore they bring liquidity to the exchange. Takers are the ones who accept these offers and execute the orders. They subtract liquidity but increase volume. Makers are typically encouraged by lower transaction fees. Besides makers, exchanges also reward large transfer volumes.
In most cases, the fees tend to get smaller as the 30-day cumulative trade volume increases. Coinbase, for example, poses 0.40% and 0.60% taker and maker fees for users with less than 10,000 USD volume, while the transaction fee decreases to 0.40% and 0.25%, respectively, for trading volumes between 10,000 USD and 50,000 USD.
Similarly, Crypto.com’s maker and taker fees are 0.0750%, but they are lowered to 0.0700% and 0.0720% for users with higher trading volume than 250,000 USD.
How To Minimize Cryptocurrency Transaction Fees
Picking the right time — Network congestion has a direct effect on network transaction fees, meaning that the more transaction requests are there, the larger the fees will be.
It is possible to detect rush hours by using a blockchain explorer, where users can see when transactions are most likely to occur. The US day times, for example, makes a significant factor as most transactions originate from the States.
Monitor the best fees — Blockchain explorers also display the best possible transaction fees users can get for trading a cryptocurrency. By monitoring the best fees, users can assess how much they can add as an extra fee to get their transfers settled in a reasonable time.
Use decentralized exchanges — As blockchain-based applications, decentralized exchanges (DEX) only charge the network fees and do not impose service fees unlike centralized exchanges, most notably Binance or Coinbase. Although slightly more complicated to use, it’s more likely to secure low transfer fees through DEX.
Future of Cryptocurrency Transaction Costs
Crypto transaction fees are an inevitable reality that constitutes an integral cog in most blockchains’ machinery, and in return, intrinsically depend on the ongoing activities in a network.
Transaction fee fluctuations are a critical issue for blockchain developers and traders alike: blockchain networks are limited in how many transactions they can process, and an increasing demand results in a surge in transaction fees.
That being said, stabilizing transaction fees lay at the heart of current solutions like sidechains or layer 2 protocols that have gained traction, all of which address blockchain networks’ problems with scaling. It would be safe to assume that traders are not at risk of paying more exorbitant fees in the future.
