What Are Transaction Fees on Cryptocurrencies and How Do They Work?

Many people often use the word “Transaction fees” when it comes to transactions on Cryptocurrencies. If you’ve been searching for a detailed explanation of what it all means, keep reading this article.

Transaction Fees, What Are They?

Every transaction on a blockchain requires the effort of validators and miners. To ensure the smooth running of the system, Blockchain operators charge fees that users pay for the successful completion of their transaction. Afterward, the miners and validators receive the fees as a form of payment for their contributions to the Blockchain.

Transaction fees are never predictable. They can fluctuate depending on the busyness of the network. Also, transaction fees can be flexible in nature.

Sometimes, users may want a quicker confirmation of their transactions, and to incentivize the miners, they will pay a higher fee to push their transaction forward. Transaction fees are often fixed on many crypto exchanges, but users can adjust them through certain wallets.   

Are Transaction Fees Necessary?

Transaction fees have become a necessary and important part of a blockchain network. The earlier purpose of the fees was to deter malicious actors from spamming the Bitcoin network with fake transactions. Back then, Satoshi followed Adam Back’s hashcash system based on the Proof of Work system.

But after two years, a developer Gavin Andresen discovered a source code rule which needed a Transaction fee of 0.01 BTC. In those years, the transaction fee wasn’t much to pay, but after some time, when Bitcoin value increased, the fee became too high for users who want to transfer small amounts of crypto.

After a while, bitcoin devs removed the rule and instead increased the block size in their SegWit2x upgrade. Presently, transaction fees on the network are below 0.01 BTC. Due to the success of transaction fees on Bitcoin, other blockchains like Ripple and Ethereum adopted the strategy to motivate the miners on their networks.

How Do Transaction Fees work?

In the Bitcoin network, every pending transaction enters the mempool where miners pick and add them in a new block.

If miners notice that the mempool is full, they’ll pick the transaction requiring higher transaction fees and keep the others for the next block.

This is why transaction fees on cryptocurrencies fluctuate because many users will prefer to increase them to push their transactions ahead of others in the pool.

Transaction fees are almost close to nothing in Ripple due to the absence of miners whose work is to generate new XRP coins.

But on the Ethereum network, developers measure transaction fees in gas, i.e., small ETH fractions. Ethereum has more upgraded features such as dApps, smart contracts, and because of that, transaction fees are very important on the network. But sometimes, issues may arise when a user adds a lower gas fee.

Apart from Bitcoin, Ethereum, and Ripple, stable coins pegged to USD, such as Tether, don’t require transaction fees to transfer funds between two USDT accounts. But when it comes to converting USDT to fiat, users pay some fees for that.

Blockchain and Transaction Fees

Many blockchain projects are existing in this era, and their transaction fees defer. But one of the ways to determine their transaction fees is that those networks that are capable of completing many transactions every second demand for lower transaction fees.

Ripple charges lower fees, and presently, it is at 0.00001 XRP, and the price of the token is lower than $0.25. This means they’re charging almost nothing.

Ethereum, on the other hand, charges higher transaction fees, and it also goes high when the network is congested.

For instance, in August, the fees went as high as $99, and on the 1st of September, ETH miners made a profit of $500,000 in one hour.

During this period, there have been complaints about the high transaction fees which Ethereum users pay. That’s why the recent upgrade seems like a Godsend, as many expect it to lower the fees.

On Bitcoin, transaction fees increased in 2020 as well. In July, the fees were $1, and in August, it rose beyond $6 until it got to $10 in October.

Outside Bitcoin & Ethereum networks, other blockchains such as Bitcoin Cash, Litecoin, Ethereum Classic, and Cardano charge lower fees, which is lower than 1 cent. Tron also charges very low fees like what Ripple is charging.

Another interesting network is ILCoin, which charges very low fees because its blocks can handle millions of crypto transactions in one second. That’s why the network can afford to charge lower fees than others.

Factors Determining the size of Transaction fees

The two factors that determine the size of the fees include:

  1. Transaction size
  2. Demand for block space

Some networks can’t contain much data in one block. That’s why validators and miners have a particular limit while adding transactions to the blocks.

Sometimes when users send too many crypto funds at the same time, the demand for block space will spike, and many transactions will be waiting to be confirmed.

At times, the demand for block space will cause network congestion, and the transaction fees will increase uncontrollably. Also, when the transactions are large, they’ll occupy more space and also take a longer validation period. But when transactions are small, the opposite becomes the case.

Final Words

Transaction fees on cryptocurrencies motivate miners and validators on a blockchain to facilitate optimum user experience. Without the fees, there may be no provisions for compensating these facilitators. Some networks charge higher fees, while others do not collect fees at all.

However, these fees can fluctuate and are also flexible depending on the demand for block space and the number of transactions which a block can complete in a second.

Many users also willingly increase transactions, especially when they want to push their transactions in front of the miners and validators.

So, it all depends on the platform and the activities of the users. But one thing is clear; transaction fees help to keep a network running smoothly without issues.