Crypto transactions are conducted on a decentralized peer-to-peer ledger. The blockchain allows users to interchange transactions without the need for a central authority. Who controls the blockchain? Dispersed nodes operate the network in return for a fee paid by the user. Just like how traditional financial platforms charge fees for confirming transactions, the blockchain requires crypto transaction fees to process your service.
That’s right. Decentralizing a system doesn’t make its services free, it just means that the process of paying those fees differs. This article will be your guide to understanding why you have to pay transaction fees, their importance, and how to calculate them.
What Are Crypto Transaction Fees?
Node operators keep the blockchain running by verifying transactions and adding blocks to the blockchain. Think about it. These nodes don’t refer back to a central authority that pays them wages. Each node is a decentralized entity that works alone and comes together with the rest of the network through consensus.
Centralized companies such as Mastercard, Visa, and Paypal earn their revenues by charging users a fee for confirming their transactions. But these mega corporations capitalize on the workers’ efforts. In decentralized blockchains, the node that is responsible for adding the block to the blockchain receives the users’ fees entirely to themselves.
So, what is the goal of crypto transaction fees? Well, for starters, they reward miners/validators who process transactions and add blocks to the blockchain. Transaction fees are the incentive that brings more people to operate nodes on the blockchain, which emphasizes the second goal, which is security.
Crypto transaction fees prevent bad actors from attacking the network. First, running more nodes eliminates the possibility of 51% attacks. Second, spammers are less likely to forge a transaction if they have to pay for it.
Types of Crypto Transaction Fees
Not all transaction fees you pay are for the same purpose. Let’s see the difference between network fees and exchange fees.
- Network Fees: The network fees are the fees you pay when conducting a transaction on the blockchain. It’s a way to pay the responsible node for verifying transactions and adding the block to the blockchain.
- Exchange Fees: Exchange fees are the fees you pay when using a decentralized (DEX) or centralized (CEX) exchange platform. These platforms generate revenue by receiving fees in return for a service, such as trading, deposits in online storage spaces, withdrawals, liquidations, and loans.
How Do They Work?
So, what’s the underlying mechanism of translation fees? Are they the same amount each time you conduct a transaction? Not exactly. Transaction fees are not static, instead, they are affected by variables. There are two factors that influence transactions fees:
- Transaction Size: Crypto transaction fees relate to the weight of the transaction itself. That means, the more complex a transaction is, the higher the fees. For example, a regular transaction would not cost as much as executing a smart contract. In addition, miners/validators have monetary incentives, which means, they will always favor transactions with higher fees over ones with lower fees.
- Network Congestion: When the blockchain becomes congested as demand rises, transactions can get piled up in the mempool, which can result in latency issues. In this case, users have to wait a long time before their transaction gets processed. Here, it is wise to pay higher transaction fees so that miners/validators pick up your transaction amongst the hundreds of congested ones.
The blockchain is made up of thousands of nodes, so, who decides which gets the fees you’re paying? Simple, blockchains operate through a certain consensus mechanism that decides who gets to be the validator/miner that adds blocks to the blockchain. Depending on the implemented consensus, one node only can be the winner and therefore the miner/validator responsible for the node gets the transaction fees as a reward.
Transaction Fees Vs. Block Rewards
People often confuse transaction fees with block rewards, which are not the same thing. Although both act as incentives for crypto miners/validators, they differ greatly from one another. Transaction fees, as stated before, are the fees users pay to get their transactions processed by the network. On the other hand, block rewards are crypto that is newly minted as part of the verification process.
Block rewards compose the majority of a miner’s profit. Transaction fees are paid in fractions of the native currency, however, block rewards provide a high amount of newly minted coins. For example, Bitcoin’s block reward is currently 6.25 BTC, which is a huge amount.
Bitcoin Transaction Fees
Speaking of Bitcoin, the mother of all blockchains has put the standards of transaction fees across the whole crypto space. Bitcoin miners receive transaction fees for verifying transactions. However, Bitcoin miners’ biggest incentive is block rewards. However, Bitcoin has a limited supply that will ultimately max out at 21 million coins.
Bitcoin halving event cut down block rewards after every 210,000 blocks are mined or after approximately 4 years. The next halving event will cut down block rewards in half to become 3.125 BTC, and it will eventually become zero. Why does that matter regards to transaction fees? Well, the decrease in block rewards will leave miners with only transaction fees as their incentive to continue operating the network.
How to Calculate BTC Transaction Fees
Bitcoin’s transaction fees are dependent on the size of a transaction file (usually in bytes) and are paid in satoshis. This means that you don’t pay transaction fees on the amount of BTC you are transferring, instead, you are paying for the amount of data you are transferring.
1 Satoshi is equal to 0.00000001 BTC. The equation goes:
So let’s say that an average Satoshi/byte is 80 Satoshis. Your transaction is 250 bytes. That means you will be paying:
80 x 250 = 20,000 Satoshi = 0.0002 BTC
However, if you want miners to process your transaction fast, you will need to pay more than that. In addition, exchange platforms will usually give you three different fee rates for the speed at which you want to process your transaction.
Ethereum Transaction Fees
Ethereum’s fees on the other hand are not dependent on the size of the transaction file, rather it depends on the computational power it takes to validate the transaction. This power is referred to as gas. You’ve probably heard of Ethereum gas fees. Gas fees are basically transaction fees but for the Ethereum blockchain.
This means that all Ethereum-related transactions are paid as gas fees, such as trading ETH, minting NFTs, deploying smart contracts, and other related activities.
How to Calculate Ethereum Transaction Fees
Gas fees are usually paid in Gwei which means Giga Wei (Wei is the smallest denomination of ETH). 1 ETH = 1 billion Gwei.
There are two things to keep in mind when calculating Ethereum transaction fees:
- Gas limit: The gas limit is the maxim amount of gas you are willing to pay to get your transaction processed. A standard ETH gas limit is 21,000 units of gas.
- Gas Price: The gas price is the number of gas units you want to pay for the transaction.
The equation is as follows:
So, if you a transaction will cost you 15,000 gas, and the gas price is let’s say 65 Gwei, this will give us:
15,000 x 65 = 975,000 = 0.00097500 ETH
The Importance of Network Incentives
Having a good understanding of crypto transaction fees will give you insights into the expenditure required before committing a transaction. It also sheds broader light on the importance of paying those transaction fees, as they are what give blockchain operators the incentive to keep maintaining the network.
It’s important to keep an eye on the amount you are paying for a transaction. In some cases, people pay way more than what they bargained for. There are various ways you can spend less on a transaction. However, it’s vital to do your research and look for transaction fee calculators online to help you estimate the fee you’ll need to pay.