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a month ago

Bitcoin fees – How do they work, and why do you have to pay?

Miners are rewarded with the block reward with freshly minted BTC each time they successfully produce a new block. But that is just one part of the story of how they get rewarded and which incentive is in place to reinsure that they keep on doing their jobs. Fees have been a part of a larger discussion within the Bitcoin community in recent years.

While Bitcoin fees have been negligible at the beginning of the network, they became more important in 2017. One reason was the rising Bitcoin adoption, and the other one was that BTC saw a significant price increase in the same year. As a result, the prices for fees rose. At least if you denominate them in Euros or US-Dollars.

At the end of 2017, the rally experienced its peak, and so did the fees. The Bitcoin fees at that time were so high that it was simply impossible for smaller investors to send transactions without losing a significant portion of their BTC holdings.

In today’s article, we'd like to dig a little bit deeper into Bitcoin’s fees and explore how they work and why they are important.

Bitcoin fees are transaction fees

Bitcoin is useable without paying any fees. It is possible to send transactions without paying fees. But with more and more people interested in transacting, miners will prefer transactions that will reward them with fees in addition to the block reward. You might already have experienced that a transaction became stuck in the mempool. The mempool is the place where all transactions are gathered and saved before they get confirmed.

Yours got stuck for hours in the mempool because somebody else paid more fees and therefore got first in line. So, one role of the fees is to reward miners and decide for users how important their transactions really are and to determine who is first in line. Need to pay a bill using Bitcoin urgently? Increase the fee up to a certain limit, and in return, you’ll get the transaction confirmed within the next block because you are sitting first in line in the mempool.

Which factors contribute to the size of transaction fees?

As we have shown, it is a simple game of supply and demand. But the above explanation only tells you how the demand side is handled. On the other hand, the supply depends on each blockchain and is determined by the block size. Each block can contain a maximum of data, and therefore only a limited number of transactions.

This was also part of the debate in 2017 and the reason why Bitcoin Cash came into existence. A smaller portion of the Bitcoin community believed that only larger blocks would increase transaction speed and lower the costs. But the proposal to increase the block size drastically didn’t win the majority. And because that group felt unhappy, they forked BTC and created BCH.

But Bitcoin has a solution to the limited block size. With SegWit, the size of each transaction became reduced, and in return, it was possible to send more transactions using the same block size. Using native SegWit addresses sending Bitcoin will save in most cases up to 70 % in transaction fees.

It is also worth mentioning that larger transactions also take more space. Therefore, they are also more expensive than smaller transactions.

Are there any cryptos without transaction fees?

With Bitcoin, all fees are voluntary. If you don’t like to pay a transaction fee, you have to be willing to wait for a long time, and you don’t have to mind if your transaction gets dropped out of the mempool after 14 days. Other cryptocurrencies are seeking different solutions. This is not only because they like to be cheaper, but they also have a different census model than Bitcoin.

One notable example of a cryptocurrency that uses feeless transactions is Nano. However, it remains to be seen if Nano can prevent transaction spam effectively in the coming years.

Bitcoin’s solution for feeless and - even more important – fast transactions is the lightning network. It is a second layer solution on top of the blockchain that also allows micropayments and aims to make Bitcoin available for everyday payments. Because even if you increased block size, people would need to wait for at least 10 minutes until a transaction has its first confirmation.

The Lightning Network is not flawless yet, and it is recommended to use it for payments of up to 50 US-Dollars or less. With Bitcoin’s solution still under development facing some hiccups, fees are likely going to be debatable in the future.

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