Bitcoin Beginner Basics
Part #2 Overview
Bitcoin transaction fees is one of the beginner basics series of articles offering as non-technical an explanation as possible to those new to cryptocurrency. While it isn’t necessary to learn every aspect of the underlying technology, knowing how to use Bitcoin could be an important nugget of knowledge in the future.
Bitcoin is used to conduct fast, peer-to-peer transactions for worldwide payments and the low processing fees represent one of its most important features. The number of Bitcoin transactions has risen consistently in the last couple of years as more people are participating and adoption has increased. There was much reported in the news back in December 2017 about the high fees users were paying on average for Bitcoin transactions, which has since dropped considerably. To understand how fees work requires basic knowledge of how Bitcoin works.
Bitcoin Transaction Fees
Bitcoin’s blockchain is made up of “blocks” – a set of transactions that are restricted to be less than or equal to 1M bytes of data and designed so that only 1 block every 10 minutes or so can be created. A Bitcoin transaction must be added to the blockchain in order to be successfully completed. A complex mathematical problem is solved to verify transactions, and those waiting to be added to a block for confirmation sit in the Bitcoin Mempool (memory pool).
Miners are those that create these blocks, and they can choose the transactions they want in the blocks they create. Miners are paid all the bitcoin transaction fees in the block they mine so, naturally, they pick the 1 million bytes of transactions that pay them the most money. The miners play a critical role in keeping the network secure.
Bitcoin miners don’t care about the value (dollar or bitcoin amount) of a transaction, just the size (amount of bytes), because they are only allowed to create blocks of 1 million bytes or less – also referred to as 1-megabyte. Therefore, from a miner’s perspective, the fee per byte is what is taken into consideration. Miners are incentivized for the time, effort and resources they expend to validate the unconfirmed transactions. As a result, miners earn 12.5 newly created BTC for a successfully mined block plus the transaction fees paid by the senders.
What drives Bitcoin transaction fees?
Now that we understand who collects bitcoin transaction fees and why, it is easier to understand that if the Mempool is full, users looking to push their transactions through faster will complete on fees. Users can cause the fee to rise by bidding to get their transaction included in the next block set to be mined. When a Mempool bottleneck occurs, the transaction fee is obviously affected.
Transaction size also plays a role in determining the fee, as miners can only include certain transactions in that 1-megabyte block. Miners prefer to select small transaction sizes that are easier to confirm vs. those that occupy more space and require more work to validate. So there are two factors that determine transaction fees – transaction size and network congestion, both of which also play a role in the time it takes for a transaction to be confirmed.
If a transaction has a very low fee attached to it, and the Mempool is full, then miners may not select it because of the low incentive to do so and it could take several hours for that transaction to be confirmed. If a user is willing to pay a higher fee, then the first confirmation could arrive in 10 minutes and six confirmations are required for complete validation. The usual time for a transaction to be fully confirmed is about an hour, however, the recipient of the bitcoin receives notification instantly.
Solutions to Keep Bitcoin Transaction Fees Low
It is clear to understand how the rise in price combined with the number of new users flooding the market resulted in higher transaction fees when Bitcoin hit all-time highs in 2017. When the number of unconfirmed transactions increases faster than the rate at which new blocks are mined, network congestion results. The average Bitcoin transaction fees go up because users are willing to pay higher fees.
This scenario occurred for the first time in a big way and revealed a scalability problem due to the limited number of nodes in the Bitcoin network. Any computer that connects to the Bitcoin network is called a node, which is a program that fully validates transactions and blocks, relaying them to other full nodes. The Bitcoin community set out to find ways to circumvent this issue so many transactions can be executed quickly with low fees in the future. The Lightning Network is one such solution under development. This “second-layer” payment protocol sits on top of the Bitcoin blockchain and is capable of high-volume, high-speed transactions which occur “off-chain” and reduce the load on the blockchain.
Constantly Emerging Technology
When the meteoric rise in Bitcoin’s price occurred, it accomplished more in a few weeks than what simulations could in 20 years. Developers were able to gain new knowledge and data rapidly as investors poured into the cryptocurrency space. While the Bitcoin network proved to be very secure, it wasn’t able to adapt quickly to the market’s needs. However, innovative ideas and solutions very quickly emerged by developers working on cryptocurrency. Unlike the closed network of the traditional investment environment, cryptocurrency is capable of rapid improvement and growth.
Bitcoin has endured some testing times of late, but the data shows there is a steadily growing market of investors and consumers looking to actively participate in the cryptocurrency marketplace.