As crypto natives, it is such a usual thing that we pay fees for every operation with blockchain, such as token transfer, minting, smart contract establishment, etc. The fee for each transaction might be small, but it can accumulate into a significant sum of money over time.
Let’s explore what a transaction fee is and why it is important for the existence of blockchains.
What is a transaction fee (TX fee)?
Transaction fee is the fee that users have to pay when conducting transactions on the blockchain space. The fees are often paid in the native token of the blockchain, which can vary over time. Due to different blockchain designs, transactions come with flexible fee structures.
Besides fees for blockchain transactions, in the crypto world, there are many other transaction fees for service providers, increasing their total revenue.
For example, the total revenue of the Ethereum network is around $8.4B, updated on Jul 7, 2022. A considerable proportion of that might come from transaction fees.
Where do transaction fees go?
Blockchain networks or crypto projects generate billions of revenue from daily transaction fees. It is a major factor that can turn an ecosystem into a sustainable one. The effectiveness of how transaction fees are distributed will yield massive results if it is carefully planned.
Let’s track where transaction fees possibly go.
Validators/nodes: Without a doubt, node operators will receive a proportion of transaction fees since they make an effort to complete the transactions. They are incentivized to operate systems of nodes because it is profitable.
Treasury: Blockchains or service providers might extract a small portion of transaction fees to build their treasury for ecosystem growth or hedging risk management.
Burning mechanism: To go against inflation, some blockchains have the token burning mechanism. This means a small proportion of transaction fees will be used to buy the native token, then it will be burnt to maintain a sustainable supply. For example, BNB Smart Chain has extracted over $22M of BNB from tx fees to burn.
Service providers/project teams: In most cases, we have to go to trading platforms or use blockchain wallet applications to conduct transactions instead of directly interacting with the blockchain.
Those service providers will charge us a fraction of the transaction amount as fee. The fee rate depends on the policy of the service providers. Uniswap is one of the top leading trading platforms on Ethereum that charges 0.3% of the transaction amount for most token pairs and around 1% for exotic pairs.
Why are transaction fees important?
Let’s see notable reasons why transaction fees are important for long-term success.
Motivation for blockchain nodes/validators: The more nodes a blockchain has, the more decentralization and computing power it has. Running validators or nodes will reward operators with a proportion of transaction fees.
Overload prevention: Let’s imagine how congested a blockchain network will be if every transaction is completely free and users have nothing to pay. Both users and trading bots constantly conduct no-fees transactions while blockchain validators are not incentivized to operate. This leads to an unstable system for the blockchain network.
A sustainable ecosystem: Blockchains and protocols generate revenue from charging fees for activities such as transactions, lending/borrowing, etc. The generated revenue will be reinvested in the ecosystem to create more value. This is why transaction fees are the key driver of growth.
How to calculate the transaction fee
Bitcoin miners are responsible for validating blockchain transactions in every new block generated. Pending transactions are consolidated in a group called mempool (memory pool). Miners will verify those transactions and receive the transaction fees associated with new block rewards in Bitcoin.
The block rewards and the Bitcoin hash rate decrease by half after each Bitcoin halving (4-year period). Therefore, in the far future, Bitcoin rewards for miners will primarily depend on the sum of transaction fees.
In general, Bitcoin's transaction fees vary, depending on the data volume and the status of the network, not the transaction amount. The maximum data of one Bitcoin block is 4 MB which only includes a limited number of transactions in one block. Each transaction requires a number of bytes in the Bitcoin block.
Users have to pay the tx fees in Satoshis (sats), the smallest unit of Bitcoin, 100,000,000 Satoshis for one Bitcoin. The sats/vByte rate is used to calculate the transaction fees of Bitcoin where sats are satoshis, and a block has one million of vBytes. The data volume of the transaction is multiplied by the sats/vByte rate, which is the fee for each transaction.
Some blockchain wallet interfaces allow users to adjust the rate in case they are in the rush or do not have time to wait. During the network congestion, investors have to pay more fees to be prioritized in a block fixed to have 4 MB in size.
Every operation on the Ethereum network requires a certain amount of gas, representing miners' computational efforts. In simple terms, gas is needed to successfully conduct a transaction on the Ethereum network. It can vary depending on the status of the network, and it is paid in the native token of Ethereum, ETH.
The gas price is denoted in gwei (giga-wei). Wei is the smallest unit of ETH and one ETH equals 1,000,000,000,000,000,000 wei or 1 billion gwei.
The transaction fee is calculated:
Gas units (limit) * (Gas price + Tip)
For example, Alice sends 1 ETH to Bob with a gas limit of 40,000 units. At the same time, the gas price is 50 gwei and Alice wants to give a tip to miners of 10 gwei. As a result, she has to pay 40,000*(50+10) = 2,400,000 gwei = 0.0024 ETH as the gas fee. Alice will be deducted 1.0024 ETH in order for Bob to receive 1 ETH.
A priority fee is an amount users have to spend as a tip to miners. The bigger the tip, the more likely the transaction is preferentially executed. A gas limit is an adjustable number for users to limit the transaction fee at their discretion.
Besides revenue generation, Bitcoin, Ethereum, and other blockchain platforms charge fees to prevent network spamming from congestion. This sometimes happens to blockchains with cheap transaction fees, exposing them to be attacked.
Other platforms or protocols
Other than blockchains like Bitcoin and Ethereum, investors might tolerate more fees from centralized platforms or protocols for using their services. The fee rate is often fixed or flexible, based on the terms and conditions.
For example, centralized exchanges like Gate.io and Binance charge the users a certain level of fees. Furthermore, the fee structure might include the utilization of their tokens. BNB holders can get discounted transaction fees based on which tier it is.
FAQs about TX fee
Who will pay the transaction fee?
Whoever conducts the transaction on the blockchain will have to pay transaction fees. Blockchain validators cannot verify the transactions without paying tx fees, making them fail to complete. On the other hand, some blockchain platforms, such as Ethereum, prioritize transactions with high tips, creating an active environment for users who have tightened hours.
How to avoid paying transaction fees
It is impossible to avoid paying fees on blockchains since validators are bonded with a strong consensus that is possibly immune to attacks. In contrast, exchanges or dApps might release incentive programs that reduce or eliminate the transaction fees for project contributors or their token holders.
Transaction fees vs. withdrawal fees
Users who conduct transactions in the blockchain environment will have to pay transaction fees. Users might have to pay fees to withdraw crypto assets from protocols or exchanges. Transaction fees and withdrawal fees describe the fees that users have to pay.
The former is for each transaction, while the latter is for each withdrawal order. However, each platform has different terms and conditions, it might charge no fees for withdrawing or depositing.
Transaction fees are an indispensable part of the blockchain world. Every operation with blockchains requires paying native tokens as fees that might go back to the ecosystem, creating a compounding growth loop.
In addition, tx fees can prevent network spamming because it might cost hackers a tremendous pile of transaction fees. During market selloffs or high-level congestion, the transaction fees might peak, discouraging investors to conduct any additional transactions. To reiterate, the advantages of transaction fees might outweigh the limitations.