How high transaction fees are handled in the blockchain ecosystem

High transaction fees have long been a recurring problem for users on popular blockchain networks such as Ethereum and Bitcoin during periods of increased demand. However, there are protocols, platforms and methods that help users reduce costs.

What are transaction fees?

Transaction fees are fees that users pay to send a transaction or interact with a smart contract on a blockchain network. While gas fees can refer to transaction fees on any blockchain, the term is mainly used to describe transaction fees for the Ethereum network.

Transaction fees are paid in small fractions of the network’s native cryptocurrency. For example, with Bitcoin (BTC), users will pay in Satoshi’s (very small fractions of BTC), and with Ether (ETH), they pay in gwei.

There are two main reasons why users have to pay fees when sending a transaction. The first reason is to pay miners or validators (also known as nodes) to secure the network. Proof-of-work (PoW) blockchains have miners who validate transactions by using their computing power to solve complex algorithms. In contrast, proof-of-stake (PoS) blockchains have validators who stake tokens to secure the network.

In return for securing the network and ensuring that no fake transactions are placed, these nodes are compensated with transaction fees on the blockchain. Network validators enable the blockchain to operate in a decentralized manner without having to rely on centralized entities to ensure that no malicious activity takes place on the network.

The second reason users pay transaction fees is to enable the operation of smart contracts. Smart contracts are programs that run automatically when certain conditions are met. For example, a smart contract can be programmed to release tokens or a nonfungible token (NFT) when they receive a payment or when a certain amount of time has passed. Just like users, smart contracts also have to pay fees, since they also issue transactions. So if a user wants to perform a certain function on a smart contract, they pay the gas fees.

Why can transaction fees be very expensive?

The transaction fees are not static and they vary based on many variables. One of these variables is speed, meaning that transactions with higher fees are prioritized by nodes, reducing the time it takes for them to arrive. On the other hand, transactions with lower fees take longer to validate since nodes do not prioritize them.

Most common platforms, such as wallets and exchanges, pre-set the fee for a transaction at a medium level. However, users can change the fee, increase the amount for urgent transactions and decrease the amount to save money while waiting longer for the transaction to complete.

Supply and demand are the biggest factors for high transaction fees. Once a blockchain network has a high demand for transactions, costs naturally rise as the supply cannot keep up. This causes nodes to prioritize transactions with higher fees, which causes users to increase their transaction fees, which raises the bar higher. For example, imagine that the average transaction fee is $3.00, but the network is congested. So many users are starting to set the transaction fee at $10. Reasons could include a popular initial coin offering or NFT offering that people are trying to get into.

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However, demand continues to grow and even the $10 transactions are taking too long to complete. So users start paying $15 for gas, then $25, $50 and so on. In addition, there can be a huge ecosystem of tools and products (ie additional NFT offerings, yield farming, lending, borrowing, general decentralized finance (DeFi) etc.) such that the demand for transactions has exploded across various sectors. Now, transaction fees cost over $300, as was the case in May, with gas fees costing over $450 on Ethereum due to Yuga Labs launching their Otherside NFT collection.

Ivo Georgiev, CEO of crypto wallet Ambire, told Cointelegraph, “As much as all of us in Web3 like to challenge TradFi and expose its weaknesses, one should admit that there is no problem with gas fees in TradFi. Fees for operations in traditional finance are insignificant, and people are accustomed not even to care about them.”

Georgiev continued, “Now imagine that you enter Web3 and at busy times you have to pay a fee of $30 to exchange tokens worth $150. Given that in crypto interactions are done more often – add/remove liquidity, move positions between protocols, bridges between layers – is it important that gas fees are low enough to bring the next 1 billion users to crypto with lower friction.

So essentially, when there is high demand, users are willing to pay more to ensure their transactions go through. As transaction fees increase, other users pay more to outbid previous users and ensure their transactions are completed first. Over time, this leads to an overall increase in transaction fees on a blockchain network.

Anthony Georgiades, co-founder of Pastel Network – an NFT and Web3 infrastructure and security project – told Cointelegraph:

“Low gas fees reflect less congestion and lower ‘network difficulty’ on the blockchain, allowing users to engage in cheaper network transactions with increased capacity for capital efficiency. Also, the cost of buying and listing cryptoassets decreases with low gas fees.”

Georgiades continued, “High fees are also a major deterrent for new and existing users who do not want to spend exorbitant amounts on gas – sometimes equal to or more than the cost of the purchase. To ensure that the space remains accessible and welcoming to users, it is important to keep gas taxes low.”

Current solutions for high transaction fees

Various protocols have been developed in response to the high transaction costs experienced when a blockchain is congested. One of the most popular solutions is layer-2 platforms.

Layer-2 platforms operate on top of the main blockchain, or layer 1, and take a portion of the transactions and validate them off-chain. By verifying transactions on a separate network, L2s reduce the load on the main blockchain, preventing congestion and keeping fees low while keeping speeds high. L2 networks themselves have very low fees and high speeds. The most popular L2 platform is the Lightning Network which helps scale the Bitcoin blockchain. Polygon is another popular L2 for the Ethereum network.

Another popular layer-2 solution is zero-knowledge rollups (zk-Rollups)

which works by taking batches of transactions from the main chain and rolling them into a single transaction. The single transaction is verified and a proof of validity is sent back to the main chain. Zk-Rollups enable the Ethereum blockchain to have lower transaction fees, increased transaction capacity, and faster transaction times due to the reduced load on the network.

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Protocols and wallets have also taken measures to reduce transaction fees for users. Ambire Wallet, for example, has a gas tank feature that enables users to reduce transaction fees by prepaying. This works by using credits to pay current gas taxes, which will be applied to future transactions. So, for example, if gas taxes are currently low, a user can prepay a transaction using current taxes, so they can send the transaction at a later time with the prepaid rates. Users can also pay for gas fees using stablecoins such as USD Coin (USDC) or Tether (USDT), which are less volatile than regular cryptocurrencies.

Various ways users can reduce transaction fees

There are different ways users can manually save on transaction fees. One way to reduce fees is to schedule transactions for periods of lower activity or network congestion. For example, the Etherscan gas tracker shows the average gas charges on the Ethereum network as well as the highest and lowest values. Users can aim to send out transactions when costs are at their lowest to take advantage of the reduced fees.

Depending on the wallet or exchange, users can manually reduce the fees they pay for transactions. However, doing so may cause their transactions to be delayed due to the lower priority they will receive from nodes on the network. If users reduce their fees too much, they may wait a long time before their transaction is validated. This approach is best used during periods of high network activity and for transactions that are not urgent. Timing of transactions is a better option.