May 25, 2020 07:00 PM | Kyle Torpey

Bitcoin transaction fees are currently at heights that have only otherwise been seen during the late 2017 to early 2018 bubble in the crypto asset market, specifically initial coin offerings (ICOs). According to Coin Metrics, the 7-day average of the daily median transaction fee reached $3.14 on Friday—the highest reading since February 6, 2018.

In Bitcoin, transaction fees are paid to miners based on the data size of a transaction, not the amount of Bitcoin involved in the transaction. Users effectively bid on the available block space as new blocks are mined on a regular basis.

Why are fees relatively high right now? It comes down to the supply and demand dynamics of the block space available on the Bitcoin network. Notably, blocks have been found by miners at a much slower pace ever since the halving took place, according to data from BitInfoCharts. Less blocks per day means a lower supply of block space per day. Lower supply and constant or higher demand means higher prices.

Additionally, Bitrefill CEO Sergej Kotliar pointed out on Twitter that there’s a large entity currently overpaying for the consolidation of their unspent transaction outputs (UTXOs). Consolidating the UTXOs in one’s Bitcoin wallet has the side effect of lowering the fees on future transactions, as fewer outputs means less data needs to be placed on the blockchain.


More Efficient Use of the Bitcoin Blockchain

The current price for block space also illustrates how much more efficiently the Bitcoin blockchain is being used today, as compared to early 2018. In terms of payments per day, Bitcoin was sitting at a 7-day average of roughly 707,000 on Friday. This is an increase of 22% from the roughly 579,000 payments per day that were seen the last time fees were this high.

This is a rather dramatic increase in payments per day made available for roughly the same price, especially when you consider the lower supply of block space available since the halving, in which the miner subsidy associated with each new block was cut in half. Additionally, the average fee per Bitcoin payment, which is not the same as a transaction, is currently around $2.13, while it was roughly $2.64 on February 6, 2018.

In Bitcoin, a payment is different from a transaction. In Bitcoin, many payments can be batched into a single transaction. For example, customer withdrawals from exchanges are often batched together.

Not only are there more payments happening on the Bitcoin network, they’re happening at a lower cost. Potential reasons for this change in block space economics include increased capacity enabled by Segregated Witness (SegWit), improved fee estimation in Bitcoin wallets, and more efficient use of the blockchain by exchanges and other key entities via mechanisms like batching.

Of course, this data ignores the fact that Bitcoin users can now transact via secondary protocol layers, such as the Lightning Network and Liquid, too. The Lightning Network effectively allows users to cache their transactions and only interact with the underlying blockchain when absolutely necessary. This enables a much faster, cheaper secondary payments layer for Bitcoin. Liquid is a permissioned blockchain that operates as a Bitcoin sidechain run by a federation of exchanges and other key entities that allows traders to gain access to features like faster block times and Confidential Assets.

And again, it should be reemphasized that the above numbers will illustrate even greater efficiency gains once block times normalize at around ten minutes per block.

So, while Bitcoin transaction fees are hitting historical levels right now, the reality is these fees would be much higher if upgrades like SegWit were not activated and exchanges and other key users were not using the blockchain more efficiently than they were prior to 2018. 

Going forward, these high fee levels could incentivize greater adoption of SegWit, Lightning, and Liquid by Bitcoin users, as they have in the past. Over the long term, however, transaction fees will become an increasingly important part of securing the Bitcoin network, as the block subsidy continues to be cut in half roughly every four years. Over time, transaction fees replace newly-created Bitcoin as the main incentive for miners to do their work. 

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