Why Do Bitcoin and Other Cryptocurrencies Charge Transaction Fees?

Cryptocurrencies are designed in a way so that traders can trade them across every online network without any interference from the government or bank. But, to trade cryptos, you need to pay processing fees to the networks which maintain bitcoin or other cryptos. The third-party charges such as exchange rates, trading app costs and other additional fees are further added in cryptocurrency trades. While the network fees include incentives that are paid to the people operating computers to keep the network alive, service fees are the way these people earn money. Although the crypto network is run on a voluntary basis, some networks have built-in incentives. Others have mining rewards for newly minted coin but almost every network charge transaction fees.

How do bitcoin, databases and blockchains work?

Every validated transaction in bitcoin is stored through a blockchain which is like a database for storing data electronically. Databases use tables to structure the data and blockchains are stored in blocks. Whenever the block gets filled, it is added, chained and stamped to the older block which creates a new record.

Just like databases, blockchain needs multiple computers which can store and manage data. Although databases need servers that have to be owned by a person or a group, blockchains store data on multiple computers which can be owned by various people or groups. In bitcoin, the network includes thousands of computers which are called nodes. They work together to validate the transaction, fill the block gaps and keep the system function smooth.

What is Blockchain Trilemma?

Blockchain needs to be secured, decentralized and made scalable to function at its best. The concept of blockchain trilemma was introduced by Ethereum founder Vitalik Buterin and it refers to the notion that every blockchain project struggles to meet all three demands. This means every blockchain development must look for these trilemmas to refine the network and build tools that can attain optimal functionality.

Security

The security in the blockchain trilemma refers to the security maintained by blockchain through coding and consensus algorithm that dictates the nodes numbers required for confirming transactions before settlement. As blockchains are made up of various blocks that record data in hash fuctions within the timeframe, security proves its resilience against data hacking or tampering.

Decentralization

Decentralized blockchain networks are characterized as a setting where no one has to be connected with one another since all nodes share the same information on a distributed ledger. Consensus algorithms or processes add to the security of decentralized systems like Bitcoin by avoiding double spending and guaranteeing peer equality. Decentralized systems like Bitcoin are basically immune to these problems. A majority of network members must agree to prevent any effort to change or manipulate the ledger.

Scalability

A scalable blockchain is necessary for maintaining a smooth functioning within the centralized network especially when traffic jam takes place during heavy uses. Many blockchain developers make direct changes to the network to avoid network congestion-related issues and address the blockchain trilemma. It must be noted that blockchain technology is relatively new and is evolving. With time, all the three trilemmas are expected to be solved through potential solutions.

Why do bitcoins have transaction fees?

When bitcoin was introduced initially, the miners worked tirelessly to validate new transactions. But when the digital coin became popular, transactions became complicated and numerous. As a result, bitcoin transaction fees were levied to speed bitcoin transaction validation. Fees are calculated according to the transaction size and input stages which may comprise several bytes that may take more block data and higher transaction fees.

With additional fees, the transaction validation may speed up in the system but users may have to pay more. All the fees collected ultimately go to the coin miner who records and validates bitcoin transactions besides keeping the system functional and smooth. The miners support the transaction process, pay the ones who validate transactions and eliminate spam transactions to preserve bitcoin network integrity.

How are bitcoin transaction fees calculated?

Although bitcoin’s decentralized mining nature can make it easy for miners to participate, the mining process proves complex and expensive to many. Mining rigs can be very expensive and may consume an immense amount of electricity. Block subsidies, as well as transaction fees, can help miners with these costs and incentivize them whenever a new block is created.

When the miners validate a new block to the blockchain, they are rewarded with blocks and transaction fees. The block subsidy is fixed per bitcoin mining and is reduced by half that occurs every four years or after 210,000 blocks have been mined. The halving event further drops the hash rate and increases the computation power and energy needed in new blocks. But the rising transaction fees help in incentivizing miners to maintain sanity and security in the network.

The bitcoin transaction fees are calculated based on the following factors:

  • Cryptocurrency’s network congestion at the given time
  • Amount of data present in the bitcoin transaction
  • Transaction priority, and
  • Users control

For example, if you need your bitcoin transaction to be processed urgently, you may choose to pay a high transaction fee based on priority. But when the transaction is less urgent, your fees can be lowered but may remain in the memory pool or the mempool for a significant time or until the traffic is low. The mempool act as a queue and the transactions keep waiting until the miner confirm and add them to their block.

When the mempool fills up, the miners choose a bitcoin transaction with higher fees first. The entire system helps in smooth transaction movements but may lead to a bidding war sometimes. Since many people prefer paying higher to ensure transaction completion, the tactic may backfire during heavy usage. When some users pay more, other miners also increase their transaction fees simultaneously.

How to minimize bitcoin transaction fees?

Batch several transactions at a time

In bitcoin, batching means the number of transactions you submit in a limited space present on the bitcoin blockchain. When you combine multiple payments for a single operation, it facilitates space and cost-effective transactions.

Choose a time when the network is less constrained

Most of the time, the bitcoin network is constrained during rush hours. When the network encounters high volumes, you may have to pay more transaction fees. But you must avoid it and have patience until the network seems less congested to submit your charges.

Select a POS system that lowers costs

Your point of sale (POS) platform enables you to take payments from consumers as a merchant. Many Bitcoin POS operators levy their own processing costs on top of market transaction fees, which may quickly mount up. Instead of compounding costs, you need a POS supplier who would minimize them so you may keep more of your sales.

Use bitcoin mempool

When a transaction is confirmed by the blockchain network, you can find various sites that offer validation with minimal fees through mempool. This will also give you an estimation for priority and help you identify how many timelines will be required to meet all the demands. When mining moves quickly, transaction fees may drop temporarily and when it slows down, the fees also tend to increase.

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