This is the first opinion piece in a four-part series that explores the advent of bitcoin as a store of value and the implications of valuing the cryptocurrency in fiat. Read the first part here and the second here.
Fees: The Third Bottleneck
Just like price, transaction fees can very easily scare away people from entering the cryptocurrency market or, in the worst case, ever spending bitcoin. Even if you’re only investing, and don’t really need to use cryptocurrency on a daily basis, would you rather have to pay cents or a hefty portion of your transaction? That’s a no brainer.
If we see the case of bitcoin it becomes obvious it will soon stop being supported by merchants and people who use it as money. Check the graph below to understand why.
The exponential growth in transaction fees is indeed a bottleneck. Other cryptocurrencies haven’t suffered the same fate due to different factors. But the most important, I believe, is because of the low volume of users, compared to bitcoin.
Why is that?
Do you remember what happened to the ethereum network during the CryptoKitties boom?
If you see no relation between the network becoming clogged and transaction fees, it’s ok, although they’re intimately related (like Luke and Leia). During the CryptoKitties boom, the network became extremely slow and clogged, due to the fact people were using ethereum as money, in order to buy adorable virtual kitties. So if you actually had to make a payment, transfer, invest in an ICO, whatever it was, the only way to have your transaction processed in a timely manner was *drumroll*.. to pay high transaction fees!
In bitcoin we can easily check if there is any sort of correlation between transaction fees and the number of unconfirmed transactions. What this can tell us is something really obvious: if there are more transactions waiting to be approved, the fee will increase. We can simply look at the below mempool transaction count, which is basically the number of transactions waiting to be approved.
Transaction fees increase when the mempool increases. Obviously the overall price of transaction fees also increases if the price of bitcoin increases in USD. You can easily compare both graphs and see for yourself.
We will discuss scalability later, I assure you, but right now let’s quickly analyse transactions and miners behaviour.
What can we learn from that?
Although the incentive for validators (miners) is to have the highest transaction fee possible per block, the opposite happens for users (people who transact in bitcoin). If there is unbalance, people simple move away, switching their bitcoin into another cryptocurrencies or fiat. If transaction fees are too low, then fewer miners will want to join the network and it takes longer for transactions to get approved.
— For the sake of the argument, I’m not taking into account the massive role the difficulty algorithm plays in this scenario. What is key to understand here is that the difficulty adjustment algorithm decides how hard it is for miners to solve a block. So the less miners (or full nodes) the easier the algorithm is, the more miners the harder it gets—
If you have bitcoin in an exchange you can simple trade it for another coin and that’s it. But if you’re locked with bitcoin in your personal wallet (keep it secret. Keep it safe) that means even if you want to get rid of your bitcoin, guess what pal? You’re going to pay high transaction fees anyway, as you’ll have to send your bitcoin from your personal wallet into an exchange wallet. So there you have it. No running away from the transaction fee monster.
So… Just have faith transaction fees will get lower?
There are different outcomes that can possible lower transaction fees. Some are:
- a) More miners join the network, increasing the computer power needed to validate hashes. This in turn will lower the transaction fees, as less computer power is needed to solve each block. The power to mine a block becomes increasingly distributed.
- b) There is no spike in the number of users joining the network (lol).
- c) The number of miners does not decrease exponentially.
- d) The lightning network gets implemented (it’s well underway).
- e) Segwit is massively adopted.
- f) A different type of validation system is created (like PoS), which seems to be unlikely in the near future.
- g) The block gets increased (which is a fine short-term solution too)
Transaction fees work as an incentive mechanism and I believe the bitcoin’s pow consensus (and even a future pos) will always need fees to properly function. That also gives users the power to decide how fast they need their transactions to go through.
At the end of the day, cryptocurrency holders could just move to a different coin and be done with bitcoin. But do you really see that happening?
Featured image from Shutterstock.
Last modified: March 4, 2021 5:04 PM