Why The High Transaction Fees On Ethereum?
Ethereum has continuously evolved to become the second-largest cryptocurrency. The digital currency is gaining institutional interest from the expected network upgrade. Being a blockchain-based network has also contributed to the growth of Ethereum, and more developers are now using the platform to create decentralized applications and venture into NFTs.
At the start of this year, Ethereum was at $730; however, the digital currency continues to break personal records as it rises to over $3,500 per coin. Ethereum’s adoption and growth have led to a rise in its transaction fees.
Despite Ethereum’s improvement, are the high transaction fees worth it? In this detailed guide, we cover some of the causes of the high transaction fees and how these fees could affect Ethereum’s growth going forward.
Conceptualization of Ethereum
Vitalik Buterin, the founder of Ethereum, developed the digital currency as a blockchain-based network where developers could create apps. He also designed Ethereum to go beyond simple transactions like Bitcoin using smart contracts to automatically execute transactions once specific criteria were met. Ethereum also supports other tokens like Binance Coin and Tron that all started on the blockchain.
Although ETH was designed to improve digital transactions, its high fees are making the network time-consuming and expensive to use.
What is Ethereum Gas?
Ethereum users need to pay a certain fee to interact with decentralized apps or send a transaction. Ethereum fees are also referred to as gas. The transactions and applications require gas for them to be executed, like how a car requires gas to run.
Complex operations will require more gas to run, and simple transactions need less gas. Gas fees are paid in Ether. The gas price and cost determine how much fee you get to pay. Having to pay higher fees means that your transaction is included in the block sooner, a situation that also occurs on the bitcoin blockchain network.
Overview of Ethereum High Transaction Fees
Ethereum transaction fees got to $5.70 at the peak of the 2017/2018 bull run. However, this fee has continued to rise over the years. The spike in 2017 was due to the success of the Initial Coin Offering. The blockchain-based network sold hundreds of tokens through centralized exchanges and websites.
The ICO space continued to grow in the following year as more regulated exchanges were tasked with handling complicated KYC procedures. The process interfered with the trade of tokens, which stabilized the transaction fees.
However, this led to the creation of decentralized exchanges where anyone could lend, trade, issue, and borrow tokens without the daunting verification process.
The launch of Cryptokitties in 2018 led to the second spike. The new card game allowed players to create, trade, and collect cards with various kitties, each one with its unique attributes and design Having thousands of players trade on a network that could only manage 12 transactions per second led to a high transaction fee. However, the fees reduced as the hype around Cryptokitties declined.
The other recent spike was witnessed in late 2020, where Ethereum fees managed to gain over 50% share of the total block reward with the DeFi surge. According to Dune Analytics, an Ethereum data analysis tool, the volume in decentralized exchanges has grown over the years.
A good example was in August 2019, where the volume stood at $173 million, and in 2021, it grew to $11 billion, a 60% increase. The DeFi space is currently at $80.2 billion, which is the highest since the decentralized exchange space was introduced.
The DeFi tokens based on Ethereum’s network were in high demand, and this strained Ethereum’s network. That led to high transaction fees.
Ethereum’s average transaction fee since January 2021 has gone as high as $40. However, today, the average transaction fee stands somewhere around the $20 to $15 mark.
ETH is expected to hit new highs with the upgrade to Ethereum 2.0, which seeks to manage thousands of transactions per second.
How Has DeFi Led to High Transaction Fees?
DeFi or decentralized finances is considered the utopian future of providing financial services to different groups of people. These people include those who are offered corrupt financial services and those who can not afford the financial services provided by centralized financial institutions.
Although Ethereum provides smart contracts to fix the corruption issue, you’ll find that the transaction fee is not any lower.
Decentralized exchanges are one of the causes of the spiking transaction fees on Ethereum’s network. That’s attributed to all the actions in the decentralized exchanges that are recorded on the blockchain directly.
Having a large number of transactions happening on the blockchain network puts pressure on the network. Blocks become full as more transactions take place. There’s reduced space in the block for all ongoing transactions to be confirmed as the network is limited to a specific number of transactions per second.
Congestion or lack of space in the blocks means that transactions have to compete with each other for which one will be confirmed first. That creates a snowball effect as each transaction has to pay higher fees than the others if it wants to be confirmed first. However, this will be solved in the upcoming EIP-1559 update, which will make Ethereum a deflationary coin and solve the mining crisis.
Although there are different factors, the decentralized exchange network is one of the reasons why payments made over the ETH network are expensive, particularly for people using ERC-20 tokens or Ether to trade online.
What are the Potential Implications of the High transaction fees?
Will the high transaction fees affect Ethereum’s network’s usability? Unfortunately, yes.
The high-fee environment has edged out small investors and Dapps users from the network. It has also spurred on specific niche markets like NFTs in a tangible way. The long-term effects of these fees could negatively affect the platform. Casual crypto users could hesitate to use ETH because of the time transactions take and the cost.
Users may move towards a network that is faster, incorruptible, trustable, cheap, and one that provides unbiased services for all people. Digital cryptocurrencies like Ethereum and Bitcoin are moving to cater to people who can afford them, but the networks they are creating for the masses like Cardano and Bitcoin Cash are cheaper and ideal for adoption.
High Transaction Fees are a Scalability Problem
You may continue paying high transaction fees if Ethereum can only process a few transactions per block. As long as Dapp usage keeps increasing, the costs will remain prohibitive. Competition for block space is what is pushing the gas prices up.
An Ethereum Gas Report by Coin Metrics revealed that the current high transaction fees are due to the blocks being full at around 95% since the DeFi boom in mid-2020. Ethereum blocks have been 97-98% full for March 2021.
Will Ethereum 2.0 Reduce the High Transaction Fees?
Ethereum has faced congestion, with the average transaction fee being $21. However, the network has plans to scale the network to handle over 100,000 transactions per second by the end of 2021.
The introduction of Ethereum 2.0, a significant network overhaul, promises to solve scalability issues and make the platform eco-friendly and secure. Ethereum 2.0 will upgrade the network from PoW( Proof of Work) to PoS( Proof of Stake). Interestingly, Phase 0 of Ethereum 2.0, code named as the Beacon Chain, was rolled out in late 2020. The Beacon Chain introduced the new and improved Proof of Stake consensus protocol to the platform.
Validators maintain Proof of Stake networks as they stake currency in exchange for the right to validate transactions. Each transaction they verify is rewarded at about 7.5% of the staked tokens annually.
Currently, the Proof of Work model is energy-intensive and slow to process transactions. Proof of Stake seeks to solve the energy problem and also split blocks of transactions into smaller chunks. The sharding process will ensure that the network can handle up to 150,000 transactions per second.
Ethereum network runs on an outdated proof of work model, and its low transaction volume has led to high transaction fees. Minting an NFT could cost over $100, which makes the platform inaccessible to artists on a budget. These are some of the reasons Bitcoin has outpaced Ethereum. However, with the Ethereum 2.0 overhaul, the network will be able to handle more transactions per second and create a more secure platform for its users.
Layer 2 solutions can also help offload a large number of transactions through Ethereum smart contracts. Ethereum’s experts believe that this will allow Ethereum to process up to 3,000 transactions per second by May 2021. That will reduce the high fees.