In the early days of Bitcoin, no one really thought about transaction fees. This is because there were not very many users of the peer-to-peer digital cash system at the time. In other words, the system wasn’t exactly running at capacity. During these early years, Bitcoin was often promoted as a way to enable instant, practically-free transactions online. However, reality started to set in around 2016. This is when Bitcoin became more popular. Also, the network started to brush up against its maximum transaction limits. Find out more about BTC ATMs later in this blog.
At the end of the initial coin offering (ICO), people were paying $20 or more for Bitcoin transactions. This could be made for less than a penny not long before then. So, what happened to the promise of Bitcoin as a way to do cheap, irreversible transactions online? Why were people even willing to pay $20 to make a Bitcoin transaction? Whether it be from an online exchange or a BTC ATMs, in 2017?
High fees have are found on Bitcoin and Ethereum from time to time over the years. It’s important to understand these networks’ underlying value propositions in the first place. Bitcoin, for example, is valuable due to the high degree of decentralization found on the network. No one is in control of this new, digital monetary system. This lends credibility to the crypto asset’s apolitical monetary policy.
Of course, everyone must be able to verify the rules of the system if Bitcoin has trust. This task is complete by operating full node software that checks the validity of every transaction on the network. Additionally, full node operators usually keep a copy of the entire history of Bitcoin transactions on their hard drives. This is essential to verify all of the data that is sending through the network means. Also, the number of transactions on the network must have a limit. Otherwise, the cost of operating a full node would become too much for many to afford. With fewer and fewer nodes on the network, Bitcoin would eventually start to look more like traditional online payment systems like PayPal and lose the benefit of censorship resistance. In other words, there is a limit to the supply of block space on the Bitcoin network to preserve decentralization.
BTC ATMs Continued
When there are more transactions being broadcast than space in blocks, miners task the job of picking which transactions should happen in each block. Miners are have an interest in turning a profit on their hardware and operating costs. They tend to include transactions that pay the highest fees. Transaction fees tend to rise when there are many users trying to transact on the network all at once. In most cases, fee spikes happen in times of wild price swings. This means as people are desperate to either enter or exit the bitcoin market.
This explains why some users were willing to pay $20 or more to send Bitcoin transactions back in 2017. A similar phenomenon occurs on Ethereum more recently where someone sends a small amount of stablecoin holdings may price out due to high fees, while wealthy DeFi users are fine with paying $100 or more in gas fees. It’s simple supply and demand. Find out more about BTC ATMs later on in this blog.
As explained above, simply increasing the supply of block space has the side effect of weakening decentralization, so most efforts around increasing Bitcoin’s transaction capacity have focused on using the currently available space more efficiently. At the base blockchain layer, this means doing things like aggregating the signatures associated with transactions to save space. However, the largest, most impactful scaling improvements involve creating secondary layers for making transactions.
The Lightning Network is the most widely-known example of this sort of solution, but federated sidechains like Liquid and RSK hold promise here as well. The Lightning Network effectively creates a caching layer for Bitcoin transactions where many payments between two parties can form into two on-chain transactions.
With Liquid and RSK, users are sending their coins to a new blockchain where consensus is in control by a group of functionaries rather than proof-of-work miners. At the end of the day, not every transaction in the world needs to store on an immutable ledger for the rest of history. For example, there is not much to gain from publishing every transaction between users of different crypto exchanges on the blockchain when both parties are already using custodial services anyway. So, the next time you’re purchasing some coins via a BTC ATMs, it may be wise to consider one of these layer-two options if you’d like to save some money on network fees.
This disclaimer informs readers that the views, thoughts, and opinions expressed in the text/sponsored content belong solely to the author, and not necessarily to Bitcoin of America, organization, committee or other group or individual. All investments are at your own risk and should be done after careful research.