Are Bitcoin transaction fees too high?
Bitcoin Transaction Fee Analysis – 12/8/2017
Introduction
Bitcoin (BTC) is an open-source protocol for transferring value over a Peer-to-Peer network. The network timestamps transactions by hashing them into an ongoing chain of hash-based proof-of-work. Transactions are confirmed once they are included in a block, which are created approximately every ten minutes. Newly created blocks are linked to the most recently created block, creating what’s known as a “blockchain”, as visualized in Figure 1.
Figure 1 – Simplified Bitcoin Blockchain
Each block contains Bitcoin transactions between users. In order to be included in a block, users must include transaction fees to incentivize block creators, known as “miners”, to prioritize their transaction over other users who also want their transactions included. Each block has a maximum size of 1 MB, and each transaction has its own size, usually between 200 and 300 bytes. The block size limit creates competition for block space. If there are few transactions in the network in any ten-minute period, miners could include all transactions, even if they include minimal or no transaction fees.
In 2017, however, the Bitcoin network has seen a massive increase in use. Blocks are often full, resulting in higher transaction fees. Some users argue that the fees are too high and that the network can no longer be used for microtransactions. Others argue that competition for block space is a good thing, as it creates an economic cost to use the Bitcoin network, which can be an effective measure against spam and Denial of Service (DOS) attacks. Additionally, in order to change the Bitcoin block size limit, a network hard fork would be required, which could jeopardize the security of the Bitcoin network. As of November 1st, 2017, the Bitcoin network has a market capitalization of $100 Billion, making any software change proposal a very serious endeavor.
The Bitcoin protocol is open source, and changes to the code are driven by the community. In order to implement a major change, like increasing the block size, the entire community would have to simultaneously adjust to the new rules. At this time, some developers are pushing for a blocksize increase to 2 MB in mid-November. It is unclear if this push has enough support from the community. This could result in a chain split, with a portion of Bitcoin users following the 2 MB rules, and the rest following the 1 MB rules.
*Update 12/8/2017* The November 2 MB hard fork did not occur, as it did not receive enough support from the Bitcoin community. Bitcoin’s blocksize limit has remained at 1 MB, and there continues to be a lot of competition over block space, resulting in high fees. Many users who supported the 2 MB hard fork have stopped supporting Bitcoin and are instead supporting Bitcoin Cash (BCH). Bitcoin Cash is a fork of the main Bitcoin blockchain that was created in August 2017. Bitcoin Cash has an 8 MB blocksize limit, which helps Bitcoin transaction throughput but does not ultimately solve Bitcoin’s scalability problems. The main BTC network plans to become truly scalable by implementing the Lightning Network, which will handle many transactions off-chain, but will use the main Bitcoin blockchain for settlement. In the meantime, Bitcoin fees remain very high.
Recently, many “small block” proponents (those who want to keep BTC 1 MB blocks) have defended high fees by arguing that fees have been relatively stable, when priced in BTC. It is only when viewed in USD that the fees seem high. Since transaction fees are determined by wallets using BTC per byte, it would follow that an increase in BTC price would see USD fees per bye rise. BTC’s incredible price gains can be seen here:
Figure 2 – BTC has tripled in price in just over two months
In the last 2-3 months alone, BTC has risen from about $5,000 per coin to over $15,000.
Objectives
This study will analyze the transactions on the Bitcoin network from December 2016 to December 2017. The number of transactions per day will be analyzed and compared with the total transaction fees collected in BTC and USD. The study will attempt to determine if network congestion is driving an inevitable rise in transaction fees, and if the transaction fees are influencing network usage.
Analysis
USD vs. BTC Fees
It is clear that USD transaction fees are rising sharply over time. The chart below shows the total transaction fees per day over the last year. In January, total USD fees per day were approximately $70,000. On December 7th, fees were over $5.9 Million. This day in particular saw monumental trading volume and price volatility and can be considered an outlier. The fees on December 5th are more representative of the current state of fees, with a total of $2.6 Million.
Figure 3 – USD fees are clearly increasing over time
As stated in the introduction, if wallets are using BTC/byte to determine adequate transaction fees, it would follow that transaction fees would increase in USD as the price of BTC increases vs the USD. For that reason, BTC fees per day were analyzed over the same time period and overlaid onto the USD fee chart below:
Figure 4 – BTC fees are also increasing over time, but not as dramatically as USD fees
BTC fees per day follow roughly the same shape as USD fees per day, and there is clearly an increase over the course of the year. Unlike the USD fees, however, BTC fees spiked in the middle of the year almost as high as the current fees. Overall, the fees are more stable when priced in BTC, but still show an uptrend.
Transactions Over Time
It is clear that competition for block space is increasing over time. However, is this due to an increase in BTC users, or are the existing users simply sending more transactions? In order to draw a conclusion, the number of BTC addresses, which can roughly be characterized as the number or BTC users, was charted against the number of transactions.
Figure 5 – Both # of addresses and # of transactions are increasing over time
It is clear that both the number of transactions and number of addresses are increasing over time. This supports the argument that there is more competition over block space. While both numbers have increased, the ratio of transactions to addresses has actually decreased, showing that some users may be reducing their number of transactions due to high fees.
Figure 6 – Transactions per address has decreased over time
It is also speculated that Bitcoin has added many “unsophisticated” users in the last few months. These users likely keep their coins on exchanges and never make transfers, which could be influencing the ratio of transactions/addresses. Most new users buy their first Bitcoin on Coinbase, a USD/BTC exchange. Below is a chart showing Coinbase users over time in the same time period.
Figure 7 – Coinbase users are increasing rapidly over time – Credit @alistairmilne (twitter)
While not quite exponential, the number of coinbase users is raising sharply, particularly in the last few months. This coincides with a drop in the Txratio.
Fees per Tx
So far, we’ve discussed total fees on a daily basis. In August 2017, Bitcoin implemented an optional feature called “Segregated Witness” (Segwit). In addition to addressing transaction malleability, segwit reduces the size of Bitcoin transactions. This results in lower BTC fees for segwit transactions, as they are priced in bitcoin/byte. SegWit is opt-in, and many exchanges have been slow to implement it. Some Bitcoin developers estimate that 4x as many Segwit transactions can fit into a block when compared to legacy (non-segwit) transactions.
In order to estimate the rate of Segwit adoption, transactions per block have been charted over time.
Figure 8 – Transactions per Block
While it appears that there is no strong trend in Figure 8, the maximum transactions are the point of interest. Before August 1st, the number of transactions seems to have a hard cap of around 2200 per block. After August 1st, there are a few blocks that contained up to 2,500 transactions. This shows that some blocks in the recent past have contained about 10% more transactions, likely due to segwit. This is confirmed by the below graph:
Figure 9 – Percentage of Segwit Transactions (http://segwit.party/charts/)
10% more transactions is nowhere near the 4x number described by BTC developers, and it shows that segwit adoption has been slow. As of December 2018, Coinbase, the major BTC exchange, has not adopted segwit. It’s also important to note here that blocks were not always full, particularly in the July timeframe. This is due to less transactions taking place on the network, as evidenced by figure 5.
Fees per Transaction
Thus far, the analysis has focused on fees per day. In order to determine what impact fees have on user behavior, it’s important to determine fees per transaction. To do this, USD fees per day were combined with transactions per day as seen below:
Figure 10 – USD fees per transaction have increased over time
It can clearly be seen that the average fee per transaction has risen over time. In January 2017, fees were less than a dollar. Fees currently average around $5 per transaction, and have spiked as high as $17.50 during high volume periods. $5 fees mean that Bitcoin can no longer be used as a currency for daily purposes. You cannot buy a $1 coffee and pay a $5 fee. A $5 fee, however, would be very reasonable to send $5,000 overseas when compared to the 10-15% charge added to a USD wire transfer.
Solutions to High Fees
The Bitcoin community is actively requesting that major exchanges and wallet providers implement Segwit as soon as possible. Segwit Integration not only reduces fees paid by customers using Segwit transfers, it also helps the rest of the network by enabling more transactions per block, reducing fees for everyone. In addition to Segwit adoption, Bitcoin developers are actively working on Lightning Network, which may reduce fees to fractions of a penny. When Lightning Network is fully implemented, many transactions will take place off-chain, but users will still have the option to send transactions on the Bitcoin blockchain. The Lightning Network solutions will allow for micropayments and small fees, making Bitcoin a viable currency. The safety and security of on-chain transactions will remain as well. On-chain transaction security has been a key characteristic that has helped Bitcoin garner a reputation as a “store of value” like gold.
Conclusion
Bitcoin fees are high, and have increased over time. It appears that fees will continue to rise as more users create accounts and send transactions over the Bitcoin network. Segwit adoption has been slow, and it appears that users are modifying their behavior by sending fewer transactions in order to avoid high fees. It is important that exchanges and wallets work to implement Segwit in the near-term to help reduce Bitcoin transaction congestion. If Segwit and Lightning Network are not implemented, Bitcoin will lose its characterization as a currency, and will strictly be a store of value.