Transaction fees for Bitcoin at record-highs
Senior Quantitative Analyst, Saxo Bank
Summary: Mining activity on the Bitcoin network has suffered a recent drop, and the fees for carrying out transactions on the Bitcoin network are higher than ever. We look into the underlying mechanisms and compare to the runner-up, Ethereum.
The transaction fees on the Bitcoin network have reach new all-time high, and the average transaction fee is now above USD 60. The average fee on the Ethereum network is also high, but not relative to Bitcoin:
The network (should) align to the the mining activity
Transactions on the Bitcoin network are handled through processing of blocks of transactions. Bitcoin miners are competing for mining a bitcoin block, and the difficulty of doing this is adjusted on an ongoing basis. The Bitcoin protocol is designed to hit an average processing time of 10 minutes per block, and the processing time is regulated by changing the difficulty: if the hash rate (i.e. the activity from the miners) increases, mining of a block will be faster than 10 minutes and the difficulty needs to be increased. And likewise, the difficulty has to be lowered if the total miner activity decreases.
The difficulty is an important tool for regulating the activation and manufacturing of cryptocurrency to follow a pre-determined rate, and secondly it ensures a uniform production time of blocks, which may avoid possible attempts of fraud. Within the Bitcoin protocol, adjustments of the difficulty occurs after a fixed number of blocks have been processed, 2,016 specifically, corresponding to approximately every second week. Together with the limited size of a block, the average block creation time is the bottleneck for the throughput on the Bitcoin network.
Sudden drop in hash rate
Recently the hash rate of the miners has dropped significantly, and some crypto analysts associate this with a coal mine explosion causing a massive power outages in China in the mining hub of Xinjiang, which provides around ¼ of the global hash rate. At the same time, the shortage of semiconductor microchips is limiting the possibility for new miners to join the mining pool.
The bitcoin infrastructure does not seem fit for these sudden drops in mining activity as the network difficulty only changes every second week. As a result of the diverging mining activity and difficulty, it currently takes much longer than the expected 10 minutes to mine a block, thereby limiting the processing speed on the network. And with an increasing demand for carrying out transactions in a Bitcoin network with a lower bandwidth, higher fees are observed. This effect may be present until the next difficulty adjustment in the beginning of May, but we may hope that more miners come back online, and the hash rate goes back higher.
Ethereum difficulty regulating at a higher frequency
The current version of Ethereum is also utilizing mining for verification of transactions and also contains a dynamic adjustment of the mining difficulty. The difficulty is, however, updated with a much higher frequency as indicated in the chart below, and thus Ethereum is not as sensitive to changes in the hash rate as Bitcoin:
The original thoughts behind Bitcoin do not seem to have included the possibility of sudden dramatic decreases in the hash rate, and thus newer technologies such as Ethereum have the upper hand regarding transaction processing. This may also be one of the reasons why Ethereum has outperformed Bitcoin over the past couple of days, as the relative lack of applicability of Bitcoin has become even more evident.