Why Are Bitcoin Fees Increasing?
By: Jason Deane
Tags: Global Economy, Bitcoin, Money, Finance, Bitcoin Mining

Why Are Bitcoin Fees Increasing?

Transaction fees just hit their highest level in 12 months and are still rising — what’s going on?

Image by tom bark from Pixabay

For the last few weeks it’s been all about the halving. Pretty much everyone in the world of crypto was focused on it, with live streams, webinars and even parties reminiscent of New Year’s events for the moment the block height ticked over to 630,000.

And then, just like New Year’s itself, we find ourselves on the other side and nothing, at least to most people, seems any different. The Bitcoin network itself didn’t even bat an eyelid and simply carried on with the task in hand — processing transactions in 10-minute blocks — but behind the scenes miners are still doing the same work as before, but now with only half the pay.

I’ve already written about the likely effects for of this both before and immediately after the halving so I won’t repeat them here, but even while these scenarios, or variations therefore, play out in real life, something else was also happening that had been lost in the noise of halving; the transaction fees for Bitcoin had unexpectedly started rising.

How Do the Fees Work Again?

Most people know that when you send bitcoin to someone or pay a bill, a small charge is added to the amount to compensate the miners to make the transaction for you.

This rate is usually set automatically by the wallet you’re using and is linked to whatever the going rate is at the time, information that is publicly available to anyone on the blockchain.

Most of the time this fee is negligible, often just a few cents, and is not linked to the dollar value of the transaction. This means sending a payment of $5 to someone will usually carry a similar cost as sending $5,000,000 to someone if the network is running normally.

This, of course, is something that makes Bitcoin very appealing for people who have traditionally had to use very slow and expensive central banking systems.

The rate is actually set by the state of the network as a whole. In normal times, your transaction is added to Bitcoin’s Memory Pool (or “Mempool” for short), which is effectively a sort of queuing system.

Your transaction is then joined with others to form a block, one of which is processed every 10 minutes and, eventually, confirmed. Once it is confirmed, it is confirmed forever, and can never be retrospectively changed.

The miners receive all the fees paid to process that block (which, of course, will include many transactions and therefore many fees) PLUS the block reward provided by the network, now only 6.25 new units of bitcoin, down from 12.5 before the halving. It’ll stay that way until the next halving somewhere around May 2024, when it drops to 3.125.

What Causes Fee increases?

Usually, the queue (the “Mempool”) is dealt with in an orderly manner, just like when you arrive in a Post Office and take your number from the little number dispenser in the middle of the store. In time, you’ll be called up and dealt with.

However, what if 300 people turned up at the Post Office at the same time in a queuing system designed for 20? There’s a good chance some of them will be in a hurry, so they may offer to pay to jump the queue.

As soon as someone starts to do that, then others will pay more to go before them, and before long it becomes clear that unless you start paying yourself, you’ll be pushed further and further down the queue as the number of people arriving at the Post Office continues to exceed the number that can be processed.

It’s possible, in fact, that you’d never be seen by anyone at the Post Office if you simply waited, so paying an increased fee ceases to be an option.

Just as fees in the “normal” times are a reason Bitcoin fans point out how well the system works for transferring large sums of money, the fees in “busy” times are the reason Bitcoin’s detractors are so critical of it.

Scaling IS a genuine issue with the reserve cryptocurrency and one that many brains are working on, even now.

But we’re not there yet.

So What’s Causing THIS Increase? Part 1 — INTERNAL Network Congestion

Most people I work with or speak to regularly in the world of cryptocurrency know that I have a mining operation based in Siberia with Cyberianmine, so as soon as anything remotely mining-related happens, I get a call.

Such was the case this time.

Now, I’ll be honest. I’d half picked up that there had been an increase in fees, but since they never stay completely still due to the way the maths works, I hadn’t paid much more attention than usual. But getting first one message then another meant that I’d missed something. And I had.

Like everyone else, I’d been so focused on the halving that I hadn’t noticed the fees had actually been creeping up a few days before it happened.

Image: Bitinfocharts.com (public domain)

In fact, the fees had jumped from their steady 50 cents level, where they’d been for approximately three months, to roughly $3.00 by the time it had happened. At the time I started writing this article, the fees had reached almost $6.50, a figure that hadn’t been seen since June 2019, and even then only very briefly. Prior to that, it had been January 2018 at the tail end of the retail driven bull market.

Logging into my f2pool mining dashboard, I was able to see the effect first hand. Whilst the block reward figure had halved, the transaction fee element had jumped, softening the blow somewhat.

Something was definitely going on.

My first thought was this was linked in some way to the halving. When the block reward is halved (and this is the third time since it happens every four years as programmed) miners adjust their machines accordingly, since the event creates a drive for efficiency.

Older and less efficient machines are junked and the overall hashrate drops, in this case by around 47.7% at the maximum peak to trough measurement. According to our previous (and only) two data points, this is normal.

However, since the halving happened in the middle of the 14-day difficulty adjustment period, it meant the difficulty — the mathematical equation that ensures that the block time remains at roughly ten minutes — had not yet reduced. The lower hashrate meant that it was now too high for the network to do this and blocktimes, and the mempool itself, started to rise.

The fact that blocktimes were running within perfectly normal parameters (9.863 minutes) just before and during the having is an excellent indicator that this must be a factor.

The second the halving happened and the hashrate started to fall, the block times started to increase immediately. By the next morning, they had risen to 12.01 minutes, and by the May 18, it was 14.12 minutes, averaging an increase of 23.18% over the period.

Meanwhile, the same was happening with the mempool. There had already been a couple of spikes in the previous 30 days, contributing to fee increases, albeit at a lower level, before reducing again.

However, this time, the mempool just continued to increase, as that Post Office queue grew faster than the cashiers could deal with it.

Image: Current Mempool showing backlog of Bitcoin transactions. Source: Blockchain.com (public domain) The dotted line shows the pool status as at halving.

This makes sense with a lower hashrate and difficulty set too high. At time of this writing, the adjustment has happened, but the drop was only 6%. Although this was actually the sixteenth-biggest drop in Bitcoin’s history and is therefore significant, it feels slightly at odds with what the real world says.

But this is maths. The maths is always right, human emotions less so.

To confirm this, I reached out to Thomas Heller, Global Business Director at f2pool, and he explained it perfectly in a nutshell:

“The recent block halving took place during the middle of the period between difficulty adjustments. Prior to the halving, blocks were being mined at a faster pace than 10 mins per block, and after the halving, blocks were mined at a slower pace than 10 mins per block. Because of this, the mining difficulty only decreased by 6%, even though the network hashrate decreased by 20–30%.”

We would expect, therefore, to see a period of adjustment over the next few difficulty epochs, especially since price is stable or rising and China’s hydro season will begin shortly on May 25, making mining cheaper in those regions.

In my view, this period of adjustment must, logically speaking, be at least partially responsible for the current spike in fees.

So What’s Causing THIS Increase? Part 2— EXTERNAL Network Congestion

One thing I talked about regularly at halving webinars is how much things have changed since the previous ones.

In 2012, there were only 43,500 wallets in existence at the time of the halving. That’s not a global movement — that’s a club! In fact, the Dennis the Menace fan club, a British comic character for kids, had more members than people who were involved with Bitcoin at the time.

By 2016, this had risen to 7.85 million, and by the time of the last halving it had reached 48.37 million wallets, a million of which had been created in the 30 days immediately prior to it happening, according to data from Blockchain.com.

At the same time, google searches for “Bitcoin halving” were nine times higher than last time round, even though the number of wallets had only grown by seven times.

Google’s reports also show that general searches for the term “Bitcoin” had also doubled since the beginning of the year. There’s no doubt interest is up, but on it’s own, that doesn’t explain anything.

However, trading activity might.

Bitcoin’s current trading volume (in terms of “real” trades) has jumped to its highest level since July 2018, when its seven-day average trading volume topped $3 billion per day. This is a level three times the amount seen in April.

These numbers have been confirmed by Arcane Research and Messari and, as with most things in life, this makes the explanation for higher fees appear to be pretty simple.

Conclusion and Outlook

It seems that a spike in interest and trading activity occurred at the exact same time that a major adjustment in hashrate and difficulty was under way due to the halving, and possibly even because of the interest caused by the halving.

The logical conclusion, therefore, is that the fees simply reflected mathematically what was happening in the real world.

So, if that is indeed the case, what happens next?

From a network point of view, this will resolve itself within the next few adjustments, especially if China’s hydro season starts in earnest within this epoch and starts cutting into the block times.

But if external demand keep rising in the meantime, then the mempool as a whole won’t start reducing until it does and fees are likely to remain higher than normal.

So, since none of this is directly in control of anyone, whether miner or user, all we can do is wait and see.

After all, market forces take care of everything eventually.