How Bitcoin Fees Work | River Financial

Key Highlights

• Bitcoin transaction fees increase as transaction size and network volume rise.
• Miners receive transaction fees when a new block has been validated, supporting the profitability of mining.
• The Bitcoin halving increases the computational power and energy required to mine new blocks, lowering the subsidy of each block.

Introduction

Bitcoin transaction fees are an essential component of the blockchain network. When Satoshi Nakamoto created the Bitcoin blockchain, he implemented transaction fees in order to prevent spam transactions that could slow down and clog the network. Transaction fees incentivize miners to validate transactions and subsidize the diminishing block subsidy, helping support network security by keeping miners profitable.

Most exchanges and brokerages charge fees for buying and selling bitcoin. However, the fees charged by exchanges are entirely separate from the fees required to process a transaction on the Bitcoin network.

In 2010, a .01 BTC minimum transaction fee was implemented by a source code rule. This rule was later removed as transaction volume increased. Bitcoin transaction fees have risen in dollar amount and fallen in BTC amount as the price of bitcoin has increased.

What Are Bitcoin Transaction Fees?

Mathematically, transaction fees are the difference between the amount of bitcoin sent and the amount received. Conceptually, transaction fees are a reflection of the speed with which a user wants their transaction validated on the blockchain. When a miner validates a new block in the blockchain, they also validate all of the transactions within the block.

➤ Learn more about Bitcoin transactions.

Once a miner has validated a new block, they receive the transaction fees and block subsidy associated with that block. The sum of the transaction fees and block subsidy is the block reward.

With each Bitcoin halving, the hashrate falls. A falling hashrate simultaneously increases the cost of mining new blocks while decreasing the block rewards. Validating new blocks takes significant computing power and energy, so rising transaction fees incentivize miners to continue validating new blocks. Keeping miners in the market is essential to maintaining network security, and transaction fees play a significant role.

➤ Learn more about Bitcoin mining.

How Are Transaction Fees Determined?

Transaction fees are based on the data volume of a transaction and the congestion of the network. A block can contain a maximum of 4 MB of data, so there is a limit to how many transactions can be processed in one block. A larger transaction will take up more block data. Thus, larger transactions typically pay fees on a per-byte basis

If you are sending a transaction with the help of a Bitcoin wallet, the wallet will usually display an option for you to select your fee rate. This fee rate will be calculated in satoshis per unit of data your transaction will consume on the blockchain, abbreviated as sats/vByte. The total fee paid by your transaction will then be this rate multiplied by the size of your transaction.

If you wish to have your transaction confirmed immediately, your optimal fee rate may vary significantly. However, if you do not mind waiting, paying 2 sats/vByte will usually allow your transaction to be confirmed within a day or a week.

Bitcoin Transaction Speed

Transaction fees also reflect the speed with which the user wants to have a transaction validated. When a user initiates a bitcoin transaction, it goes into the mempool. Upon validation, it is included in the block. Miners choose which transactions to validate and include in the block. When there is a backlog of transactions waiting to be validated, it creates an incentive for miners to process transactions with higher fee rates first. Most miners target transactions with high fee to byte ratios. When network transactions begin to reduce, transaction fees will fall.

You can view the dynamics of transaction fee rates here.

Institutional Transaction Fees

Bitcoin exchanges, which facilitate matching buyers and sellers, calculate their fee in two ways: A flat fee per transaction, or as a percentage of 30-day total transaction volume. In both cases, exchanges implement a tiered fee structure based on the total dollar volume traded. Fee structures are meant to incentivize frequent trading. As a result, fees are proportionally lower for high value and high frequency transactions. Small, infrequent transactions often carry higher fees.

➤ Learn more about Brokerages and Exchanges.