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Understanding Crypto Costs: Transaction and Gas Fees

7 Minute Read

Cryptocurrencies are decentralized, which means that they’re neither regulated by a central authority nor involve an intermediary. But that doesn't mean they're fee-free. Indeed, transaction fees are an essential incentive that encourages more users to run blockchain nodes. Whether a digital currency uses a proof-of-work (PoW) or proof-of-stake (PoS) consensus mechanism, every transaction involves a fee.

One of the most common fees charged in Web3 is called a "crypto gas fee." Although most often associated with Ethereum, you’ll find crypto gas fees on every smart contract blockchain. If you’re interested in using dApps (decentralized applications) and DeFi (decentralized finance), it’s important to know how crypto gas fees work. But before we go through crypto gas fees, let’s review the basic concept of a transaction fee.

What are transaction fees?

Think of a transaction fee as a kind of "convenience charge" paid to a financial service provider. 

Every time you pay with a credit card or a fintech app, the payment provider charges an additional fee for confirming your transaction. These transaction fees are the primary way companies like Mastercard, Visa, and PayPal generate revenue. Most payment service providers charge a flat fee or a percentage per transaction.  

Transaction fees work similarly in the world of cryptocurrencies. Every time you transfer digital assets, you pay a fee. However, these crypto fees don't go to a centralized company. Instead, the transaction fees on a blockchain go to the node operators that secure the network. Most blockchains choose a validator per block to receive the fees for validating a transaction. 

These crypto transaction fees help encourage more people to either mine a PoW coin like Bitcoin (BTC) or stake their crypto on a PoS chain like Ethereum (ETH). The more nodes a cryptocurrency has, the more decentralized it becomes.   

What are crypto gas fees?

Crypto gas fees are a subset of transaction fees specific to smart contract blockchains. Ethereum was the first blockchain to use smart contracts and the first to introduce the practice of crypto gas fees. Today, many competing layer-1 blockchains like Solana (SOL), Avalanche (AVAX), and Polkadot (DOT) charge gas fees to use their networks. 

Whenever interacting with one of these chains, you’ll see an estimated "gas expense" before confirming your transaction. These fees go directly to a blockchain's validators as compensation for the energy they use to secure the network.

Unlike paying standard transaction fees, you'll need to pay gas fees with your blockchain's native cryptocurrency. For example, all crypto gas fees on Ethereum are settled in ETH. Similarly, you'll need to use the SOL token to pay for transactions on the Solana blockchain. 

You’ll encounter gas fees whenever you’re interacting with a smart contract blockchain. Whether sending some ETH to a friend, minting an NFT (non-fungible token), or using DeFi services like a decentralized exchange (DEX), it’s your responsibility to pay gas fees. 

How do you calculate crypto gas fees? 

There's no standard method for calculating crypto gas fees. Each cryptocurrency has a unique fee structure that influences how much you'll need to pay for gas. Also, crypto projects can adjust their fee algorithms at any moment.   

Since Ethereum is the largest smart contract blockchain, most people are curious about what Ethereum's gas fees are and how to calculate them. After the London upgrade of 2021, the formula to calculate Ethereum crypto fees is as follows:

Gas limit * (base fee + optional tip) = Gas fee

Here, the "gas limit" is the maximum gas you’ll use on the blockchain for a transaction, and it's measured in "units." By default, the Ethereum blockchain sets the gas limit to 21,000 units. However, you can increase or decrease your gas limit in your crypto wallet.

The "base fee" is the minimum amount of ETH you need to pay to send a transaction on the blockchain. These fees are measured in a unit called "gwei," with one gwei equaling 0.000000001 ETH (or $0.000002 if one ETH equals $2,000). 

Ethereum's base fee will increase or decrease depending on network activity. The more people use Ethereum, the higher the base fee will go. Conversely, when network activity is slow, the base fee will reduce. 

The tip is an optional feature you could use to speed up your transaction. While tips aren't required, they make validators prioritize your transaction to redeem the higher reward. Tips are also calculated in gwei. 

Since the base fee is constantly changing in relation to network activity, it’s important to use a reputable gas tracker site like Etherscan to find the latest average rates.

For example, if the average base fee on Etherscan were 30 gwei and you had your gas limit set to 21,000 units, you would calculate your cost as follows:

21,000 units * 30 gwei = 630,000 gwei (or 0.00063 ETH) 

If one ETH equaled $2,000, the above gas fee would be $1.26.

You don't have to manually calculate these formulas whenever you want to pay a gas fee, thanks to crypto wallets like MetaMask that show you a quoted gas fee before you submit a transaction. 

Does Bitcoin have gas fees? 

The term "gas fee" wasn't used in cryptocurrency before Ethereum. Therefore, most people don't refer to the transaction costs on Bitcoin's blockchain as "gas fees." Instead, it's more common to refer to Bitcoin's fees as either "network fees" or "miner fees."

Bitcoin uses a PoW algorithm to verify transactions. Under this system, BTC miners use large computers designed to solve complex algorithmic problems. Whoever solves this algorithm approximately every 10 minutes can confirm a transaction on the Bitcoin blockchain and collect transaction fees and BTC block rewards. 

The amount paid in BTC network fees depends on the size of your transaction and how congested the network is. If you're sending more than one BTC during a busy time, you should expect higher transaction fees. 

Bitcoin fees are measured in "satoshis," which refers to the smallest unit of a Bitcoin. One satoshi equals 0.00000001 BTC (or about $0.0002 if one BTC is $20,000).

Are crypto gas fees the same as network fees? 

Although crypto gas fees are technically "network fees," most crypto enthusiasts don't use these terms interchangeably. In most instances, "network fees" refer to the transaction costs people must pay on non-smart contract blockchains.

Network fees serve the same purpose as crypto gas fees, but they aren't associated with smart contracts or Web3 dApps. For instance, Bitcoin's network fees help compensate the BTC miners who secure Bitcoin's blockchain. 

Bitcoin is the primary cryptocurrency associated with network fees, but you'll need to pay these fees on any blockchain. For instance, cryptos like Litecoin, Dogecoin, and Bitcoin Cash all charge network fees

Why are crypto fees so high? 

Ethereum gas fees have gained a reputation for being cost-prohibitive. Since its creation in 2015, Ethereum has struggled to scale its operations. Even after Ethereum's PoS upgrade (aka "The Merge"), it can only handle about 10 transactions per second (TPS). However, new blockchains like Solana can process 3,000 TPS. 

Ethereum's slow confirmation speed often drives up the base fees for transactions when many people are using the blockchain. Also, some Ethereum whales may pay exorbitant tips to speed up their transactions, often resulting in a "gas war."  

For example, when the NFT studio Yuga Labs released its "Otherside" metaverse land NFTs, average ETH gas fees rose to roughly $450 for a normal transaction. The demand for these NFTs was so high that some ETH users were willing to up their tips to thousands of dollars. It's estimated Ethereum users paid $180 million in gas fees for the chance to mint an "Otherside" NFT. 

Is there a way to pay fewer gas fees? 

Currently, the Ethereum team is working on solutions to address its high gas fees. Now that Ethereum is on a PoS chain, developers can begin work on "sharding." This novel technology helps offload transaction data on the main chain to hopefully make ETH transactions faster and cheaper.

However, it's unknown when Ethereum developers will implement strategies that impact gas fees. Meanwhile, many Ethereum-compatible layer-2 chains offer a swift and nearly feeless experience. Blockchains like Polygon, Arbitrum, and Optimism interact with Ethereum, but they handle transactions on a separate blockchain to reduce congestion. 

Competing smart contract blockchains often offer cheaper fees than Ethereum. Crypto projects like Solana, Polkadot, and Avalanche use the PoS model and currently have lower fees than Ethereum. 

Wrapping up 

Crypto gas fees help power some of the world's largest blockchains. Although Ethereum's gas fees remain an issue, developers are working on strategies to address scalability concerns. Also, with the rise in layer-2 solutions and Ethereum competitors, interacting with dApps without paying exorbitant fees is easier than ever before.