The choice to attach a small fee for miners every time you send bitcoins is slowly going from voluntary to mandatory. Miners are already taking longer to confirm transactions that lack sufficient fees.
When you send bitcoins, your transaction is entered into a pool of unconfirmed transactions. This is known as a mempool, from which miners draw transactions to include in the next block on the blockchain.
The miner who wins the right to secure the next block, on top of the block reward, gets to keep the transaction fees. To maximize gains, miners give priority to transactions that have higher fees attached to them. According to BitcoinQueue:
“Transactions with 50 satoshis per byte or more have more chances to be prioritized, while transactions with fees below ten satoshis per byte are unlikely to be confirmed as long as higher priority transactions are in the queue.”
Substitute for mining reward
Bitcoin transaction fees are becoming more critical with every block reward halving, which happens after every four years and progressively cuts miner revenues. The most current halving happened in July 2016 and reduced the reward from 25 to 12.5 bitcoins per block (which occurs about every 10 minutes).
The mining reward also acts as the means by which the Bitcoin protocol releases new units into circulation. As the reward decreases, and as we approach the 21 million Bitcoin cap, miners will be forced to supplement and even substitute the reward with transaction fees as their primary source of revenue.
It is also important to note that miners need a steady flow of revenue because of the costs they incur to maintain the Bitcoin network. The hardware they use is expensive and needs to be upgraded often. The machines also consume a lot of electricity as they run around the clock. These costs will only increase as the mining difficulty grows.
How much to attach
Bitcoin transaction fees are one of the least understood aspects of bitcoin. This is partly because fees have been voluntary. Furthermore, most users have relied on wallet service providers to automatically set fee amounts.
The amount is arbitrary. It is like giving a tip whose value you are free to decide. Competition among users, however, pushes up the limits because people want their transactions to be given priority.
You are therefore better off attaching a higher than average fee, especially if you want your transaction to be confirmed in the shortest possible time. The question stands, however: How do you determine a figure that will put you in front of the line?
This is where sites like BitcoinQueue and BitcoinFees come in. They track transaction fees and suggest an approximate value to attach at any particular time of the day.
How to determines fees
The fee you pay for a transaction corresponds to the size of the data involved. According to Chris Moore& a Bitcoin developer, the more data a transaction carries, the more fees you need to attach. Meanwhile, the number of inputs and outputs determines the size of the transaction. Moore explains:
“Assuming all the inputs you are spending are from regular ‘pay to address’ transactions, each input will contribute 180 (plus or minus 1) bytes to the transaction. Each output adds 34 bytes.… And there’s a fixed extra 10 bytes which are always present.”
But wouldn’t this make Bitcoin expensive to use?
The Bitcoin community widely believes Satoshi Nakamoto released the cryptocurrency to the world to counteract the high cost of using traditional payments methods like Visa, PayPal, and bank wire services, which sometimes take fees amounting to up to 15% of a transaction’s value.
With the Bitcoin reward system serving as a way to release new units into circulation, Satoshi saw an opportunity to make using Bitcoin cheaper. Users would get nearly free service, and miners would get the new Bitcoins coming into circulation.
Even with higher transaction fees, many expect Bitcoin will continue to be one of the cheapest ways to send and receive money around the world. One Bitcoin user with the username “eldentyrell” argued on the community forum bitcoin.stackexchange.com that with a limited block size, you would expect users to compete for space and thereby push fees up. He, however, believes there is a remedy. He wrote:
“This isn’t really a closed-loop adjustment: the maximum blocksize is an arbitrarily chosen number, and there’s no reason to believe the maximum blocksize is small enough to ensure that transaction fees are high enough to incent enough miners to mine to keep the system secure.”
In other words, a bigger block size will lead to more confirmed transactions, which means the cumulative fee will be high, even though each transaction charge will be low.