If you have been in the crypto space for the shortest period, you might see the term "gas fees" flying around. Heck, even if you are not in the crypto space, you might have seen several tweets, I.G. and F.B. stories lamenting the "high gas fees" that crypto traders are charged. If you think it relates to autogas, don't worry, you are not alone. A lot of people make this mistake too.
But think of what happens when autogas rates increase astronomically; you can expect an increase in the price of groceries and many other essentials. In crypto, gas fees have become notorious for increasing at an alarming rate, and for such an essential aspect of crypto, the concept of gas fees must be explained in the simplest way.
But to understand what gas fees are, we must first take a closer look at blockchain technology, the mother of cryptocurrency.
Back to the Basis: Ethereum Blockchain
In 2009, Satoshi Nakamoto wrote the program for the world's first blockchain and cryptocurrency, bitcoin. The bitcoin program works in this way: when transactions are initiated on the blockchain (the public ledger), a network of miners, who are like tellers (or validators), compete for the prize of recording the transaction (now as a block) on the blockchain network. The lucky miner is then rewarded with bitcoins for providing the computing power for making that happen. Each blockchain transaction, much like the ACH transactions in the traditional banking system, is charged a certain amount as transaction fees.
While Satoshi's bitcoin paved the way, it was Vitalik Buterin's Ethereum that brought a new dimension to blockchain technology and its applications in finance and other sectors; Decentralized Applications (DApps). Ethereum was built on a programming language called Solidity, making it the first executable blockchain. The Ethereum network opened up the possibility for thousands of decentralized applications to be built and deployed atop a blockchain using smart contracts. Ethereum smart contracts are vital to our understanding of gas fees as we know them today.
The ethereum smart contract helped evolve ethereum from bitcoin, growing the blockchain to become the second-largest today. Ethereum's platform for building decentralized apps quickly made it the blockchain of choice for the early and later DeFi developers. But we have to visit a critical component of blockchain first. Don't get tired now, okay? Think of this as a short detour that brings you closer to the chocolate shop.
Crypto Mining Rewards: Hey, Pay Me for Validating Your Transaction!
Do you remember what we talked about earlier? About blockchain transactions being recorded on the public ledger (the blockchain) and validated by miners. Okay, let's visit that again. When transactions are made on a blockchain, they are recorded as blocks. Then, a process called mining is used to verify these blocks on a blockchain. There are two types of mining protocols; the proof-of-work (PoW) and the proof-of-stake (PoS).
The proof-of-work protocol involves a network of computers that supply the computing power needed to verify blocks on a blockchain. The process is quite technical, but it involves solving complex mathematical equations, which takes a tremendous amount of computing power.
On the other hand, the proof-of-stake protocol is a modified method that allows independent verifiers to contribute their crypto assets to create a pool of funds. The coins are "staked" for a chance to verify transactions on the blockchain. The PoS protocol significantly reduces the computing power needed to verify blocks.
Now, there are a few things that both mining protocols have in common, but we are interested in the mining rewards.
In crypto, mining rewards are given to successful miners (validators) once a block is validated. Remember that there are thousands of miners in the mining consensus, so miners have to compete to be selected to verify a block. In PoW mining, the successful miners are rewarded with new tokens of the coin that are freshly minted, but in PoS, miners can choose to either receive new tokens or be paid their rewards from the network fees.
Now, this is where our story gets more interesting. Fill another coffee.
What is Ethereum Gas Fee?
The ethereum blockchain network uses the Ethash algorithm for all of its activity. The Ethhash demands several network confirmations before a block is successfully added to the blockchain. When a transaction is made and a miner successfully picks it up for verification, the transaction fee is passed as mining rewards. But here is the catch; at any time on the ethereum network, there are thousands or millions of transactions awaiting confirmation. This creates a situation.
The miner now has to choose what transactions to verify from the numerous transactions out there. Remember, miners cannot select the exact transaction to verify (the network randomly chooses). Still, they can prioritize transactions to verify those transactions with higher transaction fees, hence receiving a higher reward.
In other words, the gas fee is the reward that miners receive, and they tend to quickly verify those transactions with higher fees. Although the network automatically sets the transaction fee, miners can significantly increase the gas fee by creating a situation where traders increase their gas fees to get their transactions verified quickly. Quite unpleasant, don't you think?
This situation is seen during the so-called 'activity times' - when ethereum transactions reach a peak or are so much and cause a backlog. When that happens, only transactions with higher gas fees are verified first, and those with lower gas fees tend to take more time before getting verified. As a result, traders often resend their transactions with higher gas fees if the first one is unverified after a long time. Others may choose to wait until more miners are free and thus willing to accept lower gas fees.
Now, let's pause and recheck that cup of coffee. Or would you prefer juice? Grab one, and let's go on.
How Are Gas Fees Calculated?
Like most measurements that we use today, ethereum is made up of units. Remember how bitcoin is divided into satoshis? Well, ethereum is also divided into smaller quantities called Weis and Gweis. The Wei is the unit of measurement of ether (ethereum). It is the smallest possible denomination of ether. Large amounts of Weis, up to a certain number, are called Gweis. Hey, do you remember your elementary lessons on Kilo, Giga, and other mega sizes? Yeah? Well, Gwei is like the mega Wei.
We have 1 Gwei = 1,000,000,000 Wei = 0.0000000001 or 1 * 10^-10 ether.
The ethereum translation fees are supposed to be far smaller than 1 ETH, so they have to be calculated in the smallest possible unit, the Wei. The latest formula for calculating ethereum gas fees is
● Total Fee = Gas unit limits * (Base fee + tip)
Hold on, don't get confused now. Let's go through the meaning of gas unit limits, the base fee, and the tip, as seen in that formula.
● Gas limit fee: When traders initiate ethereum transactions, they must input the gas fees that they are willing to pay for the transaction. Now see it as you being able to input whatever amount you want to spend as bank charges when performing fiat transactions. The only catch is that your financial institution is not bound to honor it, like the ethereum miners. The gas limit will often vary according to network interactions.
● The base fee: Here's the most important determinant. The base fee is the smallest amount of the gas fee that miners can charge from a transaction before including it on the ethereum blockchain. Think of it as the benchmark fee for tellers to issue you a receipt that your transaction is valid.
● Tips: Now, to ensure that their transactions are verified early and prioritized, traders add what is called a tip to their gas fees. Again, look at it as a legal "bribe" to make the tellers at a bank attend to you first before others.
The next and most-logical question is this:
Why Do Gas Fees Cost So Much?
There are several reasons why you can see so many complaints about the massive increase in ethereum gas fees. We briefly talked about one before; the so-called "active periods" when there are thousands or millions of transactions on the network. Since ethereum also has thousands of DApps and smart contracts engaged by millions of people, the transactions during the peak periods can cause a bottleneck on the network. When that happens, traders may deliberately increase their tips to ensure that their transactions are prioritized.
Another reason is that an increase in the price of ETH will increase the gas fees; remember the Gwei? As smaller units of ETH, the Gwei will also increase or decrease in value following ETH's price movement. Thus, you can expect to see higher gas fees when ETH is pumping and lower gas fees when it slumps.
Final Thoughts
First of all, congratulations for making it down here, no jokes! Now you know what gas fees are and why they tend to be high. Some traders have been unfortunate to send ETH worth a few dollars and pay gas fees worth hundreds of dollars for it. Just last year, Bitfinex paid over $22.5 million in gas fees to send a smaller amount of ETH.
But thanks to the proposed Ether 2.0 upgrade, the ethereum network is set to completely switch from the proof-of-work protocol to the proof-of-stake protocol. That will make the network faster and significantly reduce the gas fees traders have to pay. Cool? Yaay!
P.S.: I think I deserve some lemonade to cool my throat, yeah?
