Ethereum: What are Transaction Fees and How are They Determined? – Research Blog


By now most people have heard of Bitcoin, the first form of decentralized cryptocurrency which was created in 2009 and popularized in 2011. However, these novel tokens did not just appear out of thin air, they had to be mined. But what does this mean?

Essentially, there is a finite amount of Bitcoin, 21 million to be exact. Bitcoin miners run complex computer rigs to solve intricate and complicated puzzles in order to confirm groups of bitcoin transactions called blocks. Once a block is mined, the miner is rewarded with bitcoin. 

Bitcoin mining

On 3 January 2009, the bitcoin network came into existence after the founder, Satoshi Nakamoto, mined the genesis block of bitcoin (block number 0), and received a reward of 50 bitcoins. The rewards for Bitcoin mining are reduced by half roughly every four years due to its scarcity. Currently, miners are rewarded 6.25 Bitcoins for every block. Additionally, when a transaction is approved via mining, it is added to a block which is then added to the Bitcoin blockchain. A blockchain is an immutable, decentralized, and transparent computer network that acts as a publicly available ledger. For more information please reference my previous article here.

Not all tokens are mined, however, the most popular or widely used ones, Bitcoin and Ethereum are. Today, we will be focusing on the Ethereum Blockchain using ETH tokens.

Similar to Bitcoin, ETH is also mined by solving complex puzzles in order to confirm and verify blockchain transactions. However, ETH miners are paid in ETH, not bitcoin. In addition to receiving the ETH from mining, miners are also paid through transaction fees called gas

Transaction fees are determined by a Transaction fee mechanism (TFM), a key component of blockchain protocol. However, there has yet to be an empirical study on the real-world impact of TFMs. Recently, a study out of Duke and Peking University evaluated the effect of EIP-1559, the first TFM to abandon the traditional first-price auction paradigm. 

Every transaction or smart contract executed on the Ethereum blockchain requires gas. If you are unfamiliar with smart contracts please reference my previous article here

“Gas is a unit of measurement for the amount of computational effort required to execute a specific on-network operation”

William Zhao ’23, Student researcher

However, the price of gas is constantly changing in response to how many others are trying to make transactions on the blockchain. Gas prices are typically denoted in GWEI or a billionth of an ETH ( 0.000000001 ETH). For context as of February 1st, 2022 at 1:17 ET, ETH is worth $2778.50 USD per token

When an ETH transaction is placed it is not immediately completed and resides in a memory pool or “Mempool.” These are smaller databases of unconfirmed or pending transactions. Prior to the EIP-1559 update, the Ethereum TFM centered around the first-price auction paradigm. 

Mempool

Conceptually, the first-price auction paradigm is fairly simple. Essentially every time a transaction is made there is an accompanying gas bid. Crypto wallets like Metamask or Coinbase Wallet provide suggested gas bids for users but still allow them to alter the bid. This is because transaction verification priority is determined by the miner and thus given to whoever bids the most. Once a transaction is verified it is added to the miner’s block and then to the blockchain. As a result, some users would offer unnecessarily high gas fees in order for their transaction to skip the line and be quickly processed thus creating major delays for others.

There were several problems under this previous TFM including long wait times for verification, extremely high gas and unpredictable prices, as well as inefficiencies around block size and consensus security. Recent research examined the causal effect of EIP-1559 on blockchain transaction fee dynamics, transaction waiting time, and security. They found that while the transaction mechanism became even more complex it did also become more efficient. 

EIP-1559 improves user experience by reducing users’ waiting times, improving fee estimation, and mitigating intra-block difference of gas price paid (which is more important for miners). However, EIP-1559  did not have a large impact on gas fee reduction or consensus security. In addition, they found that when ETH’s price is more volatile, the waiting time is significantly higher. 

Figure 8: Distributions of median waiting time. Users experience a much lower transaction waiting time following EIP-1559.

Ultimately, while user experience improved, scalability issues held the TFM from having a larger effect on important components like gas prices. 

“If you can only hold a certain amount of transactions that’s a hard cap on development, however, high gas prices are a scalability issue not a mechanism design issue.

William Zhao ’23, student researcher

This research paper was recognized by Vitalik Buterin, one of the co-founders of Ethereum.

By: Anna Gotskind,
Class of 2022





Read More: Ethereum: What are Transaction Fees and How are They Determined? – Research Blog

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