Fees has always been a controversial topic for bitcoin. With the increasing value of bitcoin, same fees which used to cost cents in 2010, now costs several hundred dollars now. Even though fees suppress bitcoin usage and adoption, some core developers have insisted that bitcoin needs a fee market. In this article I will try to explain the need of a fee market in bitcoin.

How does Fees in Bitcoin work?

Whenever a user makes a transaction, he adds a small amount of miner fee to his transaction. The fee represents the urgency for the confirmation of the transaction. The higher the fee, the more the chance of it confirming in the next block. Fees depends on the size of the transaction and the size of the transaction depends on the amount of Inputs and outputs in the transaction. This fee is paid out to the miner who mines a block with your transaction included in it.

Miner Incentives

Bitcoin network pays out a fixed reward for finding a block. Every miner is currently payed out 12.5 BTC per block. Along with the block reward, the miner receives the fee from each transaction that is included in the block. Currently fee per each block is approximately 1-2 BTC which is around 10% of the block reward.

Deflation in Miner Rewards

Due to the programming logic implemented in bitcoin’s code, the block reward halves every 4 years. When bitcoin was first launched, the block reward when 50 bitcoins per block. Till now there have been two halvings. Next halving of the block reward is scheduled to happen in 2020. This allows the supply of bitcoin to increase at a controlled rate and makes bitcoin scarce. Due to halving of the block rewards, we can never have more than 21 million bitcoins.

The Need of A Fee Market in Bitcoin

As more and more halvings occur, bitcoin becomes less profitable to miners since the amount of bitcoins they receive per block is reduced. Also with the amount of ASICs produced every year and the increasing cost of electricity, the cost of operating a miner keeps increasing. At the current rate, miner reward will be reduced to less than a single bitcoin before 2030. This might lead to a point where mining bitcoin may be completely unprofitable causing lot of miners to leave the network. If a lot of miners decide to leave mining bitcoin, it will make bitcoin vulnerable to various attacks.

Due to the current rate of production of ASICs and the speed at which new mining power is added to bitcoin, the halvings are happening much faster than anticipated. This makes bitcoin less and less profitable and requires the value of bitcoin to double every halving. If the value of bitcoin does not doubles before every halving, it becomes unprofitable and will force miners to leave bitcoin.

To prevent this from happening, a fee market is required. The Fee market will allow bitcoin to stay profitable even after the block reward have been reduced to under a bitcoin. Currently fees represent around 10% of the total bitcoin block reward. In 10 years, the same fee will represent over 50% of the block reward. This will also eliminate the occurrence of empty blocks as miners now need the transactions to stay profitable.

Also if the block size is increased by a huge amount and some blocks are empty and some are full, it will create too much variance in the block reward which will make mining bitcoin a big risk for miners which will force them to go and mine other blockchains.

Conclusion

Fees will always stay controversial in the sense that there is no better solution right now. Too high fees makes doing transactions a pain, too low fees makes bitcoin mining unprofitable in the future.

Special thanks to Dragons Den and Mr. Hodl for explaining the need of a fee market and its economic value for bitcoin to me.

Let me know what you think about the need of a fee market or if there are any other better solutions.