Coinbase: Users to Pay Fees for On-chain Transactions, Internal Off-chain Transactions Still Free

The Bitcoin ecosystem evolves. Coinbase, with six million users the largest exchange platform in the US, reacts to the emerging fee market and does no longer pay the transaction fee for its customers. Off-chain transactions, from Coinbase account to Coinbase account, however, are still free.

Besides some minor updates in its so-called “Spring Cleaning” Coinbase also adjusts its wallets to the emerging fee market. The online wallet and exchange, which serves more than six million customers, explains in a blog post:

Network transaction fees: We will discontinue paying network transaction fees for on-chain transactions starting March 21, 2017. Network transaction fees do not go to Coinbase; they go to the miners of the Bitcoin and Ethereum networks. Since our inception, we have been paying network fees on behalf of our customers to help support the growth of the bitcoin and ethereum networks. We now have over six million users worldwide, and this has become a significant cost. Fees will be assigned dynamically based on the current network conditions and will be paid by customers when they send an on chain transaction. Transactions between Coinbase accounts will continue to be off-chain and free.

It is happening. After the transaction volume reached the limit of the block size, transactions compete with fees to be included in the blocks by miners. To get a place, you have to overbid the others. In last weeks this emerging fee market has led to constantly rising fees, in which 100 Satoshi per byte has become common and 300 Satoshi per byte normal. As a simple transaction has a size of roughly 250 bytes, this equals fees of 30 cents to a dollar for each transaction.

Now users and company start to evolve with the fee market. Using bitcoin is no longer for free; you have to pay to get a place on the database secured by the world’s most powerful network of computers. It might be that this development is not convenient for companies and customers, as transactions get significantly more expensive, but this does not mean that it is a bad way to go. The network regulates itself along the limit of the block size; transactions, which are too small to pay a certain amount of fees, need to search for another channel.

In an ideal world, these channels would be decentralized layers on top of Bitcoin, like Lightning or Sidechains. But these technologies are not available now and for the foreseeable future, because of technical and conceptional, as well as political, reasons. Instead, currently there are only three usable substitutes for on-chain transactions; altcoins, centralized databases like Coinbase’s, or fiat money like debit cards and so on.

If altcoins are increasingly being used to transact money, as bitcoin becomes too slow and too expensive, is hard to tell. The two coins, which have the best chances to fulfill the role of being a medium for low-value transactions, Dash and Ether, have seen a significant, if not spectacular rise in their respective prices, while there is no hard data about rising transaction volume.

With the new fee policy, Coinbase becomes the first company paving the way to divert transactions on internal off-chain bookings. The startup used its investment funds of $117 million to build a service which has been described as “the AOL of Bitcoin;” an easy to use online wallet with the option to directly buy or sell bitcoin, an exchange, and a payment processor. With this vertically integrated, full service Coinbase has the best chances to promote its internal off-chain transactions as a cheap and fast alternative. The sheer size of its customer base might help Coinbase to unleash network effects and to gain competitive advantages for all of its services.

It is possible that this announcement is the first step of the rise of off-chain payment solutions. It could start with that more and more people pay from coinbase to coinbase. But it could go far beyond. More companies could join Coinbase, like Circle or Blockchain.info, and cooperate to build a ledger for their transactions. At some point, they might use a sidechain or another distributed ledger technology which enables them to build a trustless layer of transactions.