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The Ethereum Cryptocurrency: Understanding Transaction Fees
January 15, 2024 2024-01-15 3:37The Ethereum Cryptocurrency: Understanding Transaction Fees
By Dr. Aman Saggu
You have heard about Bitcoin, but what is Ethereum?
While Bitcoin is widely known around the world, Ethereum holds the title of the second most valuable cryptocurrency, with a $270 billion market capitalization (total valuation) today. This is larger than New Zealand’s $248 billion GDP in 2022, and more than half of Thailand’s $495 billion GDP in the same year.
So, what is Ethereum? It is a decentralized blockchain, known for its smart contract capabilities. Smart contracts allow you to easily create your own cryptocurrency token, or transform your cat into a digital celebrity by minting its image as a non-fungible token (NFT). For those with technical skills, it allows you to build decentralized applications and play around with decentralized finance.
Why do transaction fees change?
Ether is the name of the cryptocurrency used to pay for transaction fees on the Ethereum blockchain. The fees are not fixed, they increase during periods of higher user demand and activity and decline during quieter periods. Complexity also influences transaction fees.
For example, a simple transfer of Ether to someone is relatively simple and costs less, while creating your own cryptocurrency token or NFT is more complex and costs more. In 2017, the surge in popularity of CryptoKitties, a type of NFT, led to a significant increase in transaction fees.
How do Ethereum’s transaction fees affect the digital economy?
A study conducted by Mahidol University International College in collaboration with the Blockchain Research Lab, and supported by the Ethereum Foundation, set out to analyze Ethereum transaction fees and their relationship with the cryptocurrency economy. They discovered some fascinating results:
- Blockchain Bridge Effect: Blockchain bridges connect the Ethereum blockchain to other blockchains. When the number of users (active wallets) increases, Ethereum transaction fees also increase. However, the relationship is weakening indicating that high Ethereum transaction fees may be causing users to migrate to other platforms.
- Centralized Exchange Factor: When centralized exchanges experience a surge in deposits and withdrawals, Ethereum transaction fees increase, causing users to make higher value transfers (for example, sending 1 ETH costs the same as sending 100 ETH, so it makes sense to transfer more when transaction fees are higher).
- Decentralized Exchange Paradox: These automatic trading platforms do not have a centralized authority. The amount of trading (buying and selling) on decentralized exchanges affects Ethereum transaction fees, but as fees increase, this influences trading behavior. Lately, these exchanges have faced challenges due to high fees.
- Maximal Extractable Value Bots: These sophisticated automated programs are used by traders for specific profit-making strategies on Ethereum. Their influence on Ethereum’s transaction fees does not show a consistent relationship.
- Non-Fungible Tokens: NFT trading influences higher Ethereum transaction fees, however the higher fees may discourage NFT trading.
- Stablecoins: The growing influence of Ethereum’s transaction fees on stablecoin activities and volumes underscores the escalating significance of stablecoins in the Ethereum ecosystem.
Implications for Developers, Investors, and Policymakers
The insights from this research into Ethereum transaction fees enable tailored approaches that benefit stakeholders:
- Developers can optimize applications for cost-efficiency to prevent users from leaving the Ethereum ecosystem.
- Investors can monitor stablecoin, NFT, cryptocurrency exchange, and bridge activity to determine the opportune times to make investments and when transaction fees are lower.
- Policymakers can steer the digital economy effectively by formulating nuanced regulations that safeguard diverse investor interests, while simultaneously nurturing innovation and upholding essential protective measures.
Reference: Ante, L., and Saggu, A. (2024). Time-Varying Bidirectional Causal Relationships between Transaction Fees and Economic Activity of Subsystems Utilizing the Ethereum Blockchain Network. Journal of Risk and Financial Management. Vol 17(1):19. https://doi.org/10.3390/jrfm17010019.
About the Author:
Dr. Aman Saggu, B.S., M.S., Ph.D., is a lecturer in Crypto-economics & Banking at Mahidol University International College.
