transaction fee vs mining reward

Transaction fee vs mining reward

Video transcription below

Introduction

In a proof of work cryptocurrency, like Bitcoin, we know that miners are a key component to the system, and that without them Bitcoin wouldn’t be a thing. And without Bitcoin, we wouldn’t be where we are today, with all these cryptos out there, that are changing the world as we know it.

We know that miners are responsible for validating transactions in the network and thus maintaining the blockchain. And that’s the only way new bitcoins come to existence. If you’re not familiar with this yet or would just like to dive deeper on the topic, we have a video on that here in the Crypto Odyssey channel, link is in the description. To be honest, there are so many things that I will mention about Bitcoin mining in this video, that I must say it’s better to watch that other video first, and then come back to this one. I promise it will make thing so much easier to take in.

But as I was saying, if that’s how miners make money, why do we have to pay a transaction fee every time we send Bitcoin from one wallet to another? Where does this transaction fee goes to? And who decided how much it should cost?

Those are just some of the questions we’ll answer in this video. So make sure to like and subscribe, and don’t forget to turn on that bell notification so you don’t miss out on any new video from the Crypto Odyssey. And if you’re real fan, join our telegram group and follow us on Instagram, links in the description.

Mining rewards

Before we move to the main topic of the video, it’s important that you understand what halving is. We know that miners get paid in bitcoin, created out of thin air, every time they add a new block to the blockchain, which is done by validating transactions in the network, but the amount they get paid in is not always the same.

To keep it short, a Bitcoin halving event is when the reward for mining bitcoin transactions is cut in half, and that happens roughly every 4 years. You can see more on the topic in that same video I mention earlier, link is in the description. But just so you know, when Bitcoin was created, the reward was set to 50 BTC per block, and now, since early 2020, it is 6.25. The next halving should take place in early 2024.

That basically defines what the mining reward is.

Now let’s go ahead and understand a bit about the history of bitcoin transaction fees.

A Short History of Bitcoin Fees

Bitcoin transaction fees date back to its creation in 2009, the purpose of which was to prevent spam transactions from eventually clogging the blockchain. You can imagine the network as a highway of transactions where bitcoin flows from one address to another. If there is no cost at all for these transactions to use the highway, users could flood the highway causing a traffic jam of transactions making the highway inefficient. This idea was actually not new at the time of Bitcoin’s creation, because Satoshi Nakamoto borrowed it from Adam Back’s 2002 hashcash iteration, as cited in Bitcoin’s Whitepaper.

In July 2010, Bitcoin developer Gavin Andresen emphasized a source code rule that stipulated a minimum transaction fee of 0.01 BTC. Which at the time, was cheaper than a few cents.

As time went by and the price of BTC rose, so did the fee. This phenomenon is caused by the increased demand for block space and the BTC USD market valuation ratio itself. Suddenly, 0.01 BTC means a lot of wealth. When the price of Bitcoin reaches 10.000 USD, 100 Satoshis, or zero followed by 5 zeros and a 1, even becomes 1 cent.

Now, remember the blocks of the blockchain? They have a size limit. And are only capable of holding 1 Mega bit of transactions.

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As I was saying for Bitcoin, a block can hold up to 1 Mega bit of transactions in it. with that in mind, some early Bitcoin traders who got disappointed by the rising cost of fees (in U.S. dollars) asked for an increase in block size to increase throughput. Thinking, if more transaction can fit in a single block, fees would be cheaper.

But that was not done. Engineers and developers realized that reduced block mining rewards need to be compensated by transaction fees. Therefore, in order to maintain the security of Bitcoin, a fee market must be developed as a financial supplement for miners.

Transaction Fees

So again, if the blocks in the blockchain have a limited size, miners get to choose which transactions are going to be prioritized and compose the next block and thus, getting validated faster. How do you think they do that?

You guessed it! They do it with Bitcoin transaction fees. This instrument is an indispensable element to the system, without it, the economic sustainability of the entire project would be questioned.

Whenever a transaction is sent, miners need an arbitrary amount of bitcoin (in satoshis, which is one hundred millionth of 1 BTC) in order for them to add that particular transaction in the next block. Bitcoin network participants will then initiate a bidding war on the block space: miners set their minimum fees, and users choose how quickly they want their transactions to be confirmed. Paying a higher fee guarantees a higher priority and thus faster verification.

The fees serve as a subsidy to operating costs and an additional factor to ensure profitability. In the long run, fees also ensure the security of the Bitcoin network and the elimination of spam transactions.

The entire Bitcoin fees thing is a beautiful snapshot of the free market in a decentralized system. The cost of including the transaction in the next block changes according to the dynamics of supply and demand: sometimes you can get away with just a few Satoshis or other times you will have to pay a bit more.

In short, Bitcoin fees have changed from preventing transaction spam to an essential element of mining profitability. As mining rewards are halved every four years, fees will become more important in the economic game theory of the network.

Wrap up

Fantastic! Now you understand why we have these two different mechanisms in Bitcoin, the transaction fee, and the mining reward. You also know how they came to be and what’s their importance for the Blockchain.

If you want to get into more details on the topics presented on this video, please check the list of related videos we left in the description. And feel free to comment on anything you wish to see here in the Crypto Odyssey.

If you liked the video, don’t forget to let us know by hitting that like button and sharing your thought on the comments down below. And if this video was helpful to you, it will certainly be helpful to your fellow ones, share the video and spread the word! See you next time!

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