Cryptocurrency

Lesson 3

12 min

What are transaction fees and why do I need to pay them?

If you decide to buy or sell Bitcoin or other cryptocurrencies, or simply want to send payments, you'll sooner or later encounter transaction fees. These fees are charged by the network once your transaction is added to the next block on the blockchain. However, the amount you pay doesn't depend on the value of your transaction, but on the specific network and its current level of congestion. This can be surprising—and at times confusing—especially for newcomers to the world of cryptocurrency.

But don't worry: we'll explain what transaction fees are, why they're necessary and how they're calculated.

Necessity: Transaction fees secure the network and enable transactions to be processed.
Origin: A fee is charged when a transaction is included in a new block.
Influencing factors: Network congestion and the size of the transaction determine the fee amount.

Optimisation: Fees can be reduced by choosing the right platform, timing your transaction well or using technical solutions.

Why are there transaction fees in cryptocurrency?

Crypto transaction fees are essential for maintaining the decentralised nature of networks and ensuring their independence from centralised institutions.

In the Bitcoin network, for example, network fees—also known as transaction fees—ensure that your transactions are processed smoothly. The fee for each BTC transaction isn’t fixed: it varies depending on the network’s current load, the block size and the complexity of the transaction.

Fees in cryptocurrencies like Bitcoin aren’t arbitrary surcharges—they’re the fuel that keeps the network running. They ensure that the network is continuously maintained by miners, who are rewarded for their work and computing power. This system helps preserve the integrity and efficiency of the blockchain by facilitating the inclusion of transactions in the next block while also preventing network congestion.

How do transaction fees work?

The way transaction fees work in crypto is similar to a bidding system at auctions. Users who want to make a payment or transaction set a fee that indicates how quickly they want it processed. Miners usually select transactions with higher fees first because they’re more profitable. The actual fee is flexible and set by the user, based on how much they value faster processing under current network conditions.

What does UTXO mean in Bitcoin transactions?

UTXO stands for “Unspent Transaction Output”. In every Bitcoin payment, new UTXOs are created, which serve as inputs for future transactions. You can think of UTXOs like digital change: if you spend 0.8 BTC but only have 1 BTC UTXOs, you'll receive 0.2 BTC in “change”. The number and size of UTXOs affect the size of the transaction and therefore influence the transaction fee.

What affects crypto transaction fees?

Beyond network congestion and transaction size, factors like block size and transaction complexity also play a role. Transactions with many inputs and outputs require more computing power or storage, so they need higher fees to be prioritised by miners.

In the context of Bitcoin mining, there’s also the Bitcoin halving, which cuts miners’ block rewards in half. This can indirectly push fees higher, as miners try to maximise earnings after the event.

The level of Bitcoin fees

Criticism of supposedly high Bitcoin fees often overlooks the important function they serve: regulating network availability. Since network resources are limited, fees help prevent overload by discouraging excessive transactions. Fees therefore reflect network demand and users’ willingness to pay for the security and speed of the decentralised ledger. Additionally, unlike traditional financial systems with hidden costs and restrictions, network fees are transparent and known upfront.

Pros and cons of Bitcoin transaction fees

Bitcoin transaction fees play a key role in the ecosystem, but they come with both advantages and disadvantages.

Advantages

Security of the network: Fees incentivise maintaining blockchain security
Decentralisation: Fees support independence from central institutions
Prioritisation: Users can pay for faster transaction processing
Prevention of network spam: Fees reduce the risk of spam and unnecessary transactions
Rewards for miners: Fees, alongside block rewards, form the income for miners

Disadvantages

Costs: Fees can be relatively high for smaller transactions

Unpredictability: Fluctuating fees can make planning difficult

Barriers: Higher fees may discourage new users

User-friendliness: Understanding fee structures can be complex

Variable costs: Fees can rise sharply during peak network usage

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Transaction fees as part of block rewards

One of the main reasons miners continue to participate in a blockchain-based network is the block reward—the incentive miners receive for validating a block. This block reward, combined with transaction fees, forms the miners’ total income. Each time a miner adds a new block to the blockchain, they receive not only newly created Bitcoins but also all the transaction fees from the transactions included in that block.

The so-called halving is a programmed event in the Bitcoin network that occurs every 210,000 blocks—roughly every four years. At each halving, the number of new Bitcoins issued as a block reward is cut in half. The most recent halving in April 2024 reduced the block reward from 6.25 to 3.125 Bitcoins. This halving mechanism is designed to limit inflation and make the currency scarcer over time.

Halving has significant implications for the network and transaction fees. As block rewards shrink, miners rely more on transaction fees to cover operating costs. This growing dependence on fees can lead to higher charges, especially during periods of high network activity. Ultimately, halving increases the importance of transaction fees relative to block rewards, prompting both miners and users to closely monitor fee trends. The next Bitcoin halving—the fifth since Bitcoin's inception—is expected on Tuesday, 27 March 2028.

How to keep track of your network fees

Tracking your Bitcoin transactions is a crucial step in ensuring transparency and security when dealing with cryptocurrencies. To stay on top of your network fees, it’s wise to get familiar with the tools and resources specifically designed for this purpose.

Many wallets and trading platforms offer built-in features that let you monitor your transactions and the associated fees. These often provide a detailed view of your sent and received transactions, including real-time updates on network charges.

The historical importance of the first Bitcoin transaction reflects the transparency that has characterised the network from the beginning. Every transaction since that first exchange can be traced via the blockchain, offering a high degree of traceability and openness.

To maximise your security and avoid surprises, regularly review your transaction history. Pay particular attention to the amount of network fees paid for each transaction. This can help you identify patterns and learn how to time transactions during periods of lower network activity to save costs. By keeping a close eye on your transaction fees, you can manage your crypto portfolio more effectively and ensure your transactions go as planned.

How can you reduce cryptocurrency transaction fees?

To minimise transaction fees for cryptocurrencies like Bitcoin, there are several strategies you can use. One is to carry out transactions during off-peak times, when the network is less congested. Since fees are driven by supply and demand, they’re often lower when fewer users are sending transactions.

You can also use fee estimators, which are integrated into many wallets and trading platforms. These tools provide a current estimate of network fees and can help you decide the best time to make your transaction and save money.

Technical solutions like SegWit (Segregated Witness) can also help reduce crypto payment fees. SegWit changed the structure of Bitcoin transactions by moving part of the data to a separate section of the blockchain. This increases block capacity and lowers fees. Another advanced system for reducing fees is the Lightning Network, which enables off-chain transactions that are much faster and cheaper than standard Bitcoin transactions. The Lightning Network is especially suited for smaller payments and can significantly cut costs.

Buying Bitcoin—without unexpectedly high fees

To buy Bitcoin without incurring excessive fees, look for platforms known for low transaction costs. Some reduce fees if you use their native currency or if your transactions involve a high trading volume. On peer-to-peer platforms, where users trade directly with one another, you can often save money. However, trading here can be more complex and carries greater risk due to the lack of a central authority.

Limit orders, which are purchase orders with a set maximum price, are an alternative to market orders. They allow you to control fees and buy at more favourable rates by avoiding the higher fees that come with instant purchases.

If you want to keep your crypto journey as cost-effective as possible, consider platforms with low mark-ups. Bitpanda, for example, offers one of the lowest premiums in the European crypto market at 0.99% for buying and selling Bitcoin. Our user-friendly Smart Investment App makes it easy to carry out transactions while keeping an eye on costs.

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Conclusion: transaction fees in the crypto world

Transaction fees aren’t just necessary mechanisms for maintaining networks like Bitcoin—they’re also a tool for managing sustainable blockchain usage. These fees support the stability of the BTC network by rewarding miners for processing transactions and preventing block overcrowding.

You can reduce your transaction costs by trading smartly and using new technologies like SegWit and the Lightning Network, making your Bitcoin activity more efficient. By planning your transaction times strategically and adopting innovative solutions, you actively contribute to the economical use of cryptocurrency. Your ability to minimise fees is quite literally in your hands and demonstrates how adaptable and user-friendly the world of cryptocurrency can be. Use this potential to optimise your crypto transactions and get the most out of your digital currency experience.

Frequently asked questions about crypto transaction fees

We answer the most common questions about transaction fees in the crypto space to help you get a clear overview.

Can you send Bitcoin (BTC) without transaction fees?

It's technically possible to send Bitcoin transactions with very low or even no fees. However, this can result in your transaction taking a long time to confirm or even being rejected. Miners typically prioritise transactions with higher fees as these are more profitable for them.

What happens if I can't set Bitcoin transaction fees in my wallet?

If your wallet doesn't let you manually set transaction fees, it usually applies a fee automatically. This default setting aims to strike a balance between reasonable cost and timely confirmation of your transaction.

How are fees for cryptocurrencies like BTC determined?

Transaction fees for cryptocurrencies like Bitcoin (BTC) aren’t set centrally. They're determined by supply and demand within the network. Users often offer a fee based on current network load to get quicker confirmation. Miners prefer transactions with higher fees to maximise their profits.

How might crypto transaction fees develop in the future?

The future of crypto transaction fees depends on several factors, including network scalability, technological advancements like the Lightning Network and user growth. These could help stabilise or even reduce fees in the long term. On the other hand, growing user numbers and network activity without proper scaling solutions could push fees higher.

How does the mempool affect Bitcoin transaction fees?

The mempool, or memory pool, is a collection of all unconfirmed Bitcoin transactions waiting to be added to a block. The size of the mempool directly affects transaction fees: when many transactions are waiting for confirmation, this can cause a “traffic jam” in the mempool, driving up fees as users are willing to pay more to have their transactions prioritised. Conversely, a smaller mempool usually results in lower fees, as fewer transactions are competing for space in the next block.