Bitcoin: Is the Cost of Transaction really low

Bitcoin is the most popular crypto-currency, running since 3rd Jan 2009, when Satoshi Nakamoto executed the first transaction and mined genesis block. Currently, there are about 16 million bitcoins in circulation with a cumulative value of about 11 billion in $US. Eventually, there will be only 21 million bitcoins on the bitcoin blockchain and that is what makes this a scarce currency and tempts people to keep it with a long-term view.

There is a popular belief that bitcoin transaction is a low-cost affair, about a fraction of the cost of current online transactions. But this is not entirely true; let’s understand it a little more –

The cost of bitcoin transaction comprises of two components:

  1. Transaction fee: It is the direct cost borne by the person making the transaction. It is voluntary and acts as an incentive to minors to pick up that particular transaction and include it in the next block.
  2. Block rewards: This is what miners receive as a reward from the bitcoin protocol for creating a block. This is also the process for releasing new bitcoins into the system. Today it is 12.5 BTC per block and was 50 BTS in the beginning when bitcoin started. Reward gets halved every 210,000 blocks or roughly four years.

So the cost of a transaction is a total of transaction fees and block reward, divided by the total number of transaction in a block. Below chart shows the average cost per transaction.

In the chart, there is a visible sudden drop, which happened when in July 2016 block reward got halved for the second time in the history of bitcoin.

The halving event suddenly decreased not only the cost per transaction but also miner’s fee per block. Miners will mine blocks till the time mining fee takes care of expenses and keeps the operations profitable.

Miners’ fee in terms of dollar/ fiat currency is a derivative of three things –

  1. Market price of bitcoin
  2. Transaction fee and
  3. Block reward

In future, block rewards will decrease with each halving event. For miners’ fee to remain consistent with time, either the bitcoin value has to go up or the number of transactions has to go up or transaction fee has to go up or a combination of these.

But there is only one way to decrease the cost per transaction and that is by increasing number of transactions per block. Since currently block size is capped at 1 MB, it is not possible. And also increasing the size of the block has its own challenges, that need to be tackled first. There have been on-going discussions around this, but so far no solutions are in sight.

Interesting times ahead!

 

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