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Are you overpaying in Bitcoin transaction fees? Are you underpaying and stuck in the mempool? Do you trust your wallet or exchange to choose the optimal transaction fee for you? In this article, we’ll analyze how wallets determine cryptocurrency fees and discuss a Litecoin soft fork proposal to create a competitive and open fee market.

When Bitcoin first started, there were no fees to send your coins. The blocks were not full and the block reward was a sufficient financial incentive for people to become miners. Satoshi Nakamoto said, “I don’t anticipate that fees will be needed anytime soon, but if it becomes too burdensome to run a node, it is possible to run a node that only processes transactions that include a transaction fee.”

Transaction Fees

In today’s world, with increasing transaction volume and limited space per block, you must pay a fee to incentivize miners to choose your transaction over others. Here is a look at the average Bitcoin transaction fees over the last 6 months.

You can have an SPV (simple payment verification) client, such as a web wallet, estimate the fee for you based on the number of transactions currently sitting in the mempool. These dynamic fees work similarly to Uber. The greater the demand on the network, the more the price surges. While Litecoin also has limited block space, the blocks are generated every 2.5 minutes instead of Bitcoin’s slower time of 10 minutes. This allows for a tradeoff between speed and security. The Bitcoin Cash community argues that increasing the block size will solve the transaction fee problem, but there are potential drawbacks to larger blocks such as miner centralization. 

You can also analyze the transaction volumes and mempool yourself. But be careful, manually selecting a transaction fee can lead to one of the following scenarios:

Overpaid Fee: The transaction makes it into the next block, but you paid more than everyone else.

Underpaid Fee: You might be waiting days or weeks for the transaction to go through.

Severely Underpaid Fee: New transactions continuously jump ahead of you with their higher fees, causing your coin to become stuck in the mempool for an extended period of time. There is a way to cancel your transaction, but it’s a situation you would like to avoid.

Litecoin Soft Fork

To solve the current problem of asymmetric fee information, Charlie Lee, the founder of Litecoin, is proposing a soft fork that would require Litecoin miners to have the block header show the minimum fee that was accepted in the block. For example, if 10 cents was the lowest fee on any transaction that made it into a block, 10 cents would be shown in the block header. This data would be useful in determining what fees to place on your next transaction. Paying the median of minimum transaction fees would make it likely that your transaction goes through in the next two blocks.

The new fork will also allow users to select a new minimum fee of 0.0001 LTC/kb. Currently, this would mean a transaction fee of fewer than 3 cents per kilobyte. With most transactions being 300 bytes, you are looking at fees of less than 1 cent. Users can signal the fees they are willing to pay and miners can now clearly signal the minimum fee they are willing to put into a block. While it certainly might not be in their best interest to do so, under this new system, a miner could in theory signal to everyone that they only accept transactions with high fees into a block to try and convince future transactions to become more expensive. However, this additional information in the block header should inevitably lead to a free market fee market.

Fee Market

Satoshi predicted that a fee market might be necessary many years from now when block rewards stopped. Charlie believes there’s value in testing the idea now. With users already paying fees, why not optimize the situation with a fee market? In emails with Mike Hearn, a former Bitcoin contributor, Satoshi said “The fee the market would settle on should be minimal. If a node requires a higher fee, that node would be passing up all transactions with lower fees. It could do more volume and probably make more money by processing as many paying transactions as it can. The transition is not controlled by some human in charge of the system though, just individuals reaction on their own to market forces.”

How Will Miners React?

There are some concerns that miners will collude towards only accepting higher fees. However, Charlie defends the soft fork by saying “They can already do that today. This proposal doesn’t make it any easier. As long as there are miners willing to mine lower fees, your low fee transaction will be mined. Will just take longer.”

There are several reasons miners don’t currently collude

  1. Raising the fees and slowing transaction times could hurt the adoption of Litecoin as a currency. Sabotaging Litecoin would lower the price of the coin the miners are working so hard to obtain. We already see criticism of Bitcoin because of the expensive fees and long transaction times.
  2. With the recent increase in the price of Bitcoin and Litecoin, block rewards are extremely profitable. So much so that it does not seem worth it for miners to engage in potentially illegal activity to make slightly more money on fees.
  3. Mining is a competitive industry. If the current miners collude to raise prices, people could invest in mining equipment and start mining the cheaper transactions. You could also start a new mining pool that decides to accept cheaper fees. It’s important to make sure that mining continues to stay competitive and decentralized. The community should keep watch for one mining pool becoming too powerful or the cost of entry becoming prohibitively expensive.

Although Litecoin already has relatively inexpensive transaction fees (about 28 cents at the time of this article), the proposed soft fork should lead to even cheaper transactions and a better overall experience for miners and users. Litecoin paved the way for Bitcoin before with the implementation of SegWit. We’ll see if this soft fork is a success for Litecoin and if Bitcoin once again follows suit. 

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