A bitcoin transaction fee is the cost you incur when you send coins from one bitcoin wallet into another. To explain how bitcoin transaction fees work, you need to know how bitcoins are created, which is through a process called mining.
What is bitcoin mining?
Though bitcoin is a digital currency, it isn’t minted by a central authority in the way that the supply of Dollar or Euro is controlled by the Federal Reserve or ECB; it is instead created through a process called mining.
With traditional fiat currencies, money supply is indirectly controlled by means of a central bank's monetary policy. Although this is a complex, multi-faceted process, the main takeaway here is that a central authority must be trusted to keep their currencies stable, thus sustaining. In addition to that, states maintains full control of who gets to transact within their system, meaning they can freeze, revert or block whatever transactions they deem appropriate.
With Bitcoin, there is no issuer (learn more about the basics of bitcoin here). Instead, a group of network participants with strong computing power, also known as miners, compete for the right to verify and add each transaction block into the blockchain. Once a transaction is verified, it gets added to the history of every other bitcoin transaction stored forever inside the blockchain, verifiable by every other participant, and the winning miner gets a reward in the form of a freshly minted bitcoin.
The concept of proof of work
Now, before a miner starts verifying a block of transaction, they need to show Proof of Work (PoW).
Proof of work requires the decentralised participants (miners) that validate transactions to show that they have a significant computing power to do so. To do so, they must solve an incredibly hard mathematical problem. This serves to secure the network by making it very difficult and expensive that any malicious actor gain control of the network, since they would need a massive investment in computing power to do that.
They do this by using supercomputers that churn out random guesses for a mathematical problem until it ends up within a specific range established by the bitcoin program. This is one of the marvels of bitcoin, an unhackable mathematical conundrum with just one solution that Miners compete to solve. This problem's difficulty is constantly and automatically adjusted by Bitcoin's algorithm to account for growing computational power in the network, so that each block takes an average of ten minutes to solve.
In practice, this means Bitcoin has a fixed and predictable inflation rate, as there is no single group that can change the issuance to better suit their interests. Instead, code ensures that the minting of new bitcoin follows a predictable pattern, and that only a limited supply (21 million) of coins will ever be in circulation.
Bitcoin transaction fees explained
In the traditional system, a transaction must go through many trusted third parties before clearing. Each intermediary collects a fee from this service, adding up to often hefty sums that make smaller payments impractical.
Let’s illustrate this model by using the most common method - a debit or credit card.
Whenever you initiate a payment with a debit or credit either online store or in shop, the transaction has to go through the card issuer (VISA, Mastercard etc), who checks with your bank to see if you have funds, and then proceeds to pay it into the vendor's bank account, sometimes converting currencies in the way. Each of these intermediaries charge a fee for their services, and the total is passed onto the price you're paying (adding usually 3-5% to the final amount).
With bitcoin, there are no intermediaries in this sense. Transactions are peer-to-peer, meaning your money is sent straight from wallet to wallet. However, transactions have to go through miners in order for them to be added to the blockchain (and being effectively cleared in the network).
To further incentive network security, each transaction carries a fee, paid to miners for their services. So technically, miners get paid twice:
the first payment is when they verify transactions and arrange them into blocks in the blockchain—they get a mining reward of fresh bitcoins. However, this reward is set to be halved every four years until the last BTC is mined (sometime around year 2140). From then on, miners will earn only from collecting fees;
the second payment are the transaction fees attached to each transaction that incentivises them to verify higher-paying transactions ahead of others.
The current mining reward per block is 12.5 BTC. Transaction fees are subject to market fluctiation depending on network demand, but you should expect to pay within $0.03 to $3 based on the size of your transaction, among other things.
Fees are not Compulsory
The truth is while miners will get a fee if you attach it to your transaction, there are certain rules that dictate if and when you need to pay them.
Speed of transfer
For every transaction that occurs in the network, there is a priority attached, and this is determined by the transaction fee. Since bitcoin transactions are validated by miners, adding a fee to the transaction is a way to incentivise the miner to validate your transaction as quickly as possible.
For transactions that don't have a fee attached, those transactions might take a while before it gets confirmed. Transactions that have a fee will have a higher priority on the network, and it will be validated faster by miners.
Presently, there are over 5,337 unconfirmed bitcoin transactions in the mempool - where unconfirmed transactions sit until a miner picks them up for processing - and before you’re done reading this article, that number would have changed.
So, it’s smarter to include a fee in your transaction.
Rules of bitcoin transaction fees
If you are considering betting with bitcoin at Cloudbet you should pay close attention to the rules of bitcoin transaction fees so you don't pay unnecessary charges.
1. Small amounts pay fees
If the numbers of bitcoin you're sending is smaller than 0.01 BTC, you will be required to pay a miner's fee. This is done so users won't spam the network with micro transactions that miners have to verify.
2. Older coins pay less fees
Each bitcoin transaction is given a priority based on age, the number of inputs and size. Old coins are coins that haven't moved in a while. This type of coins might not require a fee.
3. Smaller inputs require less fees
Every transaction is made up of inputs which determines how much resources will be required to verify the transaction. If you send 1 bitcoin made up of 4 inputs of 0.25 bitcoins from your wallet, you are more likely to pay a fee than if you send 1 bitcoin made up of just 1 input.
How are transaction fees calculated?
Calculating bitcoin fees can be quite confusing for the best of us. According to most developers, it's based on a formula that works with the size of the transaction in bytes, then multiply it by the median byte size. Then multiply the result by the median byte size, take the answer in Satoshi and divide it by 100 million.
Thankfully, there is an easier way for most of us who can't wrap our head around all the technical details listed above. Many trading platforms and web-based bitcoin wallets have built-in fee calculators that help customers fix these issues.
There are also web services like Estimatefee.com and bitcoinfees.info that simplifies the process of calculating bitcoin fees for transactions so you don’t have to boggle your mind. Plus, most bitcoin wallets (including our recommendation for beginners) do this automatically, so don't worry.
The importance of context
In attempting to explain how bitcoin transaction fees work, you have to dig a bit deeper into how bitcoin itself works, how miners earn rewards and what influences the speed of bitcoin transactions. That context is crucial, and inevitably opens up other questions and considerations, but that shouldn't put you off.
While the basic mechanisms of Bitcoin may seem relatively simple after you understand it, the practicalities can become quite complex the deeper you look. With regard to bitcoin transaction fees, if you are just interested in mitigating the cost of sending your coins or the speed, stay focused on what influence those things, especially transaction speed and network congestion.
Speeding up your transactions is certainly something that might be a key consideration if you decide to transfer your bitcoin to a betting account at Cloudbet with a specific betting event in mind. Rest assured once the deposit is confirmed you can enjoy a safe and secure bitcoin betting with great odds.