Why Have Bitcoin Fees Been So Low?

In a surprising turn of events for Timechain observers, Bitcoin has managed to maintain relatively low transaction fees despite breaking new all-time highs in value, market capitalisation, and hash rate.

This phenomenon contradicts the historical pattern where network congestion and fee spikes accompanied Bitcoin’s bull runs.

Fees have been lower than a pregnant ant’s stomach!

But what gives?

Surely, if we’re seeing significant price action, it should translate into on-chain activity, which usually spikes fees; that’s what we’re used to and expect.

That’s what’s driven so much of the scaling debate.

So, was our thesis wrong? Have we misjudged demand for Bitcoin?

The Historical Pattern: High Prices, High Fees

Traditionally, Bitcoin’s fee market has been highly correlated with its price action.

During the 2017 and 2021 bull runs, transaction fees skyrocketed as newcomers flooded the network, competing for limited block space.

The buying pressure on exchanges translated towards more people moving funds into self-custody, which required block space; at the same time, arb traders were pretty active moving funds between exchanges to make a quick buck off the backs of the volatility during those price-run-ups.  

Average fees briefly exceeded $60 in April 2021, making small transactions economically unfeasible and reinforcing the narrative that Bitcoin was better suited as “digital gold” than as a payments system.

We also saw brief spikes in fees during the launch of Ordinals and its various meta protocols, along with RUNES, with interest in these protocols dwindling faster than your average Tinder date.

$100k Bitcoin But 2 Sat Per Vbyte, make it make sense

The current market cycle has defied this anticipated high fee environment; never would I have thought that the average pleb could still comfortably afford to use the chain when we hit that meteoric meme-able number.

Despite Bitcoin reaching unprecedented heights in price, market capitalisation, and network security (as measured by hash rate), transaction fees have remained surprisingly manageable.

This shift suggests a change in how the Bitcoin network is being used and accessed, some good and some bad.

Off-Chain Bitcoin Demand

But what is taking the pressure off those blocks? It’s custodial use and paper Bitcoin products.

On the good side, it buys the network more time to mature without massive pressure on block space, creating disruptions. It gives second-layer solutions time to experiment and grow without becoming the fallback for millions before it’s ready.

While that is a sort of silver lining, it’s not without a trade-off.

The time to improve on second-layer solutions without the pressure of the masses could create the conditions for rehypothecation or a centralised honeypot hack that leads to a catastrophic bank run.

That’s always the risk you take when you use a custodial service, that your claim to the underlying Bitcoin is not honoured in full or at all.

Just ask your average FTX or Celsius Creditor what that feels like.

Custodial Services and Exchanges

A significant portion of Bitcoin transactions occur off-chain through custodial services. Major exchanges like Coinbase, Binance, and Kraken process millions of Bitcoin transactions daily without touching the blockchain.

While these services are meant to do what they say and offer a place for exchanging assets, they’ve been used as makeshift wallets as users wish to avoid the complexity of self-custody.

When a user on these platforms sends Bitcoin to another user on the same platform, the exchange simply updates its internal ledger, avoiding on-chain fees entirely.

This internalisation of transactions has been further optimised through:

1. Transaction batching: Exchanges group multiple customer withdrawals into single transactions, reducing the overall number of on-chain operations.
2. Improved use of block space: Exchanges now employ sophisticated algorithms to time non-urgent withdrawals during periods of low network congestion.

Bitcoin ETFs: Institutional Efficiency

Now we get to the 800-pound diamond-handed gorilla in the room, the spot ETF issuers.

The approval and launch of Bitcoin ETFs represented a watershed moment for institutional adoption. These financial products allow investors to gain exposure to Bitcoin without directly interacting with the blockchain.

The billions of dollars flowing into Bitcoin ETFs translate to enormous trading volume that generates zero on-chain transactions, as the underlying Bitcoin reserves move infrequently.

ETF issuers also employ best practices for on-chain movements:

1. Consolidated custody: Major ETF providers use a small number of custodians, reducing the need for frequent transfers.
2. Optimised settlement: ETF creation and redemption processes are designed to minimise blockchain interaction.

Since their launch on Jan 11, 2024, the ETFs collectively custody ₿1 134 000, so 5% of the entire Bitcoin supply sits in the hands of these institutions and doesn’t move on-chain.

While regular rebalancing transactions exist, these paper products have negated the vast majority of what would have otherwise been on-chain demand.

Layer 2 and Sidechain Solutions

The way the Bitcoin network is set up, it doesn’t take kindly to certain transaction sizes; even with the low fee environment, moving around small UTXOs can only cost you more in the future as you bloat your UTXO set.

This is a reality that many will find out the hard way should they need to transfer multiple UTXOs or consolidate coins.

Since the base chain is rather unforgiving regarding microtransactions, users are encouraged to migrate that activity to other environments like the Lightning Network or Sidechains.

The Lightning Network: Microtransactions Unleashed

Perhaps the main culprit for removing the site of small fry transactions from the UTXO set, this network of payment channels allows users to conduct virtually unlimited transactions with near-zero fees, settling on the main chain only when opening or closing channels.

The Lightning Network has seen explosive growth in:

1. Node count: The number of Lightning nodes has increased by over 400% in the past three years.
2. Channel capacity: The total Bitcoin locked in Lightning channels has grown substantially, enabling more transactions to occur off-chain.
3. Adoption: Major platforms like Cash App, Strike, and Wallet of Satoshi have integrated Lightning, making it accessible to millions of users.

Sidechains: Expanding the Ecosystem

Sidechains like Rootstock (RSK) and Liquid have also contributed to fee reduction by offering alternative avenues for Bitcoin-based transactions:

1. Rootstock: As a smart contract platform secured by Bitcoin’s hash power, RSK enables complex financial applications while keeping most transactions off Bitcoin’s main chain.
2. Liquid Network: This Bitcoin sidechain facilitates fast, confidential transactions and has always been cheaper than the base chain, but with the latest confidential transactions discount, it’s further lowered fees for users, exchanges, brokers, and institutions who move L-BTC.
3. Federated mints: These mints are built on a multi-sig and allow users to hold, transfer or redeem eCash tokens for Bitcoin on the base chain or the Lightning Network, reducing overall network congestion.

Technological Improvements to Bitcoin Core

If we look to the fringes of block space efficiency, we’ve also seen the benefit of Bitcoin Core development pushing out several optimisations that improve the network’s ability to handle more volume:

1. Segregated Witness (SegWit): This upgrade, activated in 2017, continues to see increasing adoption, allowing more transactions to fit into each block.
2. Taproot: Activated in 2021, this upgrade improves privacy and efficiency for complex transactions, reducing their footprint on the blockchain.
3. Mempool optimisation: Improvements in storing and processing unconfirmed transactions have led to more efficient block space utilisation.

Improved User Education and Wallet Technology

A portion of Bitcoin users have become more sophisticated in their approach to transaction fees, because who wants to pay more for block space if they don’t have to? Some of us are patient enough to be pennywise with every Satoshi.

And modern wallets are helping with improved UI, allowing users to perform actions like:

1. Dynamic fee estimation: Modern wallets implement better fee estimation algorithms, preventing users from overpaying during temporary congestion.
2. Replace-by-fee: This feature allows users to adjust fees on pending transactions, reducing the risk of overpaying “just to be safe.”
3. Batching awareness: Users increasingly batch their own transactions, sending to multiple addresses in single operations

Keeping fees on the down-low

Bitcoin is moving towards a market of considerable size; it’s peaked at around $2 trillion and will likely increase several folds in the coming years, off the backs of corporate and nation-state adoption.

When you have players moving trillions in value on the network, block space will demand a premium and scaling solutions will have to become a bigger part of the conversation.

The growth of the custodial use of Bitcoin remains a blemish on the network, while the goal of 100% non-custodial uses is a pipe dream; the more users we can transition away from paper products, the better.

The relative stability of Bitcoin transaction fees is a testament to several factors, but we cannot discount the value brought by the ongoing development and adoption of scaling solutions.

Solutions I have been grateful for, and I find myself using Lightning a lot more due to nostr, while Liquid had come in handy a few times during those high fee spikes when I was caught off guard.

But this, too, shall pass; remember that Bitcoin fees fluctuate on a dime depending on network congestion.

So take advantage of low fee times while you can, mix the coins you want to mix, consolidate your UTXO set, open that Lightning channel for the long term and don’t look this gift horse in the mouth.