Recently, in an apparent response to a largely-flawed critique of stablecoins from the Open Markets Institute, cryptocurrency exchange FTX clarified its position on transaction fees for withdrawals.
Its blog post was striking in that it appeared to associate proof-of-work (PoW) blockchains with high fees (which users are partly responsible for upon withdrawal) and proof-of-stake (PoS) blockchains with low fees. The conclusion: FTX wants to encourage users to use low-fee, less-energy-intensive, proof-of-stake blockchains. We can see the appeal of associating PoW with extractive, consumer-unfriendly, high fees, and PoS with efficiency and user-friendliness. But FTX is mistaken to associate consensus and fees.
In its article, FTX claimed:
“The actual amount that a blockchain requires to send a transaction differs widely based on the underlying structure of that blockchain. Platforms like Bitcoin and Ethereum are known as ‘Proof of Work’ blockchains, where the ‘work’ required to add that transaction to the blockchain uses a large amount of computing time and energy. On such platforms, average transaction fees are quite high: around $2 per transaction for Bitcoin, and around $40 per transaction on Ethereum!”
Leaving aside our surprise at seeing a major exchange take such a partisan approach, the analysis relies on a misconception regarding the relationship between consensus (or Sybil resistance) methods and blockchain fees. There simply is no inherent association between proof of work and high fees, or proof of stake and low fees. The fact that the only meaningful fees exist on two blockchains (Ethereum and Bitcoin), both of which currently happen to be PoW-based, does not mean that PoW implies or causes fees. It simply means that the two most popular blockchains both use PoW and are somewhat congested, leading to high fees (Ethereum, more so than Bitcoin).
Proof-Of-Work Basics
In PoW coins, “work” must be performed and verified before a block is appended to a blockchain. Producing work requires miners to perform several attempts before finding the number that grants them permission by the protocol to add a block to the blockchain. At first glance, it may appear that proof of work’s trial-and-error architecture naturally entails a delay in block production and that, in times of congestion, that delay pushes fees higher. However, this is a misunderstanding of what drives throughput.
The time in between blocks is not what determines throughput in crypto networks. Instead, the main determinant of throughput is block size, i.e., the number of bytes (and hence, transactions) that can fit into a block. Consider that a blockchain designed to produce one block per second with 1,000 transactions in each block has the very same throughput of a blockchain that produces one block per minute that is large enough to fit 60,000 transactions.
Critics of proof of work might be tempted to claim that an increase in the interval between blocks affects settlement time, which in turn increases congestion. That would also be misguided. A transaction included in a block is not final. All blockchains, including those that follow new architectures such as Solana, require users to wait before considering a transaction final. The reason behind this wait is that there are events that might take place within that period where the blocks in the blockchain are reorganized. Depending on the severity of these events, a transaction that was once in a block might be permanently removed from the blockchain.
Fees Are A Function Of Supply And Demand
The cause of fees is simply more demand for blockspace than there is available supply. Under conditions of scarcity, a prioritization method for transactions must be determined. One way is to create an auction in which eager transactors can pay up for priority inclusion in a block.
Having material fees is extremely healthy for a public blockchain system: it eliminates the spam problem by making it costly to insert junk data, and it constitutes “protocol revenue” that can be directed to a number of causes.
In Bitcoin’s case, this fee-based revenue will pay for security once issuance trails off. For Ethereum, fees are already being burnt to introduce a deflationary mechanic. You could also redirect fees to finance various public goods like paying Core developers. To make a rough corporate analogy, fees are “revenue” and issued supply is “equity.” Many firms do finance their operations by continually issuing stock, but shareholders generally prefer not to get endlessly diluted. The existence of fee revenue frees blockchains from dependence on dilution-based financing.
In such blockchains, fees also play a critical role in supporting their long-term security. They make it costly for information to be stored on the blockchain, thereby disincentivizing spam and DDoS attacks that have historically plagued zero-/low-fee networks, like Nano, EOS and XRP. Most crucially, fees promote a competitive environment among miners which in turn makes it prohibitively expensive for single parties to successfully attack a network. Thus far, proof of work in high-fee environments is the only battle-tested mechanism known to the industry to be resilient against attacks.
In its post, FTX claimed that “the ‘work’ required to add [a] transaction to the blockchain uses a large amount of computing time and energy.” This is erroneous. Contrary to this common characterization of PoW, there is no “energy payload” required to make a transaction. You are not using joules to push transactions through the pipes. Making, registering and validating a transaction costs very little, computationally.
The thing which is expensive (financially, and, in the case of PoW, in terms of energy, too) is winning the eligibility rights to include a block, obtainable by brute-forcing for a valid nonce. And it’s expensive because the reward for creating a block is significant — around $290,000 at the time of this writing. Logically, miners will pay up to $99 to win a bounty worth $100. But this bounty exists due to the issuance of new coins as fees are de minimis (in Bitcoin at least). The bounty is also available whether a block contains 4,000 transactions or none.
The per-transaction energy cost figure that FTX and the affiliated Solana make frequent reference to is not a useful analysis. Bitcoin could produce far more blockspace, thus driving fees to zero (as BSV did indeed do, for instance), without expending a joule more energy. Bitcoin could also process zero transactions per block, and miners would expend virtually the same amount of energy. There simply isn’t a linear correlation between transactions and energy expenditure, and there is barely any causal linkage between the two.
Why Limit Block Space?
As to why fees exist in the first place, they are the consequence of crowded block space. Congestion exists in a blockchain context because the basic security model of blockchains requires that end users can independently audit and verify the transactional history from the very first block should they choose to, and there’s a limit to the quantity of data that can be audited per unit time.
A blockchain is a replicated ledger. The orthodox security model requires that users be able to actually run a current version of that ledger, and recreate and validate all historical transactions, thereby ensuring that the rules are being followed. Bitcoin’s design philosophy aims to permit anyone with at least a weak internet connection and consumer-grade hardware to perform a full audit of the transaction log.
Ethereum takes a more liberal approach, adding computational complexity and some scalability at the cost of more challenging and expensive verification. But still, running an Ethereum node should be doable on high-end consumer hardware if users discard some historical information after validating it, a technique called “pruning.” It is not out…