What Are Gas Fees? - FXLeaders

What are Gas Fees?

Gas fees are essentially the fee that you have to pay for every cryptocurrency transaction you make in the Ethereum network. You will notice this every time you buy or sell Ethereum (ETH) using your crypto wallet or in any cryptocurrency exchange. It is a dynamic fee amount that fluctuates depending on the algorithm of the network and the number of transactions that need to be executed and computed by the network. All of which is done in a decentralized way via smart contracts.

Why are they called Gas Fees? 

You may have noticed that every time you do a transaction in your crypto wallet, like sending a few ETH to your friend or buying an NFT, you get that annoying “gas fee” message, telling you that you have to pay for the transaction in order to push through. Believe it or not, this “gas fee” is quite integral to the entire process of doing cryptocurrency transactions. 

First and foremost, before anything else, why are they called “Gas Fees”? We are talking about digital transactions and blockchain technology, so why would there be a need for “gas”? 

Well, “Gas Fees” are actually a product of the Ethereum developers’ creativity. They are not referring to the petroleum, fossil fuel or diesel that you put in your car. The term is simply a metaphor for the fuel or gas that powers the code and computations in the Ethereum network. “Gas Fees” are the fees we need to pay in order to execute any form of transaction in the network.  

How do Ethereum Gas Fees work?

As we all know, the Ethereum network is not just decentralized, digital money. Unlike Bitcoin (BTC), which is just a store of value, it is programmable. Ethereum has more utility, because it is able to create smart contracts that can execute various computations in the blockchain. 

And for the Ethereum network to work perfectly, it needs computers around the world to process the various transactions and computations for the Ethereum virtual machine (EVM). Gas Fees incentivize these computers, which are also called “miners”, to contribute their laptops’ and PCs’ computational power to the Ethereum blockchain platform. 

Gas Fee computation is based on the price of gas, which is based on the supply and demand at the actual time of the transaction. This means that it changes over time, depending on how many transactions are happening in the system. 

What are transaction costs?

Transaction costs, or the actual true cost of what gas fees will cost per transaction, changes constantly, but it is based on a relatively simple formula. It is the Gas Cost multiplied by the Gas Price. 

The “Gas Cost” is already pre-set in the Ethereum code, and it does not change. It costs three “gas” to add two numbers, 400 “gas” to check the account balance of a wallet, and 21,000 “gas” to do any transaction.

However, the “Gas Price” is based on Ethereum’s smaller unit, which is referred to as  “gwei” which changes, based on the current market value of ETH. The price of gas is higher or lower, depending on whether the Ethereum blockchain is congested or not. The more congested it is, the higher the gas requirements. Also, the price of gas depends on the willingness of the person to spend more or less to speed up the transaction confirmation, which is referred to as the “Gas Limit.” 

What is “gwei”?

“Gwei” is short for “Giga Wei”, which is equivalent to one quintillion weis of Ethereum, or in numerical terms 0.000000001 ETH. The term was created due to the fact that it is such a tiny denomination that it would be very hard to use it by itself on a day-to-day basis. The shorter, more concise term, “gwei”, is needed to refer to the number. It is much simpler to say “1 Gwei” instead of “0.000000001 ETH.”  

Why are Ethereum gas fees so high?

The simplest reason as to why gas fees are so high in the Ethereum blockchain nowadays is due to its record volumes, immense popularity and fast-rising number of use cases. The Ethereum network has become a hub for innovation in the digital decentralized cryptocurrency space. 

DeFi has brought the traditional finance process into the decentralized world, along with the ease and accessibility of doing staking, investing, trading, lending and borrowing in the blockchain. NFTs have also brought the art and culture community to the cryptocurrency world, with the emergence of new NFT marketplaces, which spurred the record numbers of NFTs that were sold in the past year. 

These are just two factors out of many that have caused much congestion in the Ethereum network. Imagine hundreds of thousands of transactions bogging down the network. This is what makes gas fees so high nowadays.

As a result, several Layer 2 solutions have emerged, in the form of scaling solutions that address the problem of high gas fees in the Ethereum network. Blockchains, such as Polygon (MATIC) and 1inch, have provided improvements that drastically lower transaction fees in their networks. 

The Ethereum network has also developed the EIP-1559, which is short for Ethereum Improvement Plan, which strives to change the current Ethereum gas fee model. It introduces sharding and a proof-of-stake model to Ethereum.

About the author

Eric Nkando // Financial Trader and Technical Analyst
Eric Nkando is a professional forex trader and financial analyst from Nairobi, Kenya. He has 3 years trading experience, with interests in Forex, cryptocurrencies, and commodities. He is a CPA(K) holder and a B.com degree (Finance) graduate. Eric’s market analysis and coverage have featured on leading financial websites including Wikifx and Seeking Alpha