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What is Gas on Ethereum and what’s fueling the Gas rally?

Ethereum is the foundation of DeFi (decentralized finance). But there are some obstacles with the network. One of them is the high transaction fees, also known as Gas fees. In this blog, we break down what these fees are, how they are calculated, and why are they so high.

What is Gas?

Every network is run on incentives, even decentralized networks. Miners make sure a network is operational, and one of the ways they’re incentivized is fees.

Ethereum and Bitcoin use the proof-of-work (PoW) consensus algorithm. This means that miners have to confirm transactions on the blockchain by solving computational problems. Once these transactions are confirmed, they are added as blocks to the respective blockchain. Miners are rewarded in two ways for their work –  block rewards and transaction fees.

Gas refers to the computational effort required to confirm a transaction in the Ethereum blockchain. Since miners have to be paid for this computational effort, Gas is fees paid to confirm a transaction. Just like you need gas in the car to go from place to place, you need to pay Gas fees to send your cryptocurrencies from wallet to wallet on Ethereum.

If you google ‘Gas fees’ you’ll notice they are denominated in a unit called ‘Gwei.’ A Gwei is one-billionth of one Ether or it is 0.000000001 ETH. This is similar to a dollar broken into one hundred cents. Here’s how other units of Ether are broken down and their price in USD given one ETH is worth $4,000.

How are Gas fees calculated?

Not all transactions require the same Gas fees. Complex transactions require higher Gas fees. The complexity of transactions and the Gas it requires is listed in the Ethereum Yellow Paper, written by Ethereum co-founder Gavin Wood. 

Any operation on the network requires computational power and Gas fees. But there are several functions within Ethereum that differ in complexity. For instance, sending ETH (the native currency of Ethereum) from one address to another requires less Gas fees than encoding it into a smart contract. 

Currently, transferring ETH through digital wallets is around 21,000 Gas. Each Gas represents one Gwei. But transferring ETH from DEXs or decentralized exchanges is 100,000 Gas. This is because DEXs use smart contracts, which require more computational effort, and more Gas.

Gas is paid in Gwei, the Gwei fee rate changes every day based on how many miners are actively validating transactions. Following supply and demand, more miners will mean less fees and vice versa. To ensure transactions are done quickly, you can pay a higher fee in Gwei. This will incentivize miners to work on your transaction before other transactions with lower fees. At the time of writing, the average fee is 64 Gwei.

You can check the daily transaction fee for the Ethereum blockchain here.

Let’s say you want to make a simple transfer that requires 21,000 Gas at 64 Gwei. The fee you have to pay is 1.3 million Gwei (21,000*64) which is 0.0013 ETH. Taking the price of 1 ETH at $4,000, this comes to $5.37. If you want your transaction to go through quicker you can pay a higher fee of say 70 Gwei, which puts the total transaction fee at $5.8. 

Here’s how the Gas fees have changed since the start of the year.

Source: CoinMetrics

Why are Gas Fees skyrocketing?

When people refer to Gas fees rising, they are referring to the value in Gwei, not in Gas directly. This means that a simple ETH transfer transaction will always cost 21,000 Gas, but if the value of Gwei rises, so will the total Gas paid.

In December 2020, the fees were less than 3 Gwei (compared to ~60 Gwei now). With the price of ETH at $600 back then, this transfer came up to $0.03. With ETH up to $4,000 and Gas at 64 Gwei, this transfer is up to nearly $5.3 Why has the Gas price risen so steeply?

There are three reasons for this rise:

Increased use

Since the last year, many DeFi protocols (on the Ethereum blockchain) have gained popularity. The value of funds locked in decentralized exchanges like Uniswap and Sushiswap and lending protocols like Aave and Compound has increased by nearly 200% since December 2020. This means Ethereum (through DeFi protocols) has attracted users, investors, traders, and speculators. Increasing use and transactions lead to greater load on the network due to an increase in computational power. This puts more work on miners leading to higher transaction fees

Source: DeFi Pulse

Raised Gas limit

Different transactions on Ethereum have different Gas fees. But there is a maximum amount of Gas fees paid for performing a function on Ethereum. This is usually reserved for complex functions involving smart contracts. The maximum Gas limit can be changed by ETH miners based on the safety of the network. 

In January 2021, the limit was 12.5 million Gas. In April, the miners raised it to 15 million in order to decrease transaction load given ETH’s price rally. This increased the weight of transactions and therefore allowed complex protocols to work on Ethereum. 

Source: Etherscan

Skyrocketing Price

The increased use of Ethereum and the raised gas limit per block has caused a rally in the price of Ether. With the price of Ether skyrocketing (up 300% since January 2021), transaction fees on Ethereum, measured in USD, also rises. A simple ETH transfer costing 21,000 Gas at 64 Gwei would’ve been $1.2 with ETH at $900. But with ETH up to nearly $4,000, the same Gwei transfer is $5.4. In both cases, the transaction fee is 0.13% of the ETH price. But since the USD price of ETH went up, so did the transaction amount in USD.

Gas: Not the only fuel around

In the Ethereum network, Gas is essential, but its rising price is a concern. Ethereum is the undisputed blockchain for DeFi protocols. Everything from Chainlink to Polygon is built on Ethereum. With so many use-cases and users, Ethereum is gaining popularity, its native currency Ether is surging and so are Gas fees. Since Gas prices are a function of supply and demand, the rally is inevitable. But now, potential alternatives to Ethereum are emerging.

Binance, one of the largest cryptocurrency exchanges in the world, launched a digital assets’ based chain, the Binance Smart Chain, in September 2020. This was integrated with its native Binance Chain which allows cross-platform functionality with the exchange. This is meant to rival Ethereum.

Ethereum and Binance Smart Chain unlock the potential of DeFi. So many financial functions like lending, invoicing, insuring, and more are possible on DeFi. To know more about DeFi and why it’s important, check out our resources on DeFi.

If you want to learn more about DeFi and begin your DeFi investment in a safe way, check out the Interaxis Academy. 

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