How Bitcoin transaction fee is calculated?

Bitcoin is the biggest cryptocurrency blockchain. So much that many people analogously use the word Bitcoin to represent all cryptocurrencies!

But you might have wondered sometimes if a bank does not control Bitcoin, where do the transaction fees end up? And how are these fees calculated?

How Bitcoin transaction fee is calculated?

Let’s take a deeper dive to understand how the Bitcoin fee is calculated.

Transactions in the Bitcoin Blockchain

All the transactions in the Bitcoin blockchain are related to two primary principles. They are (a) the creation of new bitcoins and (b) the public ledger of all transactions that take place.

As miners who ‘mine’ or create a new block for these transactions, they have to get paid. This payout requires additional work. If the pool had a total fixed size, there would be no Bitcoin rewards for miners for transactions once the rewards run out.

This will prompt the miners to stop mining! The whole bitcoin blockchain will come to a halt.

A transaction fee is charged on each bitcoin transaction to create a consistent stream of income for miners and pay them out for their work.

Thus, senders include a fee in a transaction to reward the miners that processed, confirmed and recorded their transactions on the bitcoin blockchain.

Are senders required to include a fee?

Bitcoin transaction fee

Well, yes, but actually no. The thing is, senders can decide not to include a transaction fee while sending bitcoin. But, as the miners have the authority to choose which transaction they process first, those with no fees included are likely to be left in the mempool.

The mempool contains a list of all transactions that have not been processed yet. So, if you don’t include a big enough fee while sending bitcoin, your transactions may never get processed.

VISIT MEMPOOL.SPACE FOR DETAILS

How are Bitcoin Fees Calculated?

The transaction cost depends on the bytes of data recorded because they have limited space on each newly mined block.

Miners always look to earn the highest amount of fee per block, or in changed units, satoshi per byte, to maximize their earnings.

So, finding the correct transaction fee can be a bit tricky. You don’t want to overspend, but at the same time, you don’t want your transaction to go unprocessed.

Trying to establish a reasonable fee then can become a frustrating exercise of trial and error. Therefore, most modern wallets and exchanges will do the calculation for you.

Wallets calculate the cost by looking at the number of transactions in the mempool and how quickly they get picked up depending on their associated transaction fee.

Inputs

At the core of every Bitcoin you own, is just a reference to past transactions. These references are called inputs.

When you send Bitcoin to someone, you are selecting these references as inputs and then forwarding them to the recipient as outputs.

Outputs and change

Outputs, in simple words, are the number of addresses you are paying.

Change, on the other hand, is a bit complex concept.

Bitcoin blockchain does not allow you to use parts of input as output. So, if you have 0.8 and 0.7 Bitcoin sent to you as inputs and you want to send 1 Bitcoin to an address, you can’t use the inputs partially. You will have to use both inputs and generate two outputs: 1 Bitcoin to the recipient and 0.5 Bitcoin back to you, as the change.

Thus, even if you are sending Bitcoin to only one address, you likely generate two outputs, one for the recipient and one for the change.

Script Complexity

Suppose you require some special features in the transaction script, like multi-sig (Requiring authorization from multiple keyholders). In that case, the transaction complexity increases, and the fee associated with it will also increase.

How to decrease transaction fees

There are multiple ways you can cut down the required transaction fee while sending Bitcoin. Here, we have listed the best ones.

  • Use wallets that support SegWit. This protocol, short for Segregated Witness, configures transaction data to reduce the transaction size. Smaller the transaction, the lesser the fee.
  • Group your inputs as much as possible. You can do this by sending smaller inputs to an address you own when the transaction fees are lower. This will reduce the number of inputs for your transaction, thus decreasing transaction size and reducing the overall fee.
  • Make your transactions when the system has lower traffic. If the transactions in the mempool are overflowing, miners will increase the transaction fees resulting in transactions with lower fees to be not processed.

In the End

The Bitcoin transaction fees help the miners get their hard-earned rewards and keep the Bitcoin Blockchain going. Thus, they are a necessary evil.

Many factors go into a transaction fee calculation, most of which we have touched in this article. In essence, you would like to keep the transaction size smaller and transact when the load on the system is lower. This can be done by using more intelligent wallets and grouping your inputs.

I hope this article helps you and if you have any queries related to it then do leave your comment below. If you have not joined our community then you can now. We are very active there and have been sharing important information there.

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About The Author: Shounak

Blogger, Writer, Cryptocurrency Trader and Tech Geek.