Bitcoin use in the real world may have started with the purchase of a pair of pizzas, but you'd be unlikely to see it used for such a minor exchange today.
That's because as bitcoin has soared in popularity it's become too expensive to use in small transactions.
The problem came to a head in early December, when Steam, the popular downloadable video game store, announced it would stop accepting bitcoin payments for games, citing the currency's volatility and high transaction fees. Steam relied on a bitcoin payment system called BitPay. Among BitPay's other customers are Microsoft, online retailer NewEgg, and APMEX, which sells precious metals online.
Business Insider checked in with BitPay communication manager James Walpole to find out why bitcoin transactions have become so costly. Here's what he had to say:
Don't blame BitPay for high bitcoin transaction costs
You might think that services like BitPay are to blame for bitcoin's high transaction costs. After all, BitPay's service, which lets merchants accept bitcoin as payment, is similar to a credit card processing service, and retailers are often complaining that credit card fees cut into their profits.
But the fees charged by BitPay and similar companies represent only a small portion of the total cost of a typical bitcoin transaction. For its part, BitPay charges merchants a 1% processing fee per transaction. If a customer spends $10, BitPay keeps $0.10, while sending the vendor the remaining $9.90.
That's the same fee charged by BitPay rival CoinGate, but one that is less than what's charged by Stripe or Visa on credit card transactions. Those fees can add up over many transactions, but they're not what's making individual bitcoin payments so costly.
Instead, blame the bitcoin miners
So if it's not BitPay and other bitcoin payment processors that are making transactions using the cryptocurrency so expensive, what is? Walpole points the finger at bitcoin miners.
Miners are the people or companies that record data in the bitcoin blockchain, the digital ledger that keeps track of all bitcoin transactions. Miners save those transactions in so-called blocks; they complete a block by solving ever-more-complex cryptographic puzzles.
Mining has become an expensive proposition. It requires high-powered computers that use lots of energy. Miners are typically in the business to make money. They're compensated for their services in three ways.
When they solve a particular puzzle and complete a block, they are awarded with newly created bitcoin. But they also collect fees from both individual bitcoin holders and from bitcoin payment processors such as BitPay.
Its those fees that have made using bitcoin so pricey.
Mining fees are skyrocketing
The first type of fee miners collect are mining or transaction fees. These fees in particular are surging.
At the end of September, the average bitcoin mining fee was around $2 per transaction. By December 21, average fees reached a high of around $37.
The surge in fees was a matter of supply and demand. As bitcoin's price surged from $10,000 to $20,000, increasing numbers of people wanted to invest in the cryptocurrency. The upsurge in users and transactions increased the demand for miners' services.
At the same time, supply is constrained. The blockchain system that underlies the cryptocurrency can only process around 3 to 7 transactions per second. So at any given moment, a greater number of transactions were competing for a relatively small number of slots in the ledger.
But another, related factor was at work too. Mining fees, which are paid by individual users to miners, are actually optional; bitcoin users don't have to pay them. But they usually do, because the fees encourage miners to record their transactions sooner rather than later. The sooner you want a transaction written to the blockchain, generally the higher mining fee you'll have to pay.
The advantage of having a transaction recorded quickly is that the sooner it's recorded, the sooner you can spend or sell the coins you've received — and the sooner a merchant will mark a deal as completed. That speed can be important when using bitcoin to buy high-demand goods, like concert tickets, which can sell out fast.
But speeding the recording of bitcoin transactions has been particularly important in a volatile market such as the one the cryptocurrency has experienced in recent months. With the price of bitcoin fluctuating by hundreds or even thousands of dollars in mere hours or minutes, there's a big benefit to being able to buy and sell coins sooner rather than later — and many bitcoin traders have been paying up for just that advantage.
There's also network costs
In addition to mining fees, bitcoin users often have to pay a second fee that ultimately goes to miners, something called a network fee. Payment processors such as Bitpay collect such fees from consumers making purchases to pay miners to move funds from an individual customer's bitcoin wallet address to a bitcoin exchange, where BitPay converts bitcoin into the merchant’s local currency.
The payment processors add the fee to the transaction total.
So when a customer buys something from a merchant using BitPay via the customer's personal digital wallet, the total the customer pays includes both the price of the purchased item and the network cost. BitPay doesn't make any profit off this fee though, Walpole said.
Like mining fees, network costs fluctuate based on how busy the network is. Unlike mining fees, however, network charges aren't optional; BitPay charges them on all transactions it handles to ensure that miners record those transactions as quickly as possible.
Volatility matters, but not why you think
Bitcoin's price has fluctuated a lot over the last year, but overall has gone way up. And bitcoin transaction costs have gone up in tandem with it.
But the rise in bitcoin's value and the jump in transaction fees aren't as closely linked as they may sound. The price of bitcoin doesn't have a direct impact on transaction fees. It's not like miners are charging more or bitcoin users are having to pay higher fees just because bitcoin is worth more.
Instead, all of the volatility in the price of bitcoin had led to more people buying and selling the cryptocurrency — which has meant a whole lot more transactions that need to be recorded. And more demand has led to higher fees.
But volatility is affecting demand in a more important way. Because of those fluctuations, the value of bitcoin can change significantly in a short amount of time. When there are a lot of transactions taking place, it can potentially take days to record them all, during which time bitcoin's value could have changed by thousands of dollars.
Merchants risk losing money if they lock in a price with a customer and the value of bitcoin falls before the transaction is completed. That's not a risk many merchants or bitcoin traders take lightly, so many have been willing to accept higher fees to speed the recording of their transactions.
However, Walpole said, one of the benefits of using a service like BitPay is that it removes some of the volatility risk for merchants by guarenteeing the full US dollar value for a purchase as long as a customer broadcasts their transaction with 15 minutes of creating a payment request.
Read more about the blockchain technology that powers bitcoin here.
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