Wang Chuan: Why are the fees on Ethereum so high?

This article is sourced from Sina Weibo "Silicon Valley Wang Chuan," authored by Wang Chuan.

1/ Ethereum is the second-largest public blockchain by market capitalization after Bitcoin. The Ethereum network generates over a million transactions daily, with an average on-chain transaction fee exceeding thirty million dollars in the past week (the corresponding figure for Bitcoin is eight million), and the average on-chain settlement amount over the past thirty days exceeds nine billion dollars.

2/ Different operations on the Ethereum network have varying data transfer sizes and incur different costs. The calculation of Ethereum's transaction fees is primarily derived from the multiplication of two concepts: gas price and gas limit. Multiplying the two gives the transaction fee in "Ether."

3/ The gas price is measured in gwei, equivalent to one billionth of an Ether (10 to the power of negative nine). The gas limit for the simplest operation of sending Ether is 21,000, while more complex operations, especially those involving smart contracts, require several times more. Each block has a limit on the total gas limit of all transactions, currently capped at twelve million (thus, theoretically, each block on Ethereum can contain a maximum of 595 transactions), similar to Bitcoin's block size limitation.

4/ Gas prices fluctuate dynamically with network congestion. Before 2020, they were mostly below 20 gwei, and in the first half of 2020, before the DeFi boom, they were mostly below 50 gwei. Entering 2021, with more participants joining, prices during peak times can exceed 400 gwei daily.

5/ The cheapest operation for sending Ether (eth), according to data from etherscan.io on February 24, currently costs about 0.00294 eth (140 gwei multiplied by 21,000), which is roughly less than five dollars at a price of 1600 dollars per Ether.

6/ If transferring ERC20 tokens, due to the additional data reading, writing, and computation involved, the fees are generally at least three times higher, currently around fifteen dollars.

7/ If using a smart contract like Uniswap for trading and exchanging for other tokens, it becomes even more complex. Currently, the gas fee for a single transaction is more than ten times that of basic operations, ranging between 40-70 dollars.

8/ Smart contracts that facilitate token trading, such as Uniswap, 1inch exchange, Sushiswap, and Balancer, consume over 20% of the network's traffic, making them one of the primary reasons for the congestion and high fees on the Ethereum network.

9/ One can view these smart contracts like Uniswap as a completely open international trading free port for arbitrage. The difference is that you no longer have to carry large bags, endure hardships, and navigate obstacles to conduct business as in the past. There is no physical toil of traveling, no challenges of inventory and capital turnover; essentially, you can complete operations by just clicking a mouse at home and receive settlement confirmation within minutes.

10/ From this perspective, a gas fee of 70 dollars is actually not expensive. If you find it expensive, it’s because your business is too small. If everyone finds it expensive, then they wouldn't return after the last time. But why do many others continue to engage in various operations daily, incurring transaction fees of hundreds of dollars? Are they doing charity, losing money for publicity, or quietly making a fortune?
Refer to the author's previous article
Wang Chuan: The perspective of the highest spender is the god's perspective

11/ The first thing to understand is that gas fees are not fixed but change dynamically. If fees temporarily rise, it is a signal from the market to everyone: our demand is too strong here, come and meet our needs!

12/ When prices rise, large holders are usually indifferent. After all, it is these big players who drive the price increases with their decisive actions. The loudest complaints often come from small investors, "Ethereum is too congested, no one can use it! The housing prices here are too high, so high that no one can live here!" They will then seek solutions that minimize resistance and pain.

13/ At this time, if a centralized exchange also engages in blockchain, sacrificing decentralization to offer extremely low trading fees while almost zero-cost copying all newly developed application codes and tools from Ethereum, packaging itself as an Ethereum killer, it becomes very tempting for small investors wanting to save money. Because in the short term, mining does seem to make some money. Whether it can ultimately be profitable is another matter; at least they don't have to pay the painful transaction fees of dozens or hundreds of dollars upfront like on Ethereum.

14/ Despite the overflow of traffic from Ethereum and the support of centralized exchanges, these centralized backup chains with only a few dozen full nodes still have substantial differences in ecological complexity and liquidity depth compared to Ethereum. If they face scrutiny from regulatory bodies like Ripple (XRP), they may risk a sudden drop in traffic.

15/ Smart contracts on truly decentralized platforms like Uniswap cannot be shut down. Uniswap's founder, Hayden Adams, once stated that even if one day regulators told him to shut down Uniswap, it would be futile for him to shout to all users, "Don't use Uniswap!" Because the code deployed at address 0x7a250d5630B4cF539739dF2C5dAcb4c659F2488D for Uniswap V2: Router 2 is essentially a line of code that cannot be altered by anyone, including the original author.

16/ Ethereum's imitators will always lack ecological complexity compared to Ethereum. The connotation of ecological complexity includes various token assets on-chain, wrapped BTC, various smart contracts, various software development tools, liquidity depth, developer communities, etc., all of which are indispensable. Even if transaction fees are low, if ecological complexity is low, some things simply cannot be accomplished. It's like needing to return to a major hospital in the city for major surgery, no matter how good the air and low the prices are in the countryside. When Ethereum's main chain transaction fees periodically drop and new opportunities arise, profit-seeking traffic will still return to the Ethereum main chain at any time.

17/ The solution to the decline in Bitcoin network fees largely came from exchanges switching to batch processing for transferring coins, akin to dozens of people sharing a bus. However, batch processing on Ethereum is not that simple; sending multiple different tokens to different addresses requires smart contracts, which are several times more complex and consume much more gas than ordinary transactions, often failing to save costs. Smart contracts involving automated market maker trading become even more complex for batch processing.

18/ Rollup is essentially a new batch processing technology on Ethereum, and it is the most promising layer two solution for effective scaling before the true deployment of Ethereum 2.0 sharding technology (with the Ethereum mainnet being the first layer), theoretically reducing the gas fees consumed per transaction to less than one percent of the original. Rollup is divided into two styles: optimistic rollup, which is technically simpler because it checks tickets after boarding, but requires a week to withdraw coins to the main chain; and zk rollup, which is technically more complex but allows immediate withdrawals without waiting.

19/ Various rollup projects have continuously emerged over the past two years. It is still difficult to conclude which ones will ultimately have a substantial impact on the scalability of the Ethereum mainnet, whether various wallet software can quickly integrate new functionalities from new projects, and how much of the promotional content in various white papers can be realized. Below are a few relatively high-profile projects in the industry.

• Optimism: Last year, well-known venture capital firm a16z invested 25 million dollars, and in mid-January, it began a so-called soft launch on the Ethereum mainnet, collaborating with the decentralized exchange Synthetix for synthetic assets.
• Uniswap v3: It is speculated that it will launch in the third quarter of this year or even earlier, reportedly adopting the optimistic rollup solution. Since Uniswap has the deepest liquidity among exchanges, if launched, it may be the most promising project to quickly reduce fees on the Ethereum mainnet.
• Polygon: Originally called Matic.network, it claims to be an aggregator for various layer two solutions, with no specific launch date disclosed.
• Loopring: A trading platform that supports zk-rollup technology launched in March 2020, but to date, its average daily trading volume has not exceeded twenty million dollars (original data from coingecko.com).

20/ Projects like rollup can be seen as building subways in a crowded city. Each rollup layer two solution is like a subway line funded by residents. However, a single line cannot immediately alleviate the entire city's traffic congestion, and the market acceptance of rollup projects also requires time for validation.

Different layer two solutions also need to build fast connections (cross-rollup transactions) that do not go through the mainnet, just as different subway lines need underground passages to facilitate passenger transfers between different lines. Taking the Shanghai subway system as an example, from 1993 to now, 28 years later, 19 lines have been opened. It can be imagined that various projects aimed at improving scalability on the Ethereum network will be a long-term effort.

21/ If history is any guide, the challenge of high fees on Ethereum cannot be solved with a magic bullet all at once. Before the successful deployment of Ethereum 2.0, a possible development path is:

-- A continuously emerging layer two rollup solution reduces transaction fees in a specific area, attracting more traffic to Ethereum and promoting ecological complexity.

-- Due to the influx of this new traffic, a certain application on Ethereum becomes the new bottleneck, causing network fees to surge again, and some of the traffic overflows to other centralized backup chains.

-- Large holders quietly make profits while small investors loudly complain, public sentiment turns pessimistic again, and the market capitalization of backup chains rises (similar to suburban housing prices rising faster than those in the city center during a certain period), packaging themselves as Ethereum killers to attract traffic.

-- New layer two solutions emerge on Ethereum, fees drop, traffic returns to Ethereum, and its ecology further complicates, continuing to widen the gap in ecological complexity compared to backup chains.

22/ The fees on the Ethereum network will remain relatively high compared to other backup chains in the long term. Just like housing prices in downtown Shanghai will always be higher than those in suburban areas like Jiading or Fengxian, there will always be whispers spreading the legend that "housing prices are too high for anyone to live in."

Author's Bio: Wang Chuan, investor, currently residing in Silicon Valley, California. WeChat ID 9935070, Twitter ID "Svwang1", Sina Weibo "Silicon Valley Wang Chuan". All articles express the author's personal views for reference only and do not constitute investment advice for the mentioned assets. Investment carries risks; proceed with caution.