Why Ethereum’s Gas Prices have Skyrocketed

If you haven’t made a transaction on the Ethereum network in a while, you may be in for a shock.  Ethereum’s gas prices have skyrocketed in just a few short months.  No, it has nothing to do with the price of oil which also has risen in the last few months.  After all, we’re not talking about literal gas.  

Ethereum gas is the fees you must pay to execute a transaction on the Ethereum network.  Since the beginning of the year, gas use continues to increase with the expectation it will continue to do so. According to CoinMetrics, the 7-day moving average of the total amount of gas used hit a record high of 61.12 billion in June. This far surpasses the previous high of 60.07 billion reached in September 2019.  Before we explain why let’s briefly recap how gas works on the Ethereum network.

How Ethereum Gas Works

If you want to execute a transaction on the Ethereum blockchain, you will need to come up with some gas fees.  Gas fees are used to pay for the computational power needed to carry out the transaction. It compensates Ethereum miners for the work required to secure your transaction on the network.  While we know Gas is required for transactions, it also has many other uses. Some of these include the execution of smart contracts, launching DApps, and storing data on the blockchain.

We price gas in ether. This is the currency used on the network. However, to account for its smaller amounts is expressed as a fraction of an ether called a gwei.  One gwei = 0.000000001 ether.

Gas is made up of two components, a Gas Limit, and a Gas Price.  Users set the gas limit. The gas limit is the maximum amount of Gas that you are willing to pay for the transaction.   Each operation within the transaction will require a certain amount of gas in order to execute.  The total amount of gas needed is determined by how complex the transaction is, i.e. how many instructions need to be executed.  A simple transaction might have a minimum cost of 21,000 units. 

The Gas Price is also set by you.  It is the amount of Gwei that you are willing to spend on each unit of Gas. But be warned!  If you set your Gas Price too low, the transaction may not be prioritized. Or, it may fail to execute because Ether miners may accept or decline a transaction based on the price of gas.      

How To Calculating ETH Gas Price

To calculate your total cost for a transaction, simply multiply the Gas Limit by the Gas Price.  For example, imagine you set the Gas Limit at 40,000 units and the Gas Price at 20 gwei. In this case, the total amount that you are willing to spend on executing your transaction is 40000 x 20 = 800,000 gwei or 0.0008 ETH.

Gas Limits are fairly standardized. However, Gas Prices can fluctuate.  To see what current recommendations are for gas prices, we suggest checking out ETH Gas Station. This website gives a real-time view of the current fee market. It also indicates the cost to get a basic or fast transaction through the system. 

Otherwise, you may set your Gas Price too low. If this happens your transaction might not get executed as quickly as you would like. Even worse, it may not get executed at all.  Another scenario that can occur is if you set your gas fees too low. In this scenario, you could run out of gas before your transaction has completed execution. This means the transaction aborts, and you lose your gas fees.

Skyrocketing Gas Fees

As transactions increase on the Ethereum network, gas prices go up.  In fact, since the beginning of May, the average gas price has tripled.  The reason for this is network congestion. According to Glassnode, the number of transactions on the Ethereum network has recently surged to a 27-month high of 938,265. This is up nearly 45% from January lows.  

So what has caused this recent surge in activity?  There are several reasons.

March Sell-off Frenzy in Cryptocurrencies

In March, we saw a sell-off in the stock markets when fear and panic took hold of the market. This is attributed to the uncertainties caused by the COVID-19 global pandemic and the Russia-Saudi Arabia oil price war.  Along with it, cryptocurrencies also sold off amid pressure to flee to safer, less risky investments.  

The market sell-off also triggered liquidations of DeFi lending positions.  If you are not familiar with DeFi, it is short for decentralized finance.  It is essentially crypto’s re-creation of traditional financial instruments but on a decentralized platform such as Ethereum. DeFi products include decentralized exchanges, borrowing and lending markets, prediction/betting markets, payment networks, etc.  

DApps such as Compound and Maker allow users to take out automated loans by putting down crypto as collateral.  However, the price of the crypto used as collateral might falls below a certain level. When this happens your lending positions are liquidated automatically through smart contracts.  For example, on March 12 as the stock market crashed, ETH price fell more than $50, and open positions that became undercollateralized were liquidated.  

These two incidents, the sell-off of cryptocurrencies and the increased activity in DeFi transactions, led to congestion on the Ethereum network. Along with it, comes a rise in gas fees. From the chart, we can see a spike in gas prices to 85 gwei in March. This is one of the highest levels since early 2018.

Growth In Tether and DeFi

Aside from the sell-off frenzy in March, both Tether and DeFi transactions have seen phenomenal growth in recent months, contributing to network congestion.  In case you aren’t familiar with Tether USDT, it is a U.S. dollar-backed stablecoin that has been issued on Ethereum since November 2017.  This means the cryptocurrency is pegged to the US dollar and maintains a one-to-one ratio with it in terms of value.

Tether USDT is a popular cryptocurrency. This is because it offers the stability of the US dollar (hence, the name stablecoin). At the same time, it has the advantage of being able to be moved in real-time on a blockchain, vs traditional wire transfers with the dollar.  

Tether is currently the most used stablecoin on the blockchain and has the third-highest market cap for a cryptocurrency.  The Ethereum platform currently holds 65% of the total available supply.  According to CoinMetrics, the daily transactions using Tether have increased by 450% on a year-to-date basis. Tether alone generated over $2.5 million worth of gas fees in May.  The chart below shows the steady rise in tether transactions since January 2020.

Source: https://www.coindesk.com/ethereum-logged-its-busiest-week-on-record

DeFi Activity

DeFi apps are responsible for 97% of the activity on the Ethereum blockchain.  Transaction volumes reached $5.7 billion in June.  The June release of Compound’s COMP token helped drive  DeFi’s rise in the second quarter with DeFi yield farming.  Ethereum continues to be the dominant platform for DeFi transactions.  DeFi volume on Ethereum was more than $10.3 billion for the second quarter, compared to $1.89 billion on EOS and $260 million on TRON, Ethereum’s two closest competitors in the DeFi world.

DeFi apps that have seen solid growth include decentralized exchanges such as Kyber, Uniswap, and IDEX.

Making a more complex transaction on a decentralized exchange such as a token swap, or executing a smart contract, which generally involves a number of instructions, will result in higher fees. 

Ethereum Fee Model

The current Ethereum fee model may also be a contributing factor to skyrocketing gas prices.  Ethereum uses what is called a “first-price auction”. A first-price auction occurs when everyone submits their bid (gas price) for how much they are willing to pay for their transaction.  During times of network congestion, miners prioritize transactions that offer higher fees.  This encourages users to pay more in gas fees in order to beat out other transactions, sometimes resulting in a gross overpayment of fees.

It is expected that Ethereum 2.0, to be released sometime in 2020, will resolve some of the issues surrounding rising gas fees.  Ethereum 2.0 will shift from a proof-of-work (POW) consensus algorithm to a proof-of-stake (POS) algorithm.  In a POS, miners to mine blocks or validate transactions. Users or stakes will verify data on the blockchain and earn rewards.  

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