Skyrocketing fees are fundamentally changing bitcoin

Fees as high as $28 are destroying bitcoin's value for small payments.

Originally, one of bitcoin's big selling points was that payments would be fast, convenient, and cheap. "The cost of mediation increases transaction costs, limiting the minimum practical transaction size and cutting off the possibility for small casual transactions," wrote bitcoin founder Satoshi Nakamoto in the white paper announcing the technology.

"With bitcoins, transfers can take place across continents and timezones with no problems, no timelags, and only minuscule transaction fees," wrote economics reporter Felix Salmon in 2013.

Until the beginning of this year, bitcoin fees tended to be well below $1, and often less than $0.10. Bitcoin supporters liked to point out that fees on the bitcoin network were often a lot less than the fees merchants paid to accept credit card payments. But in recent months, bitcoin's popularity has outstripped the network's ability to cope with growing demand.

As a result, the bitcoin network today is a radically different animal. Fees are high—the average transaction yesterday cost around $28. And that is having huge implications for the ways bitcoin is being used and the kinds of businesses being built on top of it. Indeed, companies that are trying to realize Nakamoto's vision of bitcoin as a platform for "small casual transactions" are starting to shift to alternative networks, because it's impossible to support small transactions when each transaction costs $20 in fees.

Rising transaction fees have been a huge headache for Bitpay

Consider Bitpay, one of the first successful bitcoin startups. Bitpay makes it easy for ordinary businesses to accept bitcoin payments. Bitpay accepts payments on merchants' behalf and offers the option to immediately convert the payments to dollars or other conventional currencies, insulating merchants from bitcoin's volatility. In the early years, Bitpay could accept payments that were just a few pennies.

But over the last year, the bitcoin network itself has seen fees go higher and higher. And Bitpay has been forced to raise transaction fees in response.

"Now that fees are reaching an average of $1 per transaction across the bitcoin network, it's becoming uneconomical for users to make micropayments under $1," Bitpay wrote in a March blog post. Bitpay also announced that it would start charging customers for the transaction fees Bitpay itself faced when it received a bitcoin payment.

Bitpay also started getting complaints about slower payment times thanks to the increasingly congested network. The way the bitcoin network deals with congestion is essentially by auctioning off scarce capacity to the highest bidder. Customers have the option to pay a higher fee in exchange for immediate delivery or to pay a lower fee and wait until congestion declines enough to make room for lower-fee transactions. As fees rise, this becomes a more and more dicey proposition.

"With the rising cost of bitcoin miner fees, refunds are also often costly to send," Bitpay wrote last month. "Customers with mistaken payments only receive partial refunds of the BTC they sent because of miner fee costs. One customer of a Bitpay merchant recently spent 0.003853 BTC on a payment which was mistakenly underpaid by a small amount. They were only able to receive a refund of 0.002247 BTC."

High fees are pushing companies away from bitcoin

Bitpay hasn't stopped processing bitcoin payments, but it recently announced it would begin accepting payments with a rival version of bitcoin called Bitcoin Cash. Fees on the Bitcoin Cash network have averaged around 25¢ in recent days, compared to more than $20 on the mainstream bitcoin network. Merchants will be able to decide whether to accept payments with bitcoin, Bitcoin Cash, or both.

Video game giant Steam announced earlier this month that it would stop accepting bitcoin payments, citing skyrocketing transaction fees. "At this point, it has become untenable to support bitcoin as a payment option," the company wrote.

A gift card merchant called BitCart switched from bitcoin to a rival called Dash back in June. "Bitcoin as a method of payment on BitCart is simply not sustainable and it's a nightmare from a merchant point of view."

Another frequently mentioned application for bitcoin is for remittances. A number of companies are working to build international money transfer services based on bitcoin that compete with conventional payment networks like Western Union and Moneygram.

But in October, one of those services, Bitspark, announced it was giving up on bitcoin because of the network's high, unpredictable fees. Bitspark is shifting support to a lesser-known cryptocurrency called Bitshares.

Notice that many of the developments I've noted so far happened before the really big run-up of fees over the last few weeks. Prior to November, average daily bitcoin fees were rarely above $5. In the last week, by contrast, daily average bitcoin fees have consistently been above $20.

This is an existential crisis for any business built around facilitating small—or even medium-sized—bitcoin transactions. If $5 transaction fees were enough to sour a few businesses away from using the platform, we can expect $20 fees to chase away a lot more. And if bitcoin's speculative mania continues, the fees could easily go even higher.

Bitcoin has a lot riding on the Lightning network

Bitcoin insiders are not unaware of this problem. But their solution, called Lightning, is still months away, and it may or may not be enough to solve the problem.

The bitcoin network is built on the blockchain, a shared global ledger that is organized into data structures called blocks. A new block is created every 10 minutes, and each block can be up to 1 megabyte in size, leaving room for around 2,000 transactions per block. A recent upgrade called segregated witness might roughly double this limit in the coming months.

Some people in the bitcoin community want to simply raise that 1 megabyte block limit to a higher number, leaving room for more transactions. But the developers who control the standard bitcoin software have resisted doing that, arguing that it's important to ensure that ordinary bitcoin users can fully participate in bitcoin's peer-to-peer networks. Frustrated big-block advocates seceded from the mainstream bitcoin community in August, creating a rival called Bitcoin Cash that uses essentially the same code but allows blocks up to 8 megabytes.

This has left the small-block faction firmly in control of the mainstream bitcoin network. And they've outlined a different vision for bitcoin's future—one that's built on a new payment layer called Lightning. Lightning uses a technique called payment channels to make bitcoin payments that don't need to be written individually to the blockchain. Instead, payment channels allow people to essentially send each other cryptographically enforceable IOUs. Many of these IOUs can be bundled together and submitted as a batch to the blockchain, spreading the cost of a single on-chain transaction across many off-chain payments.

In theory, this will allow people to make many off-chain payments for every on-chain payment, relieving bitcoin's congestion problems. The basic technology seems sound. Three teams working on independent Lightning implementations announced a 1.0 specification earlier this month and hope to unveil production-quality software implementing that specification in the coming months. But of course, the devil is in the details, and those details haven't yet been fully worked out.

And even if the network works magnificently in the long run, it's not going to arrive quickly enough to avoid fee-driven turmoil in the coming months. Businesses built on the premise that bitcoin transactions will be fast and cheap will have to find some way to cope with transactions that are slow and expensive.

That might mean switching to a rival like Bitcoin Cash or Dash. It might mean dropping cryptocurrency support all together until things stabilize. Or it might mean simply passing steadily rising costs on to customers.