The Ethereum network is switching its consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS) in an ongoing process since 2020 and is expected to conclude by 2022. According to the founder of the Ethereum network, Vitalik Butterin, the switch aims to overhaul the energy consumption process of mining, which validates transactions and adds them to the blockchain while also reducing the gas fees for transactions.
While many of us are well aware of the energy consumption problem of mining, and the need to address it, there have not been many discussions around the effect the switch to PoS would have on gas fees. In fact, there is still confusion around what a gas fee is and how it works. So, let us address some of these questions and understand what gas fee is in the Ethereum network and why it is vital to its functioning.
What is gas fee, and how does it work?
Contrary to its name, gas fees do not have anything to do with liquid fuel consumption or the impact of mining on the environment. Rather, it is the reward given to miners for putting transactions in the blockchain or executing them. You can think of it as the tip you give to your waiter at the end of the meal.
As blockchains are decentralized in nature, the transactions are added and validated in the network blockchain by anonymous miners or validators. This is the bedrock for any transactional blockchain technology. In the PoW system, miners solve complex mathematical puzzles to validate transactions for a reward of Ethereum token. There are two ways miners can earn Ethereum tokens. The first is by mining Ethereum to get paid in newly minted Ethereum tokens. The second is getting Ethereum as fees from users by processing their transactions.
More than three thousand decentralised applications (also known as dApps) are running on the Ethereum blockchain, all of which are looking to have their transactions included alongside other Ethereum network users. But there are only so many miners at a time that can validate these transactions.
This puts the miners in a situation where they must choose a certain number of transactions to validate. All transactions cannot be validated simultaneously, as the energy cost for miners would be exceedingly high.
All the unprocessed transactions are stored in something known as ‘mempool’, a combination of memory and pool. Here miners can decide which transaction they want to validate. Users add additional gas (priority fee) to the mempool to prioritise their transactions on top of the base gas fee.
The problem users have with the gas fee is that it fluctuates sporadically. Typically, when more users are on the network, the gas fees increase. This creates an unfair environment where the gas fee you pay increases without you having any control whatsoever.
How is the gas fee calculated?
As the transaction fees are minimal compared to 1 ETH (ethereum’s native token ether), it is calculated in terms of gwei, a small denomination of 1 ether unit. 1 gwei is equal to 0.000000001 ETH. The total fee you pay for transactions is calculated with the given formulae according to the latest London upgrade in the network.
Total Fee = Gas unit limits * (Base fee + tip)
Gas limit
This is the minimum amount of gas a user is willing to pay on a transaction. Users can adjust how much gas they want to spend for a transaction, but it should be noted that different network interactions will require a different minimum gas amount to complete.
Base fee
It is the minimum amount of gas necessary to include a transaction on the Ethereum blockchain. The congestion level of the network usually dictates the base fee, and they are dynamically adjusted according to the number of users interacting with the network.
Tip
These are the additional fees users pay to the miners in order to prioritize their transactions. It gives an incentive for miners to confirm the transaction of a some users over others.
Why do gas fees cost so much?
ETH prices have risen significantly in the past few years. And since the gas fee is calculated in Gwei, a smaller denomination of ETH, when the ETH price goes up, so does the gas fees. As the ETH price rises due to the popularity of the cryptocurrency and DeFi (Decentralized Finance) increases, gas fees will follow.
The base fees also increase with the number of users in the network. As there are now more than 3000 decentralized apps in the Ethereum network, the base fees will naturally increase.
The switch to PoS brings the promise of reducing Ethereum fees in line with other market competitors by significantly improving transaction-processing capabilities and doing away with miners.