The word “gas” has several meanings already, but with fossil fuel cars seemingly on their way out, it’s maybe fitting that the cryptocurrency sector has co-opted the word for their own use.

In crypto circles, gas refers to the fees charged by the Ethereum network when executing transactions. And these days, the surprisingly high cost of such fees has made gas fairly undesirable—much like the noxious odors emitted from traditional gas.

One of the primary problems is that the cost of Ethereum gas isn’t a fixed amount, it fluctuates. Ethereum miners adjust gas fees based on supply and demand—and generally speaking, as the network gets busier, so do gas fees.

The logic behind gas fees is that these payments compensate the miners for lending their computing power to process and validate transactions on the Ethereum blockchain. And while that sounds like a fair deal, the designers of this arrangement probably hadn’t anticipated that gas fees would ever constitute such a large percentage of the overall transaction.

Today, Ethereum gas fees have become so exorbitant that they’ve even been “memeified.”

And as an illustration of where the balance of power lies in the network, consider this—miners can even reject transactions when they feel gas fees aren’t high enough. And to ensure the satisfaction of the miners, the network was gradually inching toward higher fees—that is until the start of 2021, when gas fees simply exploded higher, as illustrated below.

In terms of transaction mechanics, gas is usually quoted as a fraction of a single Ethereum—units that are commonly referred to as “gwei” or “nanoeth.” Each gwei is equal to 0.000000001 Ethereum. So instead of stating that gas costs 0.000000001 of an Ethereum, one could instead say it costs “X amount of gwei.”

Along those lines, there are three main drivers of gas fees: the prevailing rate for gwei at the time of the transaction, the speed of the desired transaction, and the amount of gas required for a given transaction type.

In terms of the prevailing gas prices, they can vary greatly. Gwei could be as low as six or as high as 2,000—it all depends on how busy the network is at any given moment. And as one might expect, the busier the network, the higher the cost.

As if that weren’t complicated enough, gas fees can also vary based on the speed of the desired transaction. For example, users can choose between rapid, fast, standard and slow. As one might expect, faster transactions are more expensive.

The other big factor to consider is the amount of gas required for a given transaction. The minimum for the simplest transaction on the Ethereum network is 21,000 gwei.

Using that figure as the baseline, one can review an easy example to better understand how gas fees function on the Ethereum network.

To wit, imagine that the current cost of gwei is 60. Considering that 21,000 gwei are needed to execute a simple transaction, that equates to 1,260,000 gwei (21,000 x 60 = 1,260,000). 1,260,000 gwei is in turn equal to 0.00126 Ethereum.

With Ethereum currently trading roughly $4,400, that means the gas fees for a simple transaction would amount to $5.54 ($4,400 x 0.00126 = $5.54).

At face value, that may sound fairly reasonable. But now consider if a single gwei was trading for 1,000. That would push the gas fee for a simple transaction up to about $93.

Alternatively, consider the total gas fee for a more complex transaction, which might require 100,000 gwei, instead of 21,000 gwei.

If gwei were trading for 60, the total gas fee would be about $26 for a complex transaction (about $21 more than for a simple transaction). But if gwei were trading for 1,000, the total gas fee for a more complicated transaction would jump to an astounding $440 per instance (about $340 more than for a simple transaction).

Several months ago, a group of crypto investors pooled their funds in order to purchase a rare copy of the U.S. constitution that was coming up for auction. The organizing crypto group is known as ConstitutionDAO—referring to so-called “decentralized autonomous organizations.”

Despite accumulating millions of dollars for this effort, the group ultimately lost out on the bidding to Ken Griffin, the CEO of Citadel. Griffin ended up paying $43 million for the document—a new record for a document/book sold at auction.

While that story is interesting in its own right, one of the threads that resonated most from the story relates to gas fees. That’s because after failing to achieve their goal, the ConstitutionDAO group announced they would be refunding the pooled money back to the project’s 17,000 donors.

But that process has been anything but simple.

The big problem for the ConstitutionDAO group has been gas, and not of the flatulent variety. In the process of executing the refunds, it was discovered that a large percentage of the refunded donations were being eaten up by gas fees.

For context, the median donation to the project was about $200. And some donors have discovered that as much as half of their refund has been eaten by gas. For example, one user on the chat app known as Discord reported that he or she lost $168 of their $400 refund to gas.

Currently, some estimates suggest the total gas fees for the ConstitutionDAO project could amount to $1.5 million dollars or more. And considering that the group failed in its ultimate objective, one can see how these exorbitant gas fees might feel like the straw that broke the camel’s back.

Moreover, the Ethereum gas issue becomes even thornier when one considers that the transaction fees associated with other cryptocurrencies are far less exorbitant, as illustrated below.

Source: news.bitcoin.com

Readers should note that the Ethereum network did move to what’s called a Proof of Stake (POS) blockchain model in August 2021. Known as the “London Hard Fork,” or the “EIP-1559” protocol, the impetus was to change the way gas fees were calculated, and ideally smooth them out and make them less volatile.

But as of late fall, adoption of the new protocols was limited at best, as illustrated by the high gas fees associated with the ConstitutionDAO refund process. Some estimates suggest that only 1% of transactions on the Ethereum network utilize the new protocols.

For the sake of Ethereum blockchain, and the broader crypto universe, one would hope that gas fees decline in the near future, and become less volatile. Because absent any resolution to this problem, it’s easy to see how the Ethereum network could start to lose out to emerging cryptocurrencies, with less onerous transaction fees.

To learn more about the strong link between Ethereum and other digital assets—such as non-fungible tokens (NFTs)—readers are encouraged to review the November issue of Luckbox: The Issue with Cryptocurrencies.

For timely updates on everything moving the financial markets, readers can also tune into TASTYTRADE LIVE—weekdays from 7 a.m. to 4 p.m. CST—at their convenience.

Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to support@luckboxmagazine.com.