One of Bitcoin's Biggest Problems Is Getting Better

Before bitcoin (BTC-USD) can become a widely used currency, there are several challenges it needs to overcome. Just to name a couple, its volatility needs to calm down significantly, and merchants need an easy and convenient way to accept bitcoin payments.

Another problem facing bitcoin is its cost. Despite the common misconception among people who have never actually sent bitcoin from one place to another, bitcoin is not free. In fact, bitcoin became prohibitively expensive to use for payments as its popularity among investors surged.

Fortunately, it looks like this problem is getting better. Here's what people need to know about bitcoin transaction fees, why they could keep falling, and how they compare to transaction fees of other cryptocurrencies.

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Why does bitcoin have transaction fees?

A great and detailed discussion of how bitcoin (BTC-USD) transaction fees work can be found at bitcoinfees.com, but here's the simplified explanations.

Individuals known as bitcoin miners use specialized computing equipment to help process data on the bitcoin network. This system processes bitcoin payment transactions and helps keep the network secure.

In exchange for their effort, miners are rewarded with "blocks" of coins, which are released roughly every 10 minutes. Currently, a mined "block" is 12.5 bitcoins, but this amount is cut in half every four years -- in other words, blocks previously contained 25 coins.

Over time, the reward will get smaller and smaller, and that's where transaction fees come in. Transaction fees are added to the newly mined bitcoins to reward miners, and they will play an increasing role in the bitcoin ecosystem as the number of mined coins decreases.

A brief history of bitcoin transaction fees

Bitcoin (BTC-USD) was originally conceived as a fast, anonymous way to send money, and at a bare minimum of expense to its users. And for much of its history, that was the case. For example, at the start of 2013, bitcoin transaction fees averaged just over $0.01. Even throughout 2014 and 2015, transaction fees rarely exceeded $0.10.

It wasn't until bitcoin's surge in popularity (and price) that transaction fees got considerably higher. In early 2017, when bitcoin was trading around $1,000, the average transaction fee was about $0.30. However, as bitcoin's price surged 1,400% during the year, transaction fees skyrocketed. The average fee was over $1 by the end of April and soared to more than $25 for a roughly one-month period in late 2017 and early 2018.

The fees became such an issue that bitcoin was impractical in many cases. Payment processing company Stripe announced in January that it stopped accepting bitcoin payments for its merchants, specifically citing the high fees, just to name one example.

The cost of using bitcoin has gotten better, and could keep falling

Fortunately for bitcoin users, transaction fees didn't stay so high for long. Since bitcoin's peak in December 2017, the average transaction fee has steadily fallen and now sits at $2.12, according to bitinfocharts.com.

The main reason is that the network isn't quite as congested anymore. The number of bitcoin transactions per day in February are roughly half of what they were at their peak. Plus, a scaling feature called Segregated Witness, or SegWit, is being rolled out across the bitcoin landscape -- leading exchange Coinbase is working on implementing it.

Without getting too technical, SegWit reduces the amount of information transmitted with transactions and reduces network congestion. As it continues to be implemented, the transaction fees could be kept in check or could continue to fall, even if the actual number of bitcoin transactions continues to rise.

Compared with other cryptocurrencies

In fairness, it's important to point out that even though bitcoin transaction fees have come down tremendously over the past two months or so, they are still quite high compared with other leading cryptocurrencies.

Data Source: bitinfocharts.com. Transaction fees as of Feb. 23, 2018 and are rounded to the nearest cent (except for Ripple).

The bottom line is that while bitcoin is not the cheapest cryptocurrency to use, it is no longer prohibitively expensive either. Bitcoin still has a long way to go before it can become a widely used payment method, but this is certainly a step in the right direction.