Ethereum is crypto’s main hub for all your on-chain activities. In fact, the blockchain is such a popular DeFi hotspot that it frequently experiences network congestion, causing higher transaction fees. Although heightened activity is always welcomed, the boom in fees doesn’t make it economically viable for anyone to use the chain.
The Ethereum foundation has several scalability features underway that’ll make the network faster, cheaper, and more efficient. One major upgrade that’ll be launched in the future is proto-danksharding, which involves attaching blobs of data to transactions. However, we likely won’t see this ambitious feature launch in 2023.
As an investor in the crypto space, it’s important for you to understand how your on-chain transactions are affected by gas fees and why. Today’s article discusses how Ethereum gas fees work, why they’re so high, and how to reduce them.
Transactions on a blockchain need to be broadcasted to the entire network in order to become a part of on-chain history. Someone (in Ethereum’s case, a validator) needs to perform this broadcasting, who in return requires monetary incentive for his actions. The network rewards the validator with gas fees, which the end-user pays to account for the computational value of his request.
Imagine Ethereum being a giant highway connecting multiple cities. You want to travel to Uniswap City™ to swap USDC for LINK. To get there, you need to pay a vignette to travel on the highway – because how else will it be maintained for you and thousands of other users?
Ethereum’s on-chain roads also require maintenance for transactions – especially smart contracts –to be processed. The gas you pay for a transaction is simply the unit of cost that measures the computational effort it takes to execute certain actions on Ethereum.
The problem with modern blockchain networks is that they can only process a limited number of transactions per transaction block. On Ethereum, the number of transactions in a block is restricted by a gas limit, which ranges from 15 million to 30 million per block. A block could theoretically contain only 714 transactions.
Network congestion happens when too many people want to execute transactions at the same time. You can compare it to the speed at which cars can go on a congested road. The problem is further intensified when you consider the fact that anyone can increase their gas fee to have a higher chance of having their transaction confirmed by a validator.
The last statement shows that network congestion, in some sense, leads to constant bidding wars. Users try to pay the highest amount possible to execute a transfer or smart contract. The higher demand, the higher the gas fee required for a transaction not only to be prioritized by a validator but also to not fail.
We can conclude that the effects of network congestion are further exuberated in these so-called bidding wars. Although we currently have no solution to counteract these effects, we know what the end results are.
Users who do not have high-enough capital to make sending transactions on the Ethereum network economically viable anymore stop using the network. If we apply the Pareto principle to this case, we can assume that a majority of network participants will stop executing transactions during periods of high network congestion – leading gas fees to drop as parabolically as they have risen.
The nature of economic incentives makes network congestion often short-lived. However, the nature of financial markets – which can be irrational because its investors too, are irrational – means that we can’t predict the gas fee ceiling of any surge in congestion.
If millions of new investors were to join Ethereum today, the parabola guiding gas prices upwards would never stop. That’s why developing scalability solutions is incredibly important in the long run.
The average gas price is directly correlated to Ethereum’s network activity. The higher the network activity, the higher the gas price.
The image above shows the average daily gas price on Ethereum from August 2015 to November 2022.
The image above shows Ethereum’s price during the same period.
You’ll notice that the spikes in both images take place at almost the same exact times.
The reason why gas fees went parabolic in 2020 is that more users began to participate in DeFi by trading on Uniswap, buying NFTs on OpenSea, yield farming on Yearn Finance, and so on.
The most recent spike on Ethereum stems from…meme coins.
Meme coins are nothing we haven’t seen before. In fact, some of the first meme coins launched only years after Bitcoin did.
Dogecoin is the first-ever meme project launched in 2013. The second generation of meme coin season started with Shiba, which launched in August 2020 and initiated an entire wave of new dog-themed meme coins. Around the same time, members of Crypto Twitter airdropped a token called MEME that, at its height, rewarded holders with six figures in rewards.
2023 marked the start of another wave of meme coins after PEPE launched on April 17th.
As you can see in the previous graph, gas fees jumped from 40 gwei to 150 gwei in only 18 days, indicating a jump of 275%.
Although gas has more than halved this week, previous events of heightened activity on Ethereum show that fees can resurge and jump even higher.
The graph above shows Ethereum’s gas fees on the eve of the Uniswap airdrop – another significant period of network congestion – when UNI tokens were sent to all DeFi users who have swapped tokens on their DEX at least once.
The third and last spike on the graph took place on September 17th, a day after the airdrop took place. Gas fees reached a total of 538 gwei. Fees were 179 gwei only a week earlier, which marks an increase of 200%.
The entire period represented by the chart shows 2020’s DeFi summer. Yield farming became a popular way to earn passive income, investors used lending protocols for the first time, and many traders migrated from CEXs to DEXs. DeFi summer was a time when on-chain activity became abysmally high – and so did the fees.
If you compare the low of the previous chart to its high, you’ll see an increase of 800% in gas fees. The current meme season, which is only a month old, only brought us a 275% jump so far.
Moreover, each of the three spikes was met by a drawdown of -63%, -54%, and -79% respectively – averaging at -65%. The meme coin season is currently only at a -43% drawdown, which means that gas prices might become lower.
The last NFT mania of 2021 has also considerably raised gas prices, but not as much as the meme coin season or DeFi summer. Starting from January to February, fees grew from 99 gwei to 232 gwei – a 134% rise.
To conclude, gas fees rise parabolically whenever there is a significant rise in network activity. Past surges in activity have been marked by the birth of new narratives such as yield farming, NFTs, and meme coins. Although gas can rise up to 800% during such periods, it’s worthwhile noting that fees don’t stay high for a prolonged period of time.
Gas fees are, and will continue to be, stubbornly high. The only way you can cope and decrease the toll fees have on your portfolio is by using the right strategies.
One strategy is to plan ahead and time your transactions right.
According to data from EthereumPrice, gas is usually most expensive on Wednesdays between 6 and 7 PM (GMT +2).
You'll pay the lowest fees on the weekend when fees average 40 gwei throughout the entire day.
You can use the following time schedule for when you'll pay the lowest gas fees:
The schedule above is set for GMT +2. Make sure to convert to your local timezone for the correct time.
Another strategy is to use a Layer-2 (L2) solution to avoid high transaction fees. You have access to several L2 solutions for the Ethereum network, including:
You can find the same exact dApps on the protocols above as on mainnet Ethereum. However, keep in mind that liquidity can be varying between different L2s.
You can even save fees on the Bitcoin network - which has also seen a spike in fees - by using the Lighting Network.
My third and last strategy for counteracting network congestion is simply to stop using the network! Congestion usually occurs whenever a new trend arises, like NFTs, meme coins, yield farming, etc. You’re better off trading on a CEX during this period if you necessarily have to actively trade.
If you’re somehow forced to resume your on-chain activities, better make sure that your time in DeFi is worth the fees. Participating in a narrative like meme coins means that your risk tolerance is already way off and that you assume that your profits will massively outweigh any fee you pay – if that’s true, simply pay the toll and pray the mania doesn’t stop.
If you want to learn more about Ethereum’s turbulent DeFi sector, feel free to read the following articles:
Each day Shrimpy executes over 200,000 automated trades on behalf of our investor community. And joining them is easy.
After you sign up and connect your first exchange account, you’ll deploy an investment-maximizing strategy in as few as 5-minutes.
Whether you create your own rebalancing strategy or completely custom automation, the ability to walk your own path belongs in the hands of every crypto investor.
What are the best smart contract platforms in 2021 and do we really need anything besides Ethereum? Plenty of projects compete in the arena of smart contracts, yet rarely anyone claims victory. With the arrival of ETH2 and rising stars like Polkadot, understanding this special segment is now more important than ever.
Proof of Work vs Proof of Stake: which model is better? Consensus models are a touchy topic in the blockchain industry, loyal Bitcoin and Ethereum maximalists will curse you to death for claiming that one is better than the other. See the truth for yourself by reading a quick and simple comparison!
The Merge is an upgrade that will unify the Ethereum mainnet with the beacon chain and transition the project to a Proof of Stake consensus model. Learn more about how the Merge changes Ethereum and what that brings to investors.