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What Are Gas Fees?
If you are familiar with the fast-growing world of decentralized finance (DeFi), then it’s likely you know a thing or two about gas fees. The price of doing business in DeFi, gas fees are the charges levied by developers to process transactions on the Ethereum blockchain - where the vast majority of DeFi transactions happen.
Gas fees are typically charged in Gwei, a smaller fraction of Ether (ETH), Ethereum’s native token. This is done in order to break down the fees into more sensible units. For example, rather than charge 0.00000002 ETH for a transaction, which is a little tough on the eye, you might be charged a gas ‘price’ of 20 Gwei.
On top of this, a user will pay for gas ‘used’, setting a gas ‘limit’. The Ethereum yellow paper stipulates that every transaction requires at least 21,000 Gas, and as such, most user interfaces will set 21,000 as the default limit. The interplay of these two things will determine the price, and the higher you set them, the faster your transaction will be processed.
More congestion equals more gas
Paying a fee for a service is, of course, nothing new. Moreover, Gwei fees have historically been fairly low, allowing users of all shapes and sizes to participate in the network. However, as the number of DeFi users has soared since July 2020, growing congestion is leading to skyrocketing gas fees.
At the beginning of June 2020, the average total gas fee charged to process a transaction on Ethereum was equivalent to $0.45; by September 1, it was $12.54, an increase of 2,686%. Fees fell in the last quarter of the year as activity slowed, but come January 4, 2021, gas hit a new high of $17.56 per average transaction.
Putting gas into practice
To put this into context, let’s take a look at a transaction totaling $100. If this were processed for a gas fee of $0.45, that fee would represent just 0.45% of the total transaction (a fairly reasonable level for most users). However, if that transaction attracted a fee of $12.54, that would represent 12.5% of the total transaction.
This might not seem like much, but consider that in order to simply recoup the gas fee, your $100 would need to grow by 12.5%. The key here is that you will not be making any ‘real’ profit until you have recouped fees. So, to see just a 5% return, your $100 would have to reach $117.50.
Higher fees, less protection
If this takes one month - which has been possible in DeFi of late - it may not be a big deal. If it takes one year, though, you might find that you could have made more money by placing your money somewhere else. If, under a worst-case scenario, you make a loss on your $100, then high fees will compound that loss. If it falls to $95, for example, you would have actually lost $17.50, not $5, because of the fee.
Conversely, if you had paid just $0.45 in fees, your $100 would need to grow by just 5.45% for you to make a 5% return - or to $105.45. This is a far more achievable level that you would be likely to achieve in a year, if not sooner. And, if per-chance the value drops to $95, you will have lost $5.45, not $17.50.
Fees and low-capital users
As you can see, lower fees as a percentage of your transaction offer a greater level of protection against slow growth and potential losses. As average fees rise, then, in order to maintain a favorable ratio of transaction value to gas fees, a user would have to put more money in to make the transaction worthwhile.
As of January 6, 2021, the average gas fee on the ETH network is equivalent to around $9. At this level, to achieve a ratio of 0.45%, a user would need to transact $2,000. The more you transact, the lower the fee is as a percentage of your transaction. And so, the richer you are, the less gas you will pay in real terms.
Gas in a traditional finance view
All of the above means that, currently, those transacting smaller amounts in DeFi are making less profit while being more exposed to the negative effects of lower growth and potential losses. While this is never a good situation, it is particularly troubling for DeFi, which is intended to be a place where anyone can participate in the type of financial opportunities that, within traditional finance, are reserved for only the very wealthy.
In traditional finance, an institutional investor - like a pension fund or asset manager - would have access to transaction fees equaling a tiny fraction of a percent, allowing them to fully maximize profits. Meanwhile, even ‘retail investors’ are now able to access passive investment funds that charge as little as 0.10% per year, with often no or very low dealing fees on some online investment platforms.
Gas through the DeFi lense
Under the model of traditional finance, the current fees being levied in DeFi would effectively lock out the average retail investor - i.e. anyone transacting less than $2,000 at a time - but the picture is not quite so simple. As highlighted above, over the past year some spectacular gains have been made in the space that, in many cases, can more than justify fees.
Had a user participated in liquidity mining through yearn.finance, for example, they would have benefitted not only from returns of between 10% and 20% on their stablecoins, but also from the spectacular rise in the value of YFI, the protocol’s governance token, which has soared in value by 3,453% since July: from $790 a coin to nearly $30,000 at the time of writing. Seen in this context, high gas fees are a drop in the ocean.
Strength in numbers
However, as we covered previously, realizing gains of this magnitude is not always easy. It requires an enormous amount of time and effort spent in initial research, and then a significant amount of trial and error that can be very costly. Also, the speedy evolution of DeFi means that the sort of gains that were possible in the early days are increasingly scarce today; yearn.finance now offers significantly lower rates, for example. This places the issue of gas fees front and center.
At YIELD App, we founded our platform with accessibility in mind. As a seasoned team of investors and developers with significant experience in the field, it seemed clear to us that the evolution of DeFi would eventually see mainstream users locked out of the network as complexity and costs grew while available returns fell.
Through the use of innovative investment strategies that pool assets, we are able to help all users access DeFi and offer some of the most competitive returns on the market. Spreading capital, cost and risk is - we believe - the way to ensure DeFi achieves its mission of taking finance to the masses.