November 17, 2020
November 17, 2020
This article is the first part of a four part series surveying fees in the cryptocurrency market.
Fees have become an integral part of the crypto ecosystem. Whether you’re trading Bitcoin, transferring fiat, or simply having your personal data sold to the highest bidder, fees have taken over the industry. This is fundamentally detrimental to the evolution of the market as fees serve as a tax on early adopters and create friction for new entrants in the market.
When we talk about fees, we mean several different things. In crypto, fees come in two main forms: Direct and Indirect. Direct fees are transparent fees served to the customer in exchange for some service or feature of an exchange. This generally includes transaction fees when moving fiat between exchanges and banks, and trade fees incurred at the time of transaction. For example, Coinbase charges a flat or variable fee on every transaction.
Indirect fees are fees that are passed to the consumer without the user knowing they are paying anything at all. The most common indirect fee in crypto is the spread. A spread is the difference in price from the maker and taker and is a part of every exchange. When you buy Bitcoin on Coinbase, you are charged 0.5% of your order in spread. By acting as its own market maker, Coinbase charges the spread to its customers without disclosing the itemized cost at checkout. Other products like Cash App and Robinhood operate almost exclusively off hidden spreads.
Fee Drag is traditionally thought of as only affecting high value traders. In reality, Fee Drag negatively impacts both new entrants to the market as well as seasoned high volume traders. Noobs often pay the highest effective rates of fees, discouraging the investing habit. On Coinbase, if you spend $10, you pay 99¢ or 9.9%. If you spend between $50 and $200, you pay $2.99 in fees. That is 5.87% on $51. However, if you buy more than $200 and use funds from your bank account, you only spend 1.49% in fees. This price gouging directly reduces the likelihood that new users will begin buying into crypto. As we mentioned in our post Bitcoin is Money, the ease of conversion from fiat to Bitcoin is vital to kicking off the next era of crypto.
On the other end of the spectrum are high volume traders who experience Fee Drag on their investments. These compounding fees result in billions of dollars of profit, while traders may externalize the cost as market fluctuation. Bitcoin trailblazers that convert all or part of their paycheck to Bitcoin every month, will see fees drag on their Bitcoin holdings over a long period of time. In our earlier example, 1.49% on $500 a month is $89.40 a year in fees. And that is without taking into account the spread. Converting a full $50k a year salary costs over $700 in fees.
Fees also affect Bitcoin as a whole. Because of fee drag and high entrance costs, fees lower Bitcoin adoption rates. Buying Bitcoin for the first time on an exchange with high fees means you are able to buy less Bitcoin and minimums can even price some consumers out entirely. Furthermore, Bitcoin is money, so its value is tied to its number of users and its exchange as a currency. We explained in Bitcoin is Money that merchant acceptance of Bitcoin is vital to its success as a currency, but consumers have to own Bitcoin in the first place in order to be able to spend it. Fees directly reduce consumer adoption and thereby also reduce the value of the Bitcoin network.
This article is the first part of a four part series surveying fees in the cryptocurrency market. In the next three installments, we will discuss the impact of Direct and Indirect fees on Bitcoin investors, as well as the dampening effect fees have on Bitcoin’s evolution as an asset.