Understanding Transaction Fee Mining and its Changes
Since its introduction into the cryptoasset markets, transaction fee mining and the exchanges that support this model have been regarded with suspicion. However, it appears that the tide might be turning as some exchanges are reworking the model.
In this article, you will learn about the concept of transaction fee mining, its history, the exchanges that employ it, and recent changes.
What is transaction fee mining?
In Q1 and Q2/2018, the digital asset market witnessed a curious new development. A number of exchanges were exhibiting sudden increases in trading volumes. The changes in trading volume happened over a relatively short period and resulted in the affected cryptocurrency exchanges climbing up the rankings on cryptoasset data platforms such as CoinMarketCap. The exchanges involved in the market movements were BitForex, FCoin, CoineEx, CoinBene, and Coinsuper.
According to research published by Hacken, a cybersecurity firm with a focus on the digital asset sector, the sudden growth in trading volumes on these exchanges was due to the adoption of a new model called transaction fee mining. Also referred to as trans-fee mining, the new model drew heavy criticism from many corners of the market with a number of thought leaders and crypto-focused publications even likening it to a Ponzi scheme.
To understand what transaction fee mining refers to, it is important to first understand the model that the majority of cryptocurrency exchanges utilize. When traders execute a trade on an exchange, they are charged a fee. These fees will form the bulk of the profit generated by the exchange. In contrast, for exchanges running the trans-fee mining model, users are refunded the fees levied on their trades in the exchange’s token.
Why the backlash?
Now, exchange tokens are hardly a new idea. Binance was the first digital asset trading platform to launch its own native digital asset, Binance coin (BNB). Following the success BNB witnessed, a number of exchanges adopted the concept, making a few amendments to birth the transaction fee mining model.
FCoin, a Chinese exchange, is credited as the pioneer of the trans-fee mining model. FCoin made headlines when it began promising customers 100% of their transaction fees reimbursed in the form of its native FT token.
Similar to exchange tokens, the trans-fee mining model also confers users with greater rights as they accumulate the platform’s native token. However, because the exchanges will reimburse users the fees charged on their transactions, customers have a greater incentive to trade on platforms supporting this model. Customers typically flock to these platforms to accumulate the native asset and either sell it immediately to turn a profit or keep it in anticipation of future price appreciation.
The controversy around trans-fee mining is centered around the fact that the model is believed to incentivize dishonest activity. In theory, customers would prefer to trade on exchanges running the trans-fee model, because it is essentially a cost-free. However, because they earn money per trade, customers are more likely to collude and participate in wash trading to increase their earnings.
For exchanges, the incentive for dishonest activity is even greater. Trading platforms typically charge listing fees for the tokens of new projects. These fees are generally structured in proportion to trading volumes. Therefore, the greater the number of people trading on the exchange, the more they can charge a project looking to be supported by the platform. In other words, the larger the trading volume, the more fees the exchange stands to earn. As a result, they are incentivized to manipulate trading volumes. According to the Hacken report, this was determined to be happening in some of the exchanges running the trans-fee mining model during the 2018 controversy.
Additionally, other exchanges have criticized platforms running the trans-fee model because it bypasses the long-winded and complicated initial coin offering (ICO) process, avoiding regulatory and related concerns, while still gleaning the benefits.
Changpeng Zhao, Binance CEO, is quoted saying: “You use BTC or ETH to pay for the transaction fee to the exchange, where it pays you back 100% via the exchange tokens. Isn’t it the same with using BTC or ETH to buy the exchange tokens? What’s the difference between this and an ICO?”
Unfortunately, as trading volumes die down following the initial launch period, customers are generally left holding valueless assets.
On April 30, 2019, FCoin announced it was reworking its trans-fee mining model. Taking into account the criticism the model has drawn in the past, the exchange introduced a number of changes designed to reduce the incentives for dishonest behavior.
FCoin calls the new approach the sustainable mining model. The new model will reimburse funds in the digital currency in which the trade was made. Additionally, “Only 20% of the eligible FT will be distributed daily. The remaining 80% of the FT distributed will be locked for 1 year with holders continuing to enjoy benefits or interests such as dividends and voting during the lockup period.”
These changes have been lauded across the cryptoasset market because they minimize the risks witnessed within the model while maximizing the benefits. Su Zhu, CEO of Three Arrows Capital stated: “Interesting how trans-fee exchange mining went from being a pump and dump concept in 2018 to an effective incentive mechanism in 2019.”
However, it remains to be seen how the rest of the trans-fee mining exchanges will respond to FCoin’s new approach. What is clear, however, is that the crypto market continues to show signs of maturity with every year.