Don’t just blame DeFi for paying high ETH gas fees

Transaction costs on the Ethereum blockchain are at record highs, and no one will let you forget it. Reports often detail how decentralized finance platforms are the cause of ever-rising gas fees — tokens paid to miners who confirm and enable transactions on the Ethereum blockchain. Yes, DeFi does play a role, but the problem is institutional. 

Some exchanges, custodians and asset managers have been using multisignature platforms to secure their digital assets. Several years ago, multisig was viewed as a respected attempt to prevent private keys from being compromised. Despite initial adoption, numerous shortcomings have made institutions both question and transition from the multisig approach, in many cases replacing it with multiparty computation, or MPC, infrastructure.

Among many disadvantages, multisig platforms are not natively supported on the Ethereum blockchain. Instead, institutions are required to execute smart contracts that implement the multisig logic — i.e., a smart contract that accepts deposits and requires multiple signatures to withdraw from it.

Creating these multisig smart contracts to secure exchange clients’ funds involves gas fees, which cost millions of dollars. But it’s not just people’s wallets that have been suffering. Because fees are denominated in Ether (ETH), a more congested network may lead to slower development of Ethereum-based projects.

Multisig gas economics

Creating a multisig wallet implemented as a smart contract costs over 1 million gas units (approximately $30 at current value). In addition, every deposit or withdrawal costs more than 100,000 gas units. Therefore, multisig institutions end up paying a higher fee, given they have chosen to use a smart contract function.

In contrast to the creation of a single signature MPC wallet, there are no wallet creation fees and deposits, and withdrawals cost a standard 21,000 gas units.

Given gas deposit fees are paid by end-users, any institution implementing a smart contract may initially think this wallet creation fee is simply a one-time operation. Unfortunately, there is still another major issue with multisig addresses on the Ethereum network that results in another unnecessary fee: attribution.

Attribution

When an institution such as an exchange wants to identify deposits from different users, it creates a unique receive address for each client.

Unlike the Bitcoin network and other blockchains, Ethereum does not permit a transaction to include multiple inputs. Therefore, institutions will instead forward all deposits from each client’s unique receive address to a secure address where withdrawals are made.

The usual workaround to receive addresses for institutions is to use a forwarding contract or a way to forward any incoming funds to a new location (the omnibus multisig wallet). While this achieves attribution, it’s also one more smart contract that needs to be implemented.

Creating a forwarding contract costs around 200,000 gas units; depositing the forwarding contract costs approximately 60,000 gas units. These are all needless costs, further congesting the Ethereum blockchain.

Cost of doing business?

Suppose a new crypto exchange is seeking to establish its Ethereum wallet infrastructure with a separate receive address for each client. Based on the above pricing, if the exchange used a multisig infrastructure, it would pay $6 every time it signed up a new client and created a new receive address for them. This is before the client even deposits any funds.

The exchange will likely view this as part of its customer acquisition costs or the cost of doing business (if they’re even aware of this incurred cost, to begin with).

A recent report states that Coinbase has 35 million customers. At today’s prices, it would cost $245 million to set up a multisig infrastructure to support said clients — whether or not these clients choose to conduct transactions.

A solution to the problem

As with any maturing market, institutions have experienced increased fee compression over time, and firms have been seeking methods to scale their business at a lower cost without compromising on security.

If institutions could reassess their underlying infrastructure and consider a solution that is not dependent on an individual blockchain for support, they could easily reduce expenditure and limit infrastructure set-up fees. Gas fee payments to simply mirror multisig infrastructure on Ethereum would become a thing of the past.

Using alternative systems would go a long way in reducing the congestion on the second-largest blockchain.

The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.