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Each Ethereum transaction consumes network resources measured in units called "gas." Gas is a proxy that represents the resource consumption — such as bandwidth, storage, and processing power — involved in executing Ethereum transactions. The required cost of a transaction, known as the base fee, is calculated by multiplying the necessary amount of gas units for the given transaction type by the gas price.
Gas prices on Ethereum are set algorithmically and adjust based on the demand for transactions, or rather, gas units. When transaction demand exceeds the target amount of 15 million gas units per block, the gas price increases. Similarly, gas prices decrease if demand is below the 15 million target. The adjustment is capped at 12.5% and is proportional to the deviation from the target. Each block has a maximum capacity of 30 million gas units. If demand reaches this limit, gas prices rise 12.5% for the next block.
These adjustments happen every 12 seconds, making gas prices highly responsive to network activity. However, over a longer period, gas prices tend to stabilise as the network usage finds an equilibrium. This system allows Ethereum’s limited resources to be allocated efficiently in a free market, with gas prices reflecting real-time demand for block space and adjusting to the overall value of network activities.