It's 9.45am at the lairy end of the Cowgate, the soot-blackened, sick-splattered channel that runs through Edinburgh's Old Town, parallel to and downhill from (in every sense of the word) the wide, sunlit Royal Mile. Outside the Three Sisters pub is a man in pyjamas and flip-flops. He's either up early and come down to street level to see what all the fuss is about or – more likely, given that the "fuss" in question is the up-all-night Edinburgh Fringe – he's about to go to bed.

Actually, neither is strictly true. He's Dan Skili, a member of comedy group A Drunken Sailor, and 15 minutes later, still in pyjamas, he's bounding onto a small stage in one of the pub's tiny upstairs rooms to perform Playback: Impro, an entertaining show which asks its audience to provide anecdotes which are then magicked into improvisational sketches by the four cast members. These are delivered in the manner of opera, film noir, Shakespearean play, whatever.

Afterwards, Skili's fellow cast member Julia Munrow will tell me about the private show they once did for a 50th birthday party at which one guest – possibly an ex-girlfriend of the birthday boy, Munrow still isn't sure – delivered a story about the orgies he used to host. Oh for something as interesting today. Instead the anecdotes are jaw-droppingly mundane. The quartet soldiers on heroically, even through a long-winded story about a madeira cake and an episode of The Great British Bake Off that has even them glazing over slightly.

So far, so Fringe. But what makes this different is what happens at the end of the show, when Munrow produces a pint glass and stands at the doorway collecting donations. This, you see, is the Free Fringe, and the idea is you pay what you think the show is worth. Or you pay nothing at all.

It's becoming more popular every year and, depending on your point of view, it's either turning a whole strand of Edinburgh in August into a glorified busking session or returning it to its sweaty, anarchic, free-market beginnings.

Today's haul from an audience of 30 is about £14 each for the Playback: Impro cast members. They divvy it up downstairs in the bar afterwards. It isn't enough to live on, but a berth on the Free Fringe does mean you avoid having to pay for a venue and aren't required to hand over a £295 Edinburgh Festival Fringe registration fee. So any profit you make you keep. Or drink. Or spend on pyjamas.

Across town at Clouds & Soil on Picardy Place, I encounter Alex Brockie promoting his one-man Free Fringe show, An Audience With Gorgeous George. It's a retelling of the life of George Wagner, an American wrestling star of the 1950s whose shtick was to dye his hair platinum, dress in an effeminate fashion and act (and wrestle) accordingly. He outraged America and became a star as a result.

Brockie, a 30-year-old lecturer in drama when he isn't handing out flyers dressed in white winkle-pickers and a suit the colour of pistachio ice cream, is a wrestling nut. He brought another self-penned wrestling-themed play to last year's Fringe proper, but this year he's gone down the Free Fringe route. "I've made more and spent less," he tells me.

To him, it's a no-brainer – unlike his show, which is clever, witty, moving, flawlessly performed (he has the Texan accent to a tee) and as professional as anything you'll see in the cluster of powerhouse venues which dominate the Fringe. He's had one review and garnered just one of those all-important stars. I'd happily add the missing four.

Comedian David Callaghan is another who deserves a wider audience. His performance space is so small he really doesn't need a microphone, so hot he has to apologise (twice) and so crowded that he isn't the only stand-up in the room: arriving last, I'm squeezed upright into a corner behind the door. It's the only available space.

It's worth it, though. "Only live dogfight on the Fringe, ladies and gentlemen," Callaghan yells as he climbs over the seat backs dressed as a Second World War fighter pilot and with a toy plane attached to his head by a cardboard tube (to make the dogfight more convincing, if that's humanly possible, he's joined for this bit by fellow comedian Richard Brown. Brown is supposed to burst in through the door dressed in a similar fashion, but the fact that I'm leaning on it makes his entrance more comical than was intended).

Other flights of fancy see the 26-year-old musing on how congas start at weddings and why having a Subway franchise next to a Post Office is a bad thing. But there's a keen intelligence at play here and underpining the whole thing are some seriously-held beliefs about politics and consumerism. In short, Callaghan's like a taller, funnier version of author and left-wing political pundit Owen Jones, though much less likely to be invited onto Question Time. Which is a shame. His show is called No Momentum, but on this evidence I'd say he has plenty.

Sometimes you can have the opposite problem to Callaghan. La Belle Angele won't feel cavernous when Sleaford Mods play there in October, but even with a decent audience of 30 people Casper Thomas can't fill the space – and he's a magician. Not having a microphone doesn't help either, but his memory tricks, illusions and close magic skills see him through. No rabbit-concealing top hat to collect his money in, but you can't have everything.

Proof that the Free Fringe isn't quite as democratic as it seems comes when I meet stand-up Caroline Mabey trying to drum up an audience outside Opium, a hard-rock drinking den to the west of the Three Sisters. Between it and Opium is Sneaky Pete's, where a large queue is forming. It's for two-hander Beard: The Grin Of Love. "They've got money for PR" is Mabey's terse assessment as she looks on.

This PR comes in the form of a mini-brochure, a snappily designed, Samsung Galaxy-sized publication produced by Beard's London-based promoters The Invisible Dot. They have 10 shows in Edinburgh, six of them on the Free Fringe. I go with Mabey instead. Including the barman there are nine of us in the room by the time she takes the stage for a show about the trials of motherhood. By the time it finishes, she's dressed as a sausage roll and talking about blowjobs. It isn't even lunch time.

As Mabey knows, the PR works. One of the hits of the Free Fringe is Mike Wozniak, another Invisible Dot act. Again it's standing room only at his show, One Man Dad Cat Band, but the difference is there's seating for a couple of hundred and it's all taken. Late arrivals sit on the pool table or manoeuvre pallets into a space at the back and make an impromptu bench (you can do that sort of thing in Free Fringe venues). Mind you, Wozniak is a former Edinburgh Comedy Award Nominee, given the nod in 2013 for a show at The Stand, so the ability to see him for free is a draw in its own right. When he stands to collect his takings, however, I note that his is the biggest cash bag I've seen yet.

Comedy dominates the Free Fringe and what theatre there is tends to be monologue-based. A close cousin of both is spoken word and it has found a home of sorts at Pilgrim, an eccentric bar built out of recycled materials such as cinema seats and suitcases. Here, as my day comes to a close, I find Agnes Torok, a slam poet and (it says on her flyer) "YouTube sensation" whose extraordinary performance is part self-help group, part TED talk, part salvation show.

Her large audience, teenagers and twentysomethings mostly, hang on her every word and clap and cheer sporadically as she presents If You're Happy And You Know It Take This Survey. If you want to recapture the bright-eyed fervour and idealism of #indyref, get down there. The enterprising Torok has CDs and poetry collections for sale and, for the first time today, I see notes rather than coins being produced by the punters. Happy? She looks it.

My own pockets have been cleaned out of both coins and notes by now, proof that "free" is less a statement of fact and more a fiscal concept with extremely fuzzy edges. Or, to put it another way, proof that even a man in pyjamas and flip-flops, even a comic dressed like a Gregg's lunch on steroids, even a magician who can't magic up a mike, are worth something to the non-paying customer.