As you now know, nodes have to expend CPU power in order to generate a valid hash for the next block. Expending power costs money. Therefore, for nodes to willingly expend this CPU power, it makes sense that they need some sort of reward.
Satoshi explains the concept of Bitcoin incentives as follows:
“The first transaction in a block is a special transaction that starts a new coin owned by the creator of the block. This adds an incentive for nodes to support the network, and provides a way to initially distribute coins into circulation, since there is no central authority to issue them.”
Every Bitcoin block holds a certain number of transactions. The first of these transactions, also called the coinbase, is the same in every block and generates new Bitcoins.
The new Bitcoins generated in each block are called the “block reward.” At inception, each block reward was 50 Bitcoins (BTC). In other words, each block produced 50 new Bitcoins. The block reward is halved after the discovery of every 210,000 blocks, which takes around four years.
- 210,000 blocks x 10 minutes per block = 2,100,000 minutes
- 2,100,000 minutes / 60 minutes per hour = 35,000 hours
- 35,000 hours / 24 hours per day = 1458.333 days
- 1458.333 days / 365 days per year = ~4 years
Each time the block reward gets cut in half, it is known as a “halving.” The first halving was in November 2012 when the block rewards were cut in half to 25 BTC. By this point, half of the BTC that will ever exist – 10.5 million – were out in circulation. Another halving later, 12.5 BTC were created in each block. Today there are 6.25 block rewards per block.
And at some point in 2040, we will reach a point where no new BTC will be created in each block. At that time, the incentive to mine will only come from transaction fees.
“Once a predetermined number of coins have entered circulation, the incentive can transition entirely to transaction fees and be completely inflation free.”
You might be thinking that this means transaction fees will undoubtedly go up after 2040. You’re right. They have to be high enough to cover the costs of a miner expending CPU power to mine.
Why does it work this way? Because Satoshi wanted a finite supply of Bitcoins to exist. Rather than generating all the coins at once, he came up with the clever idea of releasing new Bitcoins in each block and using them as an incentive for nodes to mine the next block.
We can see how this is very different from the current monetary system that we operate under, which is centralized and inflationary. The Fed can increase or decrease the supply of currency in circulation at will. On the other hand, with Bitcoin, the supply is predictable and encoded into the algorithm. At any point in time, we know exactly how many Bitcoins exist in circulation.
It is fairly obvious why Satoshi designed the system this way. The first Bitcoin block encodes “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”
He was referencing the headline of this newspaper:
The fact that Satoshi designed Bitcoin such that no central entity can create BTC outside of the strict schedule is a reaction to the current monetary system, which can create money at will (e.g., 2008 QE, which we learned about in this lesson).
How do we protect against greedy or malicious miners?
Alright. So we now understand that we can have a system where miners are incentivized to mine new blocks. But what is the incentive for miners to not be dishonest when they generate new blocks, such as by including double-spent transactions?
“If a greedy attacker is able to assemble more CPU power than all the honest nodes, he would have to choose between using it to defraud people by stealing back his payments, or using it to generate new coins. He ought to find it more profitable to play by the rules, such rules that favour him with more new coins than everyone else combined, than to undermine the system and the validity of his own wealth.”
As Satoshi rationalizes above, a greedy and dishonest attacker that has somehow managed to accumulate more CPU power than all the honest nodes can choose to attack the network, but as soon as the network finds out about the attack, the entire Bitcoin network becomes invalidated, destroying the attacker’s own Bitcoin wealth). Satoshi argues that a rational attacker would rather use all his CPU power to mine new honest blocks that earn him new Bitcoin rewards, rather than risk subverting the network with dishonest blocks.
If you have burning questions, send them!
Next up, we’ll look at the way in which Satoshi envisioned optimizing the storage of all the transactions on the blockchain (since it takes up a lot of space). See you in the next lesson 🙂