Mining and Consensus
Bitcoin makes heavy use of hashing, from addresses to transactions IDs and mining. This chapter introduces the mining process. Let's start with some background on the mining process by looking at the monetary aspects of mining, incentives, nodes, and transaction validation. Later, we will discuss some of the more technical aspects of mining.
Introduction
Bitcoin Economics and Currency Creation
Bitcoin are "minted" during the creation of each block at a fixed and diminishing rate. Each block, generated on average every 10 minutes, contains entirely new bitcoin, created from nothing. Every 210,000 blocks, or approximately every four years, the currency issuance rate is decreased by 50%. For the first four years of operation of the network, each block contained 50 new bitcoin.
In November 2012, the new bitcoin issuance rate was decreased to 25 bitcoin per block. In July of 2016 it was decreased to 12.5 bitcoin per block, and in May of 2020 it was decreased again to 6.25 bitcoin per block. The rate of new coins decreases like this exponentially over 32 "halvings" until block 6,720,000 (mined approximately in year 2137), when it reaches the minimum currency unit of 1 satoshi. Finally, after 6.93 million blocks, in approximately 2140, almost 2,099,999,997,690,000 satoshis, or almost 21 million bitcoin, will be issued. Thereafter, blocks will contain no new bitcoin, and miners will be rewarded solely through the transaction fees. Supply of bitcoin currency over time based on a geometrically decreasing issuance rate shows the total bitcoin in circulation over time, as the issuance of currency decreases.
Figure 1. Supply of bitcoin currency over time based on a geometrically decreasing issuance rate
Note: The maximum number of coins mined is the upper limit of possible mining rewards for bitcoin. In practice, a miner may intentionally mine a block taking less than the full reward. Such blocks have already been mined and more may be mined in the future, resulting in a lower total issuance of the currency.
In the example code in A script for calculating how much total bitcoin will be issued, we calculate the total amount of bitcoin that will be issued.
Example 1. A script for calculating how much total bitcoin will be issued
link:code/max_money.py[]
Running the max_money.py script shows the output produced by running this script.
Example 2. Running the max_money.py script
$ python max_money.py Total BTC to ever be created: 2100000000000000.0 Satoshis
The finite and diminishing issuance creates a fixed monetary supply that resists inflation. Unlike a fiat currency, which can be printed in infinite numbers by a central bank, bitcoin can never be inflated by printing.
Deflationary Money
The most important and debated consequence of fixed and diminishing monetary issuance is that the currency tends to be inherently deflationary. Deflation is the phenomenon of appreciation of value due to a mismatch in supply and demand that drives up the value (and exchange rate) of a currency. The opposite of inflation, price deflation, means that the money has more purchasing power over time.
Many economists argue that a deflationary economy is a disaster that should be avoided at all costs. That is because in a period of rapid deflation, people tend to hoard money instead of spending it, hoping that prices will fall. Such a phenomenon unfolded during Japan's "Lost Decade," when a complete collapse of demand pushed the currency into a deflationary spiral.
Bitcoin experts argue that deflation is not bad per se. Rather, deflation is associated with a collapse in demand because that is the only example of deflation we have to study. In a fiat currency with the possibility of unlimited printing, it is very difficult to enter a deflationary spiral unless there is a complete collapse in demand and an unwillingness to print money. Deflation in bitcoin is not caused by a collapse in demand, but by a predictably constrained supply.
The positive aspect of deflation, of course, is that it is the opposite of inflation. Inflation causes a slow but inevitable debasement of currency, resulting in a form of hidden taxation that punishes savers in order to bail out debtors (including the biggest debtors, governments themselves). Currencies under government control suffer from the moral hazard of easy debt issuance that can later be erased through debasement at the expense of savers.
It remains to be seen whether the deflationary aspect of the currency is a problem when it is not driven by rapid economic retraction, or an advantage because the protection from inflation and debasement far outweighs the risks of deflation.