Letter #58: Miner Difficulties - Earnings on the Bitcoin Blockchain
Read now to learn what incentives miners have to protect the Bitcoin blockchain, now and centuries in the future.
Bitcoin mining is, without a doubt, one of the most important parts of the Bitcoin network. After all, Bitcoin mining is what enables the proof of work algorithm that powers Bitcoin’s blockchain. And without proof of work, participants would be back to relying on trust-based systems, such as those governing fiat economies.
In spite of its importance, there are still a few misconceptions that plague Bitcoin mining. We’ve already spoken about its supposed environmental impact. Another example is that many people believe that Bitcoin miners have absolute control of the blockchain. But the reality is that miners have no more power to change Bitcoin than anyone else does. The block size war that resulted in the split between Bitcoin (BTC) and Bitcoin Cash (BCH) is proof: large numbers of miners supported the protocol that became Bitcoin Cash; however, most non-miner participants chose Bitcoin instead, which remains the larger and more successful protocol to this day.
There is perhaps an even more detrimental misconception though, and that revolves around Bitcoin’s 21 million coin supply cap. In simple terms, many people wonder how the eventual mining of the last Bitcoin will impact miner incentives and whether the supply cap will be increased or eliminated as a result.
Incentive #1: Block Rewards
Let’s dive a bit into how the Bitcoin blockchain functions. Miners are currently incentivized to support the network primarily by the block subsidy, which is a number of “new” Bitcoin that are released with every block added to the blockchain. When the Bitcoin blockchain first began operating, the block subsidy was 50 Bitcoin per block. It has since dropped to 6.25 Bitcoin per block. The current amount might not seem like a lot by comparison, but remember that the price per Bitcoin has also jumped from essentially nothing to over $60,000 USD during that time.
The block subsidy will continue to halve about every four years until the very last Bitcoin is released, which is expected to occur around the year 2140. Since the block subsidy is currently the primary driver of miner participation on the network, many people have openly wondered what will keep miners coming back after the last Bitcoin is released.
Will the 21 Million Cap Be Removed?
In the grand scheme of things, it’s not very surprising that people think removal of Bitcoin’s 21 million coin cap will be the answer. We are certainly familiar with currencies and assets that don’t have hard caps. Fiat currencies are the most well-known offender in this regard, since their total supply is more or less infinite. Almost more perversely though even than that, most governments have successfully convinced large numbers of citizens that caps in the money supply will cause irreparable harm to local and global economies.
But will Bitcoin’s supply cap be removed? The answer is a resounding NO for one simple reason: Bitcoin’s cap is the main thing that sets it apart from all fiat currencies, as well as most financial assets and altcoins. In other words, Bitcoin would have very little value, intrinsic or otherwise, if it didn’t have its supply cap.
Lest anyone be confused, know that the innovation driving Bitcoin isn’t that it’s digital money. Fiat currencies were digitized long before Bitcoin came into existence. Nor is blockchain, its exceptional qualities notwithstanding, the true innovation. After all, there are several thousand cryptocurrencies running atop blockchains at this point and none of them are as valuable as Bitcoin.
The true innovation of Bitcoin is its unforgeable digital scarcity as represented by its 21 million coin supply cap. To remove that cap would be to kill the innovation, and thus, kill Bitcoin.
Incentive #2: Transaction Fees
Transaction fees currently contribute little to the total rewards that miners receive for supporting the Bitcoin blockchain, and the monetary value of those transaction fees today compared to that of the block subsidies is minuscule. That will change over time, in no small part thanks to the price appreciation of Bitcoin.
Think about it. If Bitcoin superfans are to be believed, global wealth will one day be denominated in Bitcoin. Once that happens, and I count myself among the believers, the per Bitcoin price will be massive. Let’s use 2021 as an example, even though global wealth in real terms is likely to have increased significantly by the time the last Bitcoin is mined in 2140:
Global wealth (2021) = ~$450 trillion
Bitcoin in circulation = ~ 19 million
Per Bitcoin price = ~$23.5 million USD
Why does this astronomical price per Bitcoin matter in the context of transaction fees? Because it highlights that, in the long run, a lesser number of Bitcoin collected as transaction fees may be needed to incentivize miners to keep supporting the Bitcoin blockchain.
Think of it this way: At today’s prices, miners are mostly incentivized to mine on the network in order to win around $400,000 ($65k * 6.25) worth of Bitcoin per block. The amount of Bitcoin received as transaction fees is much smaller: usually .05 - .15 Bitcoin, or just a few thousand dollars, per block. Of course, if the Bitcoin price were $23.5 million as we hypothesized before, those same transaction fees of .05 - .15 Bitcoin would be worth $1 - 3 million instead.
Bitcoin Is The Perfect System
Satoshi Nakamoto, the pseudonymous founder(s) of Bitcoin, knew what s/he was doing when the protocol was created. As we’ve seen above, the Bitcoin blockchain is capable of incentivizing people to support and protect it at various stages of its life cycle. We would do well to learn and understand this for ourselves.
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Crypto Roundup 🤠
Bitcoin Upgrades: Taproot, the first major upgrade accepted by the Bitcoin community in several years, will go live soon and will introduce additional privacy and smart contract capabilities. Read more
Crypto Education: New York’s Mayor-elect has conveyed a desire to have crypto education taught in the city’s schools. Read more
Bitcoin Nation: The country of Zimbabwe has indicated that it is considering a framework that would allow cryptocurrencies like Bitcoin to be accepted as legal tender. Read more
Into the Twitterverse 🐥
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