There are a number of key features which are coded into Bitcoin that one must be aware of in order to fully appreciate Bitcoin for what it is as a cryptocurrency.
The Bitcoin protocol and its mining revolve around the following 3 supply parameters:
- 21 million bitcoin – a known finite total supply
- Halving rate – a predictable diminishing rate of supply
- Adjusted difficulty – a steady consistent rate of supply
Once you understand how the above three parameters work in relation to one another, you will begin to fully appreciate bitcoin for the cryptocurrency that it is. Let us now look at each parameter in detail.
A. 21 Million Bitcoin – A Known Finite Total Supply
There will only ever be 21 millionDue to the exponential drop in the rate of supply, the exact total is 20,999,999.9769 btc bitcoin in existence by the year 2140 when all bitcoin have been completely mined. Yup, that’s another 120 years from today! This is an arbitrary figure designed into the Bitcoin mining algorithm from the onset. But why the limit in total supply?
When President Nixon took the US dollar off the gold standard in 19711, it ended the direct international convertibility of the US dollar to gold which was established by the Bretton Woods systemA fully negotiated monetary order established in 1944 and became fully operational since 1958 to govern monetary relations among independent states, with a monetary policy that that maintained its external exchange rates within 1 percent by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments of fixed exchange rates. With the dollar no longer tied to the value of 1/35th of an ounce of gold, it led to the adoption of an expansionary monetary policyExpansionary monetary policy is when a central bank uses its tools to stimulate the economy by increasing the money supply, lowering interest rates etc, thereby lowering the value of the currency and decreasing the exchange rate. and lax in foreign exchange rate policy, essentially turning money into fiat currenciescurrencies which governments have declared to be legal tender but which are not backed by any physical commodity such as gold and precious metals.
Eventually, the Federal Reserve and the central banks of countries allowed for the “printing” of more money by adding credit to banks’ deposits. At the extreme end, if the output of a country’s economy remains the same, overprinting of the money supply could lead to inflation and hyperinflation. The most famous case of this was the devaluation of the German D-mark in 1923 post-World War I2, and more recently with the Zimbabwean dollar3 and Venezuelan bolivar4. See news references at the bottom of this page.
Bitcoin is designed with this parameter to prevent this, i.e. there will never be more than 21 million bitcoin. This total number of bitcoin is fixed and finite in order to ensure it is not inflationary by virtue. If a bitcoin is lostA bitcoin is never really lost, but is considered lost when the private key to access it on the blockchain is forgotten and the ability to spend it is no longer possible., it can never be “replaced”, thereby reducing the total number of bitcoin in circulation. Although that “lost” bitcoin still exists on the blockchain, it remains inaccessible and cannot be spent unless the private key is recovered. The concept of private/public keys is covered in What is a Bitcoin Wallet.
Some other interesting facts on this parameter of known fixed finite supply are:
- As at end 2018, there are already almost 17.5 million bitcoin in circulation.
- The very last fraction of a bitcoin will be mined and released into circulation by the year 2140.
- Hence, the remaining nearly 3.5 million bitcoin will be created and issued over the next 100+ years.
Now that we have some figures in mind, let’s look at the rate at which bitcoin is created, and why more than three quarters of all the bitcoin that will ever exist is already in circulation today.
B. Halving Rate – A Predictable Diminishing Rate of Supply
The next parameter we will need to understand is the rate at which new bitcoin is released into circulation.
So far, we have learned that:
- a block of bitcoin transactions is added to the blockchain roughly every 10 minutes through the mining process; and
- each of these blocks comes with a fixed preset number of bitcoin as mining reward to the bitcoin miner…
Well, the Bitcoin mining algorithm dictates that the supply rate of new bitcoin per block shall be halved after every 210,000 blocks. Just to put this into perspective, let’s chalk this out:
= 2,100,000 minutes
= 35,000 hours
= 1,458 days
= 3.993 years
= 4 years approx.
i.e. 210,000 blocks coincide at roughly every 4 years.
The bitcoin reward halving storyline can therefore be described as follows:
- When Bitcoin started in 2009, the supply rate was 50 BTC per block. What this means is a miner was rewarded with 50 bitcoin with every block that was successfully mined.
- The bitcoin blockchain reached its 210,000th block 4 years later on 28th November 2012 and the block reward was halved to 25 BTC per block from that point onwards.
- The next 210,000th block, i.e. Block No. 420,000 was reached 4 years after that on 9th July 2016, and the block reward was further halved to 12.5 BTC per block since then.
- The next halving is expected to take place some time in May or June of 2020, and the mining reward for Block No. 630,000 onwards will be 6.25 BTC per block, and so on and so forth.
The above may be easier to comprehend when summarised in the following table:
At the start of 2019, there were already more than 17.5 million bitcoin in circulation. With the supply of new bitcoin dropping by a factor of 2 every 4 years, it is easy to understand why there were already more than three quarters of all bitcoin that will ever exist. From here, it is also easy to extrapolate that 98% of all bitcoin that will ever exist will be in circulation by the year 2030.
N.B. Click on the chart above to view with data and details on www.blockchain.com.
What this creates is a case of predictable diminishing supply rate or controlled currency supply, and as long as there is a constant or growing demand for bitcoin, the basic law of economics suggests that price goes up as supply decreases and demand increases. And as we have seen in the last over 10 years, the usage, adoption and demand for bitcoin have been constantly growing. Also, the price of bitcoin tends to spike up at every halving.
“A fixed money supply, or a supply altered only in accord with objective and calculable criteria, is a necessary condition to a meaningful just price of money.”
Whether intentional or not, it is interesting to observe that most of the bitcoin was designed to be released into circulation at the start of the bitcoin phenomenon when belief and adoption were at their infancy.
A large quantity of bitcoin at practically no value was held by very few people in the beginning, those who believed that it actually meant something. As the years went by and as more people became aware of what bitcoin is, the demand for it increased and the price of one bitcoin went up in tandem.
N.B. Click on the chart above to view with data and details on www.blockchain.com.
We foresee that as more and more people realise the value of bitcoin as a store of value and payment system, and with the supply of new bitcoin diminishing, it is easy to understand why its value can only go up, as long as there is a demand for it.
C. Adjusted Difficulty – A Steady Consistent Rate of Supply
We now know that miners are required to solve a mathematical puzzle with each block in order to earn the reward in the form of newly-minted bitcoin. This is achieved at approximately every 10 minutes.
There is another very important mechanism that has been incorporated into the Bitcoin mining algorithm. This is the mining difficulty adjustment, explained as follows:
- The Bitcoin protocol is designed such that after every 2,016 blocks (which coincides with about 14 days), the rate at which these blocks are solved is checked and adjusted.
- As more miners join the network, more computing power is deployed to the network to solve these puzzles, and over time, a block becomes quicker to solve.
- As blocks are solved earlier than 10 minutes, the puzzle difficulty is adjusted and made more difficult, so that each block once again takes approximately 10 minutes to solve by miners.
- The reverse is also true. For whatever reasons, as miners leave or quit bitcoin mining, the block puzzles will begin to take longer than 10 minutes to solve. The difficulty is once again adjusted after 2,016 blocks to make the puzzles easier, in order to restore the time it takes to solve a block puzzle, i.e. roughly every 10 minutes.
- This adjustment by virtue also helps to keep bitcoin mining profitable especially for miners who have staying power and the ability to weather through hard times caused by either high mining difficulty or low bitcoin price, or both at the same time. Both of these factors usually lead to less established miners leaving the network, hence becoming less competitive to the miners who can stay on.
Number of BTC Mined Per Day
Taking the current Reward Era of 12.5 BTC per block as an example, we can calculate roughly how many bitcoin can be mined per day. At the rate of 10 minutes per block, in 24 hours, the total number of bitcoin that can be mined in a day would be 12.5 BTC per block x 6 blocks per hour x 24 hours = 1,800 BTC per day.
Note that this is only an approximate figure as each block is solved in more or less 10 minutes on average. Sometimes a block is solved as quickly as 4 minutes, and sometimes as long as half an hour. With a cap limit to the number of bitcoin that can be mined in a day, as more miners join the Bitcoin network in mining, the number of bitcoin available to each miner becomes less as it is distributed to more miners across the globe. And then there is the increasing difficulty that miners will have to contend with.
This difficulty adjustment to maintain the 10-minute per block solving rate is critical for 2 important reasons:
- it ensures that 210,000 blocks coincides with about every 4 years when the halving takes place, and with that;
- it also ensures that the last fraction of bitcoin will be mined by the year 2140.
N.B. Click on the chart above to view with data and details on www.blockchain.com.
Mining Difficulty in 2019
Mining difficulty is expressed in absolute numbers which describes how much harder it is for a miner to solve for the current block with respect to the first block mined in 2009. For example, clicking the chart in Fig. 102f. above and zooming in to 3rd January 2019 (refer to Fig. 102f.), we can see that the difficulty is expressed as 5,618,595,848,853.
What this means is a block on 3rd January 2019 was over 5 trillion times harder to solve than the first block mined 10 years ago on 3rd January 2009, in order to maintain the solving rate of 10-minute per block. To put in perspective, a block on 3rd January 2010 (one year after the first block) was just 1.183 times harder to solve.
That, dear readers, is also an indication of how far we have come in terms of growth in bitcoin miners as well as advances in mining hardware technology, in just a “short” span of 10 years.
The Key Take-Away Point
If there is a key take-away point, it’s this…
Bitcoin is not merely a digital currency. Fiat currencies have also been digital for a very long time now. When you purchase something online and send funds to the seller using a credit card or via Paypal, that is essentially fiat currency moving digitally across the internet.
When you transfer money from one bank account to another, that’s ones and zeroes moving around electronically to make changes in the final account balance.
The big difference is bitcoin cannot be created out of thin air. It only seems to be created out of thin air by the Bitcoin software that releases it, but as we have learned, mining bitcoin involves resource-intensive proof-of-works and it comes at a cost – a very high cost not very different from the manner in which gold is mined.
Fiat currencies on the other hand, can be printed at will by central banks and governments in what is known as quantitative easing An expansionary monetary policy where new money is introduced into the money supply by a central bank..
Also, you cannot derive a bitcoin out of existing bitcoin the way banks do with fiat currencies and loans with the implementation of fractional reserve banking, which is the common practice by banks of accepting deposits and making loans or investments, while holding reserves equal to a fraction as low as 3% of the actual cash on hand that is available for withdrawal or loan, literally creating money out of thin air.
In other words, for every $100 that the bank has in actual cash, it is allowed to give out $97 in loans, keeping only $3 in the vault as cash reserves.
As an example, let’s consider the following scenario between Person A (saver), Bank B, and Person C (lender):
- A deposits $10,000 in Bank B as savings.
- C walks into Bank B and applies for a loan.
- Bank B is allowed to loan out as much as $9,700 to C if he is eligible for that amount.
- Bank B only needs to keep as little as $300 as cash reserves.
- In this instance, Bank B still owes A $10,000 if A wishes to withdraw the full amount.
- But now, C also owes Bank B $9,700 from the loan he took in the first place.
- Assuming A doesn’t make any withdrawals, and C settles his debt in full, Bank B now holds $19,700 in hand. All from money that Bank B never owned in the first place.
- Bank B essentially created $9,700 out of thin air. We have left interest payments out to keep this simplistic.
The worst scenario happens when A wishes to make a full withdrawal and C defaults on his loan entirely. Multiply that by tens of thousands of people and one can see how this can quickly end in a disaster. In such situations, bank runs, bank holidays and bail-ins are common terms you will see.
Watch the following video to understand fractional reserve banking and its consequences.
In fractional reserve banking, if every account holder were to visit the bank and demand to withdraw all their savings at the same time (say in the event of a financial crisis7), the bank would not be able to comply and complete a full withdrawal for everyone.
When understood from that point, it becomes clear that fiat currencies are actually more virtual than bitcoin. Scary, when you think about it. See news article by Financial Post at the bottom of this page.
Bitcoin Mining and the Blockchain
- Bitcoin is released into circulation by a process called bitcoin mining.
- Bitcoin mining is carried out by miners who deploy huge resources in computing power to the Bitcoin network to verify transactions across the globe.
- Bitcoin uses the hashcash proof-of-work based on the SHA-256 (a 256-bit encryption algorithm developed by the NSA) in its mining core and validation of the blockchain transaction log.
- In validating such transactions and placing them into blocks, miners are required to solve mathematical puzzles and the first miner to solve this is rewarded with a preset number of bitcoin, including the fees for all the transactions in that block.
- Completed and validated blocks are added to the blockchain, an open and public ledger that records and keeps track of every bitcoin transaction ever made since Bitcoin started in 2009.
- The blockchain is accessible by anyone over the internet at all times, and is immutable and thus cannot be altered. It is an append-only database – you can only add and not subtract or modify information along the way.
- Bitcoin mining is designed to be difficult and resource-intensive to safeguard the security of the blockchain and discourage a 51% attack on the network, an attack which is only hypothetical and has never taken place as such a hack requires a huge amount of money and resources with non-permanent consequences.
- Miners are also discouraged from deploying hashrates approaching 50% of the network strength as this brings about fear in the community that the network may be manipulated, which would likely devalue bitcoin as a cryptocurrency. This deters human greed and ensures fairness in distribution and looks after the health of the bitcoin network.
- Bitcoin mining was first carried out with CPU, and then later on with GPU, FPGA and ASIC miners.
- Pool mining was implemented to increase the chances and likelihood of each miner to earn mining rewards on a more regular basis.
- Bitcoin mining may or may not always be profitable, and is dependent on a number of factors such as mining hardware efficiency, access to cheap electricity, operating overheads, and the price of bitcoin.
- Bitcoin mining helps to keep the bitcoin network stable, safe and secure, and is an integral and fundamental process for Bitcoin to function in the real world.
Bitcoin Supply Parameters
- There will only ever be 21 million bitcoin in existence by the year 2140 when all bitcoin have been completely mined. This establishes a known finite total supply.
- The block mining reward halves at every 210,000th block, which is roughly every 4 years. This creates a predictable diminishing rate of supply
- The mining difficulty adjusts itself after every 2,016 blocks, which is roughly every 2 weeks. This helps to maintain a steady consistent rate of supply.
External Articles for further reading:
- Forbes: Nixon’s Colossal Monetary Error: The Verdict 40 Years Later
- Wikipedia: Hyperinflation in the Weimar Republic
- Economics Help: Hyperinflation in Zimbabwe
- Forbes: Why Venezuela’s Hyperinflation Problem Is So Difficult To Solve
- BBC News: Argentina – The Crisis in Six Charts
- International Business Times: What Greece can learn from bitcoin adoption in Latin America
- Financial Post: Greece in limbo as it shuts banks, puts limits on cash withdrawals to avoid financial collapse