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7 days ago

Block reward: One of Bitcoin’s most ingenious features

The block reward is one of the important features that serves more than one purpose. It is crucial to understand its relevance, not only for the sake of understanding Bitcoin’s technology but also its value.

When you try to create a currency controlled by no single entity, you have to solve many problems. One of the most pressing issues is the trust problem. Why should you trust that there are only 21 Million BTC are ever coming into existence? Why should you trust that your transaction will be forwarded and confirmed correctly by the network?

The block reward is part of the answer to this question. In today’s article, we will dig a little deeper into why this particular feature is working so well, even though other cryptocurrencies suggest different consensus models than proof of work.

The block reward is a strong incentive

Miners have an important role in Bitcoin’s network. Basically, they are trying to solve a cryptographic puzzle. While the miners are relentlessly searching for the correct hash of the next block, they have to use a lot of energy and provide hardware for the computation.

This process comes at a high cost. Therefore, nobody is interested in spamming the network with fake blocks. It would simply cost too much money. But how to create an incentive to pay the costs of mining?

Simple: each miner is rewarded with freshly minted BTC if – and only if – he successfully hashes the next block and adds it to the chain. Hence the name blockchain. These chained blocks can be verified by every node in the network. If a miner tries to add a block with an incorrect hash, the network will reject it. A perfect balance is created between the miners’ best interest and the best interest of all other network participants.

This system represents game theory at its best. Play fair, and you’ll get rewarded. Try to cheat, and you lose your investment, which is your electricity bill plus the opportunity costs during the time your hardware was busy doing something that is not rewarded.

A decentralised monetary policy

But it gets even better: the block reward is also part of Bitcoins monetary policy. Each minted BTC creates inflation. In the beginning, the block reward was 50 BTC per block. Bitcoins protocol dictates the reward is cut in half every 210,000 blocks. Every 10 minutes, a new block is created, so it takes about four years for a halving to occur.

The current block reward is 6,25 BTC per block, and the last halving occurred in May 2020. With the block reward reduced, the inflation gets thinner over time. Once 20.999.999,97690000 BTC are created this way, there will be no new BTC minted. It is estimated that the world is going to witness the final stage in the year 2140. From that point forward, the miners have to live purely on the transaction fees spent separately by people sending transactions in the network.

So, in terms of the monetary policy, the block reward provides two things:

  1. It ensures a fixed supply
  2. It controls and reduces inflation over time

All this is part of a decentralised system governed and enforced by a protocol instead of a central bank or a parliament.

Different approaches

The above explanation is valid for Bitcoin and a couple of other cryptocurrencies based on Bitcoin’s code. But there are still other ways to incentivise the miners and secure a network and its transactions.

Ethereum is a prevalent example. Until the final release of Ethereum 2.0, it is based on proof of work, and it provides block rewards to its miners. The trick is that Ethereum has no supply cap, and therefore it is hypothetically possible to create an infinite amount of Ether. So, in this case, the block reward controls inflation but does not ensure a fixed total supply. You can read all about Ethereum 2.0, here.

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