Bitcoin is a highly valuable network and needs to be protected as such.
This protection isn’t free though…
That’s where block rewards come in.
Put simply, block rewards are a payment to the people who keep the Bitcoin network secure. Thus block rewards are a critically important part of Bitcoin and just another one of Satoshi’s prescient inventions.
In this article, we’ll dig into how block rewards work, how they dictate the economic policies of Bitcoin and how the size of the block reward can directly affect the security of the Bitcoin network.
Some people have called Bitcoin the largest computer network in the world, owing to its miners. A miner (commonly called an ASIC) is a specialized computer that resembles a black brick, has a fan on the back and generates a surprising amount of noise and heat.
Recent estimates suggest that there is more than one million ASIC machines mining Bitcoin. At a rough average of $2,000 per machine (cutting edge models can cost more), that’s a lower bound estimate of $2,000,000,000 invested in Bitcoin mining. That investment was not made out of altruism.
The way Bitcoin’s security model works, all of these million-plus ASIC machines are trying to solve a difficult math problem. The single ASIC machine that solves the problem correctly is gifted the block reward.
Currently, that rewards stands at 12.5 BTC, however, in May of 2020, the reward will be cut in half to 6.25 Bitcoin. Hence the Bitcoin term: the halvening.
How does Bitcoin secure itself by paying a bunch of computers to do difficult math? The answer is surprisingly simple. In order for a bad actor to hijack or defraud the Bitcoin network, they would need to control more than half of all ASICs currently mining Bitcoin.
This would be expensive ($1 billion in hardware costs is probably a gross underestimate) and difficult from the supply chain side as it’s not possible to simply go out and buy half a million ASICs at one time.
Thus Bitcoin is secured by a large network of benevolent ASICs doing complicated math in order to get the block reward making the network very difficult to 51% attack.
As mentioned, every four years the block reward gets cut in half in an event known as the halvening. Historically the halvening has marked the start of a new bull market, although prices often don’t reach old all-time highs until six months to a year after the halvening.
Although many people cheer the halvening as a bullish event there are security concerns that cannot be dismissed. Once the halvening happens Bitcoin miners experience a 50% decline in profits in a matter of ten minutes.
There is perhaps no other industry in the world where profits get cut in half in less time than it takes to wash the dinnertime dishes. The concern is that as profits decrease miners will go out of business, the Bitcoin network will be weakened and it will become affordable to attack it.
Historically this problem has been mitigated by the price appreciation. If the block reward is cut in half, but the price of Bitcoin doubles, then profits remain the same.
If the price of Bitcoin appreciates significantly, as it tends to do after halvenings, then mining profits can be great even if the block reward has been cut in half. However, if the Bitcoin price stagnates even after the block reward gets cut then there may be serious concerns about the security of the Bitcoin network.
As with anything it doesn’t pay to panic. Even if prices don’t appreciate after the halvening and some miners go out of business, it hardly spells the end of the Bitcoin network. However, at the same time, it’s prudent to pay attention to the mining industry and the health of the network.
People start using Bitcoin for different reasons. Some like the fact that they can send an international payment in just 1 hour and for a small fraction of the fee charged by banks and remittance companies.
Other people like that they can hold Bitcoin and no government can take their money, as has happened in Argentina for instance. Still others like Bitcoin because of its deflationary nature. When speaking of Bitcoin’s deflation model it’s important to first expose the weakness of traditional, fiat currencies.
Fiat currencies, under the control of central banks, can be printed at will. It is only societal norms, values, laws, expectations, etc. That controls the printing of money.
There is no hard and fast restriction like there is with gold. No matter how much demand there is for gold, no matter how high the price goes, only so much can be mined at any one time.
On the other hand, if a government wants to print fiat there is nothing stopping them. Governments abuse this privilege and the result is hyperinflation which we can see examples of in countries like Zimbabwe, Argentina, Venezuela, etc.
Bitcoin is different in that the block reward is hardcoded and cannot be changed on a whim. Every four years the inflation rate of Bitcoin gets cut in half, no matter whether the economy is soaring or tanking.
No matter how many people demand that more Bitcoin gets mined, the block reward remains unchanged and a predictable amount of Bitcoin is created every ten minutes.
This is a very attractive feature of Bitcoin especially for investors who have watched their life savings get inflated away. For those interested in the implications of a deflationary currency Plan B has a great stock to flow (S2F) model.
The Bitcoin block reward is a payment to the ASIC miners who secure the Bitcoin network. It also represents the inflation rate for the Bitcoin network and that the inflation rate gets cut in half every four years.
When people compare Bitcoin to digital gold they are often drawing the comparison between gold’s inflation rate and the inflation rate of Bitcoin, which are both low and cannot be altered by the whims of bankers or the government.