Bitcoin Mining: A Fair Distribution Mechanism

"Knowledge of Mining" is a mining science column for novice users of Zhikuang University. This column will start from the most basic knowledge particles, from shallow to deep, step by step, so that you can systematically and deeply understand the relevant knowledge of Bitcoin mining.

Today, we will introduce the birth of Bitcoin and the issuance mechanism of Bitcoin.

01
The Birth of Bitcoin

Bitcoin is a cryptocurrency invented by Satoshi Nakamoto, and the first block of Bitcoin was also mined by Satoshi Nakamoto. Satoshi Nakamoto is both the inventor of Bitcoin and the earliest miner of Bitcoin.

There are two landmark events in the birth of Bitcoin: one is the release of the Bitcoin white paper, and the other is the mining of the Bitcoin genesis block.

On November 1, 2008, Satoshi Nakamoto posted the link to the Bitcoin white paper on the Cypherpunk mailing group;

On January 3, 2009, the Bitcoin Genesis Block was mined on a small server in Helsinki, Finland, marking the official operation of the Bitcoin network. The period from the release of the white paper to the mining of the Genesis Block is figuratively compared to the ten-month gestation of Bitcoin, and the mining of the Genesis Block is likened to the birth of Bitcoin.

The reason why Satoshi Nakamoto created Bitcoin can be seen from the words engraved on the Genesis Block. Satoshi Nakamoto engraved the front-page headline of the Times of the day: "The Times 03/Jan/2009, Chancellor on brink of second bailout for banks" on the Genesis Block of Bitcoin, implying that the excessive issuance of currency and unreasonable monetary policies by governments were the root causes of the global economic crisis at the time.

Against the backdrop of the global financial crisis, Satoshi Nakamoto created Bitcoin, launching a social experiment with enormous impact.

02
What is the difference between Bitcoin and fiat currency?

The biggest differences between Bitcoin and the legal currencies of various countries are mainly reflected in the following points:

There is no upper limit on the total amount of legal tender issued, but the total amount of Bitcoin issued is fixed, which is about 21 million.

Fiat currency is accounted for by a centralized organization, the bank, while the people involved in Bitcoin accounting are a distributed group of miners;

The use of legal tender is strictly regulated by governments, while Bitcoin, which uses distributed ledgers, can circulate more freely as long as there is a network.

…

Let’s take the example of money transfer to compare the difference between fiat currency and Bitcoin:

If you transfer 100 yuan from your bank account to Zhang San, your bank account will decrease by 100 yuan, and Zhang San's account will increase by 100 yuan. This accounting process is completed by the bank.

The same scenario happens with Bitcoin, but the accounting method is different. If you transfer 1 BTC to Zhang San's "Bitcoin account", your "Bitcoin account" will decrease by 1 BTC, and Zhang San's "Bitcoin account" will increase by 1 BTC. This accounting process is completed by distributed miners, and it is uncertain in advance which miner will record this transfer.

Why is this so? This starts with the issuance and incentive of Bitcoin, that is, the mining mechanism.

03
Bitcoin issuance and mining

Fiat currency is issued in the form of debt. Whoever has more debt can enjoy more fiat currency issuance bonuses. This is not a fair distribution method. What is the issuance method of Bitcoin? Can it guarantee the fairness of issuance?

Satoshi Nakamoto designed a total of 21 million bitcoins. How to distribute these bitcoins fairly? How to motivate people to participate in the accounting of the Bitcoin system? How does the distributed accounting method ensure the consistency of the ledger? These seem to be problems. The genius Satoshi Nakamoto designed a very clever solution to solve these problems.

1. Mining: A fair game of "coin tossing"

To obtain Bitcoin, you must participate in mining. What is mining? Mining is to continuously perform hash operations to find answers that meet the requirements of the Bitcoin system. Whoever finds the answer that meets the requirements first will mine a new block and receive the corresponding Bitcoin reward. This process is called mining. The Bitcoin system will automatically adjust the mining difficulty at regular intervals based on the computing power of all participants.

The mining process can be simply understood as a fair game of coin tossing:

Each time 256 coins are tossed, whoever is the first to toss the first N coins to land on heads will receive the corresponding game reward. The game will adjust the difficulty according to the number of participants. If there are fewer players, the difficulty will be lower, that is, the number of coins that land on heads will be lower; if there are more players, the difficulty will be higher, that is, the number of coins that land on heads will be higher, so as to maintain the average game time of 10 minutes per round.

This mining process, similar to the "coin tossing" game, solves three problems:

1) How to distribute Bitcoin fairly. Mining requires mining machines. The more mining machines there are, the better the performance, the faster the calculation speed per unit time, and the greater the probability of obtaining Bitcoin rewards. This is what people often call the proof of work mechanism (PoW). The more work you put in, the more rewards you get. In addition, Bitcoin mining does not require permission, and anyone has the freedom to participate in and exit mining, which also reflects the fairness of Bitcoin mining.

2) How to motivate miners: Mining can get Bitcoin rewards, so miners are motivated to mine.

3) The accounting rights are clarified to ensure the consistency of accounting information of all miners. Whoever mines a new block first will obtain the accounting rights of this block, and other miners will synchronize the accounts recorded by the miner, which ensures the consistency of the ledger and facilitates reconciliation and checking. If they can get system rewards by mining new blocks, why are miners still willing to keep accounts? This is exactly the question to be discussed below.

2. Effective mechanisms to continuously incentivize miners: halving rewards and transaction fees

When miners mine new blocks, they receive two rewards: one is the block reward given by the system, and the other is the transaction fee for packaging transactions, commonly known as the miner's fee. The miner's fee is not only to motivate miners to keep accounts, but it is also closely related to the Bitcoin halving mechanism and the total issuance, and even to the life of Bitcoin.

The Bitcoin system reward is variable. Initially, each new block mined received a 50 BTC system reward (also called a block reward). After every 210,000 blocks, the system reward was halved until the smallest indivisible unit of Bitcoin, "Satoshi" (100 million Satoshi = 1BTC), was reached, and all Bitcoins were distributed.

According to the halving rule, all 21 million (the exact number is 20999999.9769) bitcoins will be mined by 2140. The halving rule and the smallest divisible unit of bitcoin determine the total amount of bitcoin.

▲Bitcoin halving cycle and total issuance

The Bitcoin block reward is halved, which means that the system reward has less and less incentive for miners. After 2140, when all Bitcoins have been distributed, how can miners be motivated to continue mining? The answer is transfer fees.

As in the previous example, if you transfer 1 BTC to Zhang San, the process requires miners to keep accounts, and you need to pay the miners a fee, commonly known as the miner's fee. With the development of Bitcoin, the number of Bitcoin users continues to increase, and the number of transactions on the chain gradually increases. Transaction fees will also continue to grow, replacing block rewards and becoming the main source of income for miners. Transaction fees have become an effective mechanism to continuously motivate miners.

Readers who have some knowledge of Bitcoin should know that the current upper limit of Bitcoin blocks is only 1M. Based on the average transaction size of 250B per transaction, a block can record more than 4,000 transfers at most.

As the block reward continues to halve, can Bitcoin, which maintains a 1M block limit, continue to develop healthily? We will leave this question for later discussion in subsequent articles.