In this article, you will understand how new currencies are created and the operation of this parallel market that moves billions of dollars every day!
Bitcoin: A Peer-to-Peer Electronic Money System
In free translation, this was the title given by Satoshi Nakamoto to the Bitcoin whitepaper .
This document is a summary of the network model and how it works. Composed of summary, conclusion and 12 chapters. However, Bitcoin did not start with the full supply available. Currently, as of April 2022, we have just over 19 million BTC in circulation. But after all, how are these tokens created?
First, it is necessary to understand how transactions work on the network.
One of Satoshi Nakamoto’s main challenges was solving the problem of double spending (the use of the same currency for two different transactions). However, the use of blockchain technology was the solution found.
As stated in the whitepaper: “The only way to confirm the absence of a transaction is to be aware of all transactions. In the mint-based model, the mint is aware of all transactions and decides which one came first. To achieve this goal without a relying party, transactions must be publicly announced, and we need a system for participants to agree in a single history the order in which they were received. The drawer needs proof that, at the time of each transaction, the majority of nodes agree that it is being received for the first time.”
To reach the goal, the hash system was used, which works like a fingerprint. Therefore, an identifier hash is used that is constructed for each block. But this hash takes into account the data of the current and previous block for its creation.
In addition, the use of this hash system guarantees the greatest integrity of the network. For example, if any data in a block is changed, its hash will be modified and will no longer be recognized by the network. Since the blocks succeed it cannot validate the block because it has a different hash.
However, so far we have been talking about network transactions and blocks, but where does mining come in?
The creation of blocks and validation of hashes, which allow transactions to take place safely, are performed by devices that provide computational power to the network. That process is mining. Mining, in real-world analogy, is the process of using resources to obtain a reward that has a finite availability.
The use of computational resources is what resembles, for example, the use of excavation machines in gold mining.
What is a miner and what does he do?
The Bitcoin miner is the one who makes his computational resources available on the network for creating new blocks and validating transactions.
In a transfer, there must be at least one party that validates it. In the case of Bitcoin, there is no central entity like a Central Bank or payment processor. As the network is decentralized, the network nodes act as validators.
These nodes are computational resources allocated to perform the operations required by the Bitcoin network.
To keep the network working properly, most of the nodes remain turned on and connected 24 hours a day, participating in the process.
There are several mining systems. Proof of Work, used by Bitcoin, consists of a system where the central idea is to avoid cyber attacks and spam. It works, as explained earlier, through the effort of CPUs to perform tasks (mathematical calculations) and receive rewards. Bitcoin uses proof of work – hash cash, where powerful computers are used that result in greater processing capacity.
Key mining metrics
The computational power used during the Bitcoin mining process is identified by the Hashrate indicator. Its unit of measurement is hash/second. This means the amount of mathematical calculations that are processed per second on the Bitcoin network.
Another important indicator is the mining difficulty. It shows the complexity of the calculations that need to be solved. The greater the mining difficulty, the greater the computational power required by the network. Mining difficulty is automatically adjusted every 2016 blocks (approximately 14 days) based on the performance of miners.
These indicators fall within a category that is called “on-chain data” or “network data”. They are of great importance and are differential in well-done analyses. In Vector Pro, these indicators and various other on-chain data are available.
By allocating computational and energy resources to perform mining, what is the expected return?
When validating a transaction, solving mathematical equations faster than the other participants, the miner receives a value for the mined block and transaction fees. Currently, as of April 2022, the reward per validated block is 6.25 Bitcoins. That is, every 10 minutes 6.25 BTC are generated.
The amount of BTC generated in each block decreases in a process known as Halving. Thus, after all 21 million Bitcoins are mined, the miners’ remuneration will come from transaction fees.
Halving is a mechanism that was created with the aim of removing the inflationary component from fiat currencies. Thus making Bitcoin less inflationary.
With a limited stash of 21 million Bitcoins and a reward per mined block, where does this account go?
In the Genesis block, which was generated on January 3, 2009, the reward was 50 BTC. And with the advent of Halving, that amount is now 6.25 BTC.
In other words, Halving consists of a halving of the reward every 4 years. For example, at the beginning there were 50 BTCs, after 4 years (2012) 25 BTCs, after another 4 years (2016) 12.5 BTCs and so on until the issuance of 21 million Bitcoins, scheduled for the year 2148.
In addition, another factor in addition to having limited stock is that with the reduction in the amount of Bitcoins released with each block generated, a feeling of scarcity is generated, causing greater appreciation. As with the very law of supply and demand.