Video - Bitcoin - The Money Supply

The mechanisms by which the supply of bitcoins is controlled. The difficulty increases automatically every two weeks, in correspondence with the amount of computational power that is being used to mine. It increases in such a way that each transaction block (challenge) on average takes approximately 10 minutes to solve.


In the last video, I talked about how Bitcoin transactions are really incorporated into a global and a publicly accessible ledger of sorts that we called the transaction block chain.  And this work is actually carried out by nodes in the Bitcoin network that are known as Bitcoin miners.  And as a reward for all that effort, especially since some of the competition of heavy lifting is done by these Bitcoin miners.  They're basically awarded a certain number of Bitcoins for their efforts.  And this happens by the miners effectively constructing what's called a coin base transaction and then basically assigned themselves Bitcoins within that transaction.
So in a sense then, and this is kind of intriguing Bitcoins are effectively generated almost out of thin air during this process.  And of course, if you see something like that that might raise in your mind, the question of whether there is ever an upper limit to the Bitcoin money supplied.  Fortunately, the answer or maybe not so fortunately depending on your viewpoint, the answer that question is actually yes.  And the Bitcoin system is actually designed so that there can be at most 21 million Bitcoins ever generated, okay.  So that the maximum number of Bitcoins ever, that can ever come up in the system.  Beyond that point no more new Bitcoins will ever be accepted or generated or allowed to be generated.  And so as a result, nodes at that point or from that point onward, once 21 million Bitcoins have been generated, nodes will no longer get a reward for augmenting the transaction block chain, okay.  The Bitcoin miners who do all this effort are not going to get a guaranteed award for doing that effort.  And keep in mind that because every transaction in the Bitcoin system is public and the nodes in the system actually know how many coins have been generated, it's possible to really enforce these limits on the total number of Bitcoins created.
Now, there are actually two points I want to make regarding this particular limit.  So first of all, even after it's reached, you know, we're still going to need nodes to do what Bitcoin mining nodes you today.  So that involves things like incorporating transactions into transaction blocks and incorporating these transaction blocks into transaction block chains and so on and so forth.  But if you think about it for a moment, once the 21 million coin limit is reached these nodes don't get that automatic reward of Bitcoins for performing this extra effort.  And now you might be wondering well, what incentive is there for these nodes to engage in this additional effort and why are they doing this sort of thing if they're not going to get Bitcoins as a guarantee for doing that work.  And really at this point, the hope is that when we reach a 21 million Bitcoin limit or as we get closer and closer to it, that actually transaction fees will play a more prominent role in a nodes decision to be a Bitcoin mining node and in particular the idea here is that we hope the transaction fees will be enough of an incentive and more and more people will, in general, I think hopefully about this point we'll be using Bitcoin and so as a result, I think there is an expectation or it's not unreasonable to think that as more and more people use Bitcoins there will be more and more transactions and as a result more and more opportunity to make money of a transaction fees.
And it turns out that in the context of Bitcoin mining a lot of the heavy lifting is in this proof of work piece not in being able to incorporate all these transactions into a transaction block.  So even if there is a lot of transaction in the transaction block, if not that much more effort for the miners to really incorporate those extra transactions but if they're getting all this extra transaction fees then that might be a good incentive for them, okay.  It's also worth noting that transaction fees are actually set by the payer in Bitcoin, okay.  The payer then is going to have the onus of setting the fee appropriately so that the nodes in the Bitcoin network are incentivized at that pairs transactions to their transaction blocks, all right.  So hopefully that makes some sense.
The second point I want to make regarding this limit of 21 million Bitcoins is that really Bitcoin does allow for fractional coins and I haven't really talked much about that in these videos as I've really kind of inclusively talked only about the idea of coins being these whole entities like Alice transferring 10 coins to Bob or 25 coins to Bob and so on.  But it turns out that you can actually have coins that are fractional, okay.  And in fact, the smallest possible unit in Bitcoin, it's a very small number, it's 0.00000001 Bitcoins, okay.  And this is one hundred millionth of a Bitcoin.  And this actually, this unit by the way just as an FYI, is known as a Satoshi.  And this name actually come from the name Satoshi Nakamoto.  And Satoshi Nakamoto is the pseudonym of the inventor of Bitcoin.  Nobody actually is sure that there is somebody actually named Satoshi Nakamoto but as far as anybody can tell the only person who's ever taken credit for the invention of Bitcoin is this Satoshi Nakamoto name and it's unlikely there isn't actually a person behind that name but it's more likely maybe some type of a group or something of that nature, okay.
Now, aside from that there are actually a couple of other additional controls that I want to mention, that are built into Bitcoin for keeping the growth of that money supply in check.  So first of all, the reward provided to Bitcoin miners, actually decreases overtime, okay.  And if you were aware of when Bitcoin began which was around January of 2009, at that time the reward for a Bitcoin miner, to do their effort was 50 Bitcoins, okay.  Now the way that the reward structure is set up is that every 210,000 blocks so when you get to a 210,000 block period that we attempt 210.000 new blocks are generated, the reward size actually gets cut in half, okay.  And so what that means is that once 210,000 are generated where it goes from 50 Bitcoins to 25 Bitcoins and from 25 to 12.5 and so on and so forth, all right.
Now, it does take approximately four years to generate210,000 blocks and I'll talk a little bit later about where this four years numbers come from.  But as of right now I'm recording this video, it's May 2013, the current award is actually no longer 50 Bitcoins the current award now is actually 25 Bitcoins per mining operation and it's going to go down and half in approximately four years and that's just going to keep happening until the estimate is around the year 2140.  So in the year 2140, we will expect that the entire Bitcoin supply will have been generated, okay.  So we're not going to, it's unlikely we'll be generating Bitcoins after 2140, 2140 is the point in which are all Bitcoins will have been generated, okay, all Bitcoins will have been generated.
Now, the last way to limit the generation of Bitcoins is to actually calibrate the difficulty of solving that proof of work protocol at a global level, okay.  And so I also want to point out that another functionality that Bitcoin has built into it is that for every 2016 blocks that are generated, the network basically estimates the time that it took to generate those blocks.  It looks like, you know, how long did it take to join the first of these blocks and how long it will take to generate the last of these blocks and it measures that amount of time.  Now, if that amount of time is, let's say it's -- I don't know, let's say it's something that significantly, let's says, it's significantly bigger than two weeks, okay.  So if it's significantly bigger than two weeks then the proof of work protocol would be simplified, okay.  But when it calibrated to that's easier to generate the blocks.
On the flip side, let's say it took a lot less than two weeks to generate these 2016 blocks.  In that case, the proof of work will be again calibrated to be made more difficult, okay.  And the goal is that we want it to be the case that of 2016 blocks, we want to be the case it takes about two weeks to generate these blocks about 14 days to generate 2016 blocks, okay.  And to get a better sense for why that number is the way it is.  You could see that let's say it takes about two weeks to generate 2016 blocks.  Would that actually will implies that it takes about 10 minutes before the proof of work is actually solved and a new transaction is -- our new transaction block rather is folded into the overall transaction block chain and you can actually work out that if you -- if it took 10 minutes to validate or to come up with one new block in the system at a global level and you multiply that by obviously, by six to get the number of blocks generated per hour so you get six blocks per hour or really six new proofs of work per hour which in turn would lead to six new transaction blocks per hour.  You multiply that by 24 hours per day and then you multiply that by 14 days and you'll actually find that when you multiply these things together, you will get the number 2016, okay.  And so you can get a sense of where this number comes from.
And I want to make one last final clarifying remark regarding this proof of work.  Since, solving the proof of work actually requires a Bitcoin mining node to come up with the proof string, which it currently does through some type of exhaustive search.  As you increase the number of Bitcoin mining nodes on the network, that really all those being equal the proof of work will be solved faster okay.  I don't mean faster for a particular node, I mean, faster at the level of the entire network.  In other words, it will take less time before at least one node comes up with a solution because these nodes are all working on that same problem concurrently.  And actually on that note, I do also want to mention quickly maybe a more subtle point which is that even though the different Bitcoin mining nodes are all validating either the exact same set of transactions or maybe a largely overlapping set of transactions, actually they're all solving entirely different proof of our protocols when they're doing this sort of thing and the reason for that is that, each node remember inserts its own coin base or generational transaction into the block that it's working on to award itself points, okay.  And this generational or coin base transaction is actually unique to each node.
So as a result, the challenge string for which let's say each Bitcoin mining node is seeking the corresponding proof of work, well that challenged will be different for each Bitcoin, no, each Bitcoin mining note rather.  And so essentially what you have is that because you have a cryptographic hash function it's being used in the process just this one difference, that the fact that this is one piece is different that actually completely randomizes the proof of work problem that results and that makes it likely that across the entire network, the solutions are likely to be widely distributed and we can expect that if we have enough nodes one node will come up with a solution in about 10 minutes okay, at least one of the nodes will, they won't all do it but at least one will and once one node comes up with a solution everyone else can kind of proceed from that point onward with the new chain.
So as you can see the Bitcoin protocol, you know, it takes a number of measures implement a number of mechanisms to both limit the total number of Bitcoins as well as the rate at which this Bitcoins are ultimately generated.
Written by Zulfikar Ramzan on May 1, 2013.