BTC is backed by the most precious resource of all. Time.
In Bitcoin, we refer to those that validate transactions and create bitcoin as ‘miners’. It’s just a convenient way of thinking about finding a limited resource in a familiar way. Think of the traditional gold miner, who performs an immense amount of physical work using heavy industrial equipment to find gold. In Blockchain and cryptocurrency, “miners” rely on computers and code as tools, and use electricity as the fuel, or cost to mine.
Bitcoin Mining rigs at a Data Center facility in Milwaukee, WI
While mining is a group effort, it is competitive in nature. The miner who solves a complex cryptographic puzzle first, announces to the rest of the network “I found it!” and is rewarded. The laws of mathematics and probability suggest that the amount of computational power is so massive and so time consuming, that in order to find the solution, the statistical chance is so small that it should be rewarded. In physics, power is the rate of doing work, the amount of energy transferred per unit of time. It is fitting, then, that we call this process “PROOF OF WORK”.
Miners “take all the transactions that recently occurred, the identifier of the previous block, and a “nonce”, a random number so that when we mash all this data together, we get a value guaranteed to be smaller than a target. The smaller the number, the more difficult it is to find. Find it, and you’ll be rewarded with a certain number of bitcoin.” That’s it. Sounds easy, right? Well, it’s actually so difficult to find, that it requires billions and billions of guesses, using a ton of computational power. As of today, it actually costs over $1,000 in electricity to create a single bitcoin. Therefore, the value of the bitcoins that are mined must be implicitly higher in order for it to be profitable to the mining community. In the market, bitcoin is now over $8,000. At one point, bitcoin was worth far less, and the cost of production was just a few dollars of electricity, when there was much less competition in the mining space, and the market demand for transacting with bitcoin was much smaller.
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This work is expensive and time intensive. In 2009, the MINER REWARD was 50 bitcoin per block, which means 50 bitcoin came into existence about every 10 minutes. The reward reduces by half, just about every 4 years. So in 2015, the reward was 25 BTC per 10 minutes, and now it is 12.5BTC every 10 minutes. As part of the bitcoin software — it’s built in to self-adjust the difficulty of the puzzle about once every two weeks to account for more mining hardware. You see without this adjustment, the more miners there are, the faster a block could be solved, and if there weren’t enough miners, the difficulty of the puzzle would have to be adjusted to make sure the platform to could be relied upon as an effective network. Therefore, the value of bitcoin is a function of the number of users and transactions that take place. As the demand grows, the value of bitcoin grows.
Ok — you might think… holy cow! Why don’t we just “pre-mine?” Let’s just do all the work ahead of time to find all the random numbers that generate that magic value with 30, 40, 50 zeros? That’s the beauty of it. You can’t. The system was designed so that we cannot calculate up front what we must send into the hash function to get a specific output for this unique set of transactions. The amount of computational power required is over 1.5million terahashes per second — which is more powerful than the top 500 supercomputers combined.
Once a solution is found, the miner rewards himself by assigning the new value of available bitcoin to his own address as unspent transaction outputs, UTXO, thereby ‘mining’ new Bitcoin. The solution to the puzzle is quite easily verified by the other nodes on the network, and the block is added to the permanent blockchain. Think of any really hard math problem to find the value of X on a test in school. It takes a lot of brainpower to find the solution, but easy to plug in and see if it works.
Image source: https://www.buybitcoinssell.com/bitcoin-mining-how-does-mining-works/
Immediately afterwards, the process is repeated with new transactions that have been queuing up, a “hash” of the previous block is used, and a brand new puzzle begins. As more blocks are added to the chain, we gain more and more confirmations that the recorded history is the golden standard of a true representation of past events. The fact that each puzzle solved also refers to the block before it, this makes it immutable.
If a devious miner tried to fool the network about transactions in a single block, it would have to work faster than the computational power of the rest of the network combined in order to keep up with modifying the next blocks, and the next blocks. This is mathematically and financially infeasible.
The blockchain and the value of bitcoin are backed by the laws of math and the most precious resource of all: TIME itself.
For a technical example that demonstrates how Proof-of-Work could be implemented, check out this video from “Simply Explained”.
Dan Emmons is owner of Emmonspired LLC, a Certified Bitcoin Professional, Certified Ethereum Developer, Full Stack Developer and Advisor on Cryptocurrency projects. He is also the creator of a Youtube Channel and iTunes Podcast called #ByteSizeBlockchain.