The next Bitcoin halving is less than 500 days away, and the Internet at large is speculating about its impact on the price, miners, and so forth. But to understand why this event is so crucial for the overall performance of the world’s largest cryptocurrency, there are quite a few things to be aware of, especially when it comes to Bitcoin mining and the way the network functions.
Bitcoin Mining: Abstract
Even though they are seemingly distinct, you can identify similarities between Bitcoin mining and mining precious metals like gold, for instance. Both of those activities are carried out to earn a reward.
Furthermore, both processes are energy intensive. In gold mining, it’s a matter of a physical use of energy through machines and manpower to excavate the gold from the ground. However, with Bitcoin mining, the energy is mostly electricity, which is used to solve complex and difficult computational puzzles.
How Does it Work?
Mining is the beating heart of the Bitcoin network. Miners are the ones who replace centralized entities like banks, and they maintain the payment network. Without them the network could not be secured and accountable. The reward is the way miners are incentivized for their necessary actions.
When a person with a Bitcoin wallet decides to transfer Bitcoin from his wallet’s Bitcoin address to some other wallet’s address, he has to create a transaction and sign it using his private and public key and broadcast this signature transaction to the Bitcoin network. Eventually, the goal is to add this new transaction to one of the next Blocks that will be added to the Bitcoin blockchain.
The job of miners is to pick up those transactions and encapsulate them into a list of transactions which make up a Block. In this process, the miner needs to verify each transaction they add and make sure there is no double spending.
Next, the miner needs to broadcast the new Block he just created to the network. If the miner succeeds in doing so before any of the other miners, he will be rewarded with a fixed amount of new BTC that will be reflected in his Bitcoin address. To do so, the miner will have to perform the second part of the mining process – solving a complex computational mathematical puzzle.
Simply put, the miner will have to come up with a certain 64-digit hexadecimal number which is called a nonce. This nonce will have to have a unique mathematics characteristic when calculating a particular function called a hash function. A hash function is a mathematical function that takes as an input an arbitrary amount of data and outputs a fixed-sized number. There is no real way to predict the output of the Hash function other than calculating the function.
In this case, the hash function will take as an input the block’s data which includes all the transactions, the block’s metadata, and the nonce. The goal is to find a certain nonce that when it is assigned as an input to the hash function together with the other inputs will output a number which is lower than a certain threshold.
The catch is that the only way to find this nonce number is to guess. Therefore, miners are required to guess an enormous amount of numbers until they find the right one which fits the requirements. So, miners who have a larger amount or more efficient computational power will be able to guess faster and therefore, increase the possibility of them solving the puzzle first. The number of “guesses” that the computer produces per second is referred to as the “hash rate.”
Each time a computer comes up with the right 64-digit number, a new Block is broadcast to the network. The moment this happens, the miner is rewarded with the so-called Block reward. This is nothing but a pre-determined amount of Bitcoin. Currently, the Block reward is 12.5 BTC per block. Apart from acting as an incentive mechanism, the Block reward also operates as an inflation mechanism which adds new Bitcoins to the market. The current state of the network produces one Block roughly every 10 minutes, meaning that, there are about 1,800 new Bitcoins mined every day.
That’s not the only source of profit for miners, though. As we mentioned above, miners keep the state of the network secure as they also confirm its transactions. For this, they get paid in transaction fees. Each day, depending on the network conditions, there are hundreds, if not thousands of Bitcoins paid in transaction fees.
What is Bitcoin Halving?
Back to our central question.
As you probably know, the amount of Bitcoins that will ever exist is capped at 21,000,000. As soon as the last one of these is mined, there will be no new Bitcoins added to the network.
As we already know, new Bitcoins are produced as miners solve complex math problems and receive them as Block rewards. The amount of Bitcoin rewarded to the miner for solving the problem, however, hasn’t always been the same.
See, unlike today, the Block reward was initially set to 50 BTC per Block. In other words, during…