One of the key features of Bitcoin is its ability to prevent monopoly seigniorage, a situation where a single entity profits from introducing new currency. Traditional monetary systems, governed centrally, frequently encounter difficulties such as monetary inflation and economic instability stemming from unregulated money printing. Bitcoin, in its deliberate architecture, thwarts any attempt by a singular entity to monopolize the initiation of new coins, thereby contributing to the establishment of a more stable and transparent monetary framework.
This defense against monopoly seigniorage operates through the mechanism known as difficulty-adjusted proof of work.
Proof of Work
The Bitcoin blockchain serves as a decentralized ledger, meticulously recording all transactions since its inception in 2009. To ensure decentralized transaction sequencing and prevent double spending, miners employ specialized hardware, expending energy to verifiably demonstrate the passage of time. Incentivized by newly minted bitcoins and transaction fees, miners invest in this energy-intensive process, and the network’s programmed issuance rate gradually reduces over more than 100 years, halving approximately every four years.
Enter Moore’s Law, a 1965 prediction by Gordon Moore forecasting the doubling of transistors on a microchip approximately every two years, resulting in exponential growth in computing power. This prediction, largely proven true, has been a catalyst for technological innovation, providing a framework for anticipating and planning for future advancements.
But how does Bitcoin ensure that a miner with substantial computing power doesn’t dominate the coin issuance process?
The Bitcoin network aims to create a new block roughly every 10 minutes. Adapting to increasing computational power, a bi-weekly process known as difficulty adjustment takes place. Participants evaluate whether the last 2016 blocks were produced more slowly or quickly than the targeted 10-minute block time. If slower, the difficulty decreases; if quicker, it increases.
How Bitcoin disperses seignorage
From a miner’s perspective, an upward adjustment significantly impacts their rewards: When the Bitcoin network undergoes an upward adjustment in difficulty, it has a direct and substantial impact on the rewards earned by miners. This higher difficulty level makes it more challenging for miners to successfully mine a block, and, as a result, their chances of successfully adding a block to the blockchain decrease. This reduction in successful mining efforts leads to a smaller share of newly issued bitcoins and fewer transaction fees being earned by individual miners. In essence, higher difficulty levels can substantially reduce a miner’s overall revenue.
Moreover, a miner entering the market today with new and more efficient mining hardware holds an advantage over miners using yesterday’s technology: The competitive nature of Bitcoin mining means that miners are continually seeking ways to enhance their efficiency and mining capabilities. Miners who invest in the latest and most efficient mining hardware gain a competitive edge in the race to mine new blocks. This advantage allows them to potentially earn a larger share of the rewards, including newly minted bitcoins and transaction fees. Consequently, the mining landscape favors those with access to advanced technology, but this advantage only lasts for a while. Over time, the hardware they bought will result in a smaller and smaller share of the mined blocks.
Finally, a miner’s revenue is tied to their ability to find cheap, often stranded sources of energy: Bitcoin miners’ profitability hinges on the cost of energy consumption, as mining operations are energy-intensive. Miners seek out economical energy sources to maximize their revenue. Interestingly, Bitcoin mining operations tend to gravitate toward regions where cheap, surplus, or stranded energy is available. This energy may result from various sources, such as excess hydroelectric power, geothermal energy, or otherwise untapped resources. The decentralized nature of these energy sources, spread across different geographic regions worldwide means that miners strategically position themselves near these energy sources to reduce operational costs. This in turn leads to further decentralization of the seignorage.
These mechanisms ensure fairness, aligning processing power contributions with respective shares and preventing a single miner or group from monopolizing the mining process.
In essence, Bitcoin’s employment of difficulty-adjusted proof of work acts as a self-regulating mechanism. It adeptly adapts to the ever-evolving mining technology landscape, fostering a fair and highly competitive environment. This approach ensures the equitable distribution of seigniorage among participants, fortifying the ongoing decentralization and resilience of the Bitcoin network.