New bitcoins come into circulation by a process called mining. Miners are responsible for solving complex puzzles so as to add new blocks to the blockchain. We have in this post discussed on how mining works.
Miners are the crucial part of the entire eco-system as they are responsible for confirming transactions and adding them to the blocks. As a reward for miners work they are awarded new bitcoins. This way they are also responsible for bringing in new bitcoins to circulation. Satoshi in his Bitcoin white paper provided two ways to reward miners: 1) allocating new bitcoins for every block mined, 2) transaction fees which can be charged from the users to process their transaction.
In the initial days’ block reward was 50 bitcoins, as per the protocol the reward halves every 4 years till all the bitcoins are mined. Since the beginning of bitcoins, the block reward halved twice from 50 to 25 bitcoins in 2012, and 25 to 12.5 bitcoins in 2016. As you can notice this is a geometric progression and as days pass by the block reward gets reduced.
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Bitcoin mining these days requires huge capital investment and as days pass by the difficulty level of puzzles is only bound to increase and thereby increasing the investment of hardware processors required to mine the coins. As the mining reward goes down every four years, miners are bound to look for other incentives so to keep the network afloat.
As mentioned earlier, the other way to incentivize miners is through transaction fee. In this, the user sending coins to other address will append some amount of coins as a transaction fee which goes to the miner who includes the transaction in a block.
As the block reward goes down, the transaction fee is bound to go up. In simple terms, the block reward is inversely proportional to the transaction fee. The average transaction fee at present is around $20. The higher the fee appended to a transaction the higher the chance of transaction getting processed. So even when the block reward is 12.5 bitcoins the average transaction fee is $20, what will be the fee when block reward is 3.125 or 1.56?
Miners work for incentive and not for a social cause or for any other reason. With the current protocol, the transaction fee is bound to increase making it infeasible to transact in bitcoins. I own a very negligible amount of bitcoins which is around 10$ at present conversion rate and when I decided to transfer them to another wallet the network fee came about 5$ which means I might have received $5 worth bitcoin on another wallet while the other half goes as the network fee.
One can’t easily think of any traditional transacting channel which charges such arbitrary fee for transferring such small amounts. The main aim of bitcoin was to be a peer to peer currency. But the transaction fee which is only bound to increase over the time will suffocate small users prompting them to use other channels. Although it is evident that Satoshi has foreseen the death of block reward and rise of transaction costs, he failed to see how high they might go.
Transaction Fee and Scalability Debate
One can assume that a person who owns a single bitcoin (assume the price $15,000) can easily afford a network fee of $20. But the transaction charge is not for one bitcoin but for any transaction which can be any amount: ฿ 0.1, ฿ 0.0020, ฿ 0.0001524 or anything. The argument that the network is designed for those who can afford the transaction fee is a fallacy. In a world where an annual average income of $32,400 (stats according to the Global Rich List) will place you among the top 1% how many people can you serve with such high transacting costs? And let’s not forget 1% of total bitcoin addresses own 99% of all bitcoins in circulation.
Over the past one year, the community widely debated on growing transaction costs and all the discussions directed towards an increase of block size. The volume of transactions of bitcoin network is nowhere near any fiat currency. Even with such low volume of transactions the network often lags to process them. The increase in block size is only a temporary solution which can only in last for another few years if the people adopting bitcoin increases at the same pace. To conclude, with the current protocol bitcoin is meant to be used by only a very small minority of world population.
With 1MB block size bitcoin network can process a maximum of 7 transactions per second while Visa is capable of 56,000 peak transactions per second (tps).
Many people compare bitcoin to the digital version of gold. Yes, bitcoin is digital gold and as gold can’t be used to transact by a common man on a daily basis even bitcoin can’t be a medium for day to day peer to peer transactions.