A Beginner’s Guide to Bitcoin (Part 6): Paying for Bitcoin’s Computers

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Printing Money: the Block Reward

Another problem for Bitcoin is that someone has to pay for all the computers running this ledger.  With conventional money the government pays to create coins and banknotes from general taxation, and banks pay for systems that deal with checking accounts or credit cards because they make money from them.

With our new ‘distributed ledger’ money we are going to need some computers or it won’t work.  However we don’t want to have to get someone central to pay for it all, again at least partially for ideological reasons.

The answer is that new money is created whenever a group of payments is processed and this is paid to the payment processor.  Creating new money from nothing is usually called ‘printing’ money, although there isn’t much physical printing going on in Bitcoin.

This payment is called the ‘block reward’ since it is the reward paid to a payment processor (miner) for creating a block of payments and adding it to the ledger.  In 2018 the block reward is 12.5 Bitcoins per block.

Inflation

We are printing money to pay our payment processors.  If you know a little about money you’ll know that simply printing new money reduces the value of all the money already in existence.  It leads to inflation as people have more cash to buy the same set of goods

However, running computers is cheap.  We don’t need to pay very much.  So this built-in inflation isn’t really a problem.

Only Valid Blocks Get Paid

One other point to make here is that we only pay our payment processors if they add a valid block of payments to the correct currently valid ledger.  Bitcoin has validation rules which establish whether a block is valid.  When a payment processor gets a new block created by a different payment processor they will check all these rules before accepting it into their ledger.

As we shall see, it’s also possible a payment processor can add a block to a different version of the ledger, or an older version, in which case they don’t get paid.

Transaction Fees

There’s another way that payment processors can be rewarded for their work.  A person making a payment can attach a fee to the payment instruction.  This fee will get paid to whichever payment processor includes that payment in a block of payments on the valid ledger.

As I’ve already mentioned at the time of writing (2018) you need to pay a fee of about 50 US cents to ensure your payment is processed reasonably quickly.  There’s a fair chance if you don’t include this fee that your payment won’t be processed at all.

The fee revenues for payment processors are currently very small compared to the block rewards.  However, the idea is that eventually the block rewards will go to zero and the payment processors will be paid through fees.

The Blockchain

Description

Note that in this article for the first time we’ve mentioned the concept of a block of payments being processed and added to our ledger together.

There is also an implicit ordering to these blocks: the order in which they are added to the ledger.  Thus there is a chain of blocks, a ‘blockchain’.

There’s a little more to the ‘blockchain’ than this though.  Bitcoin adds a reference to the previous block into every new block.  It actually adds the hash of the previous block to the header of the next block: we’ll discuss what a hash is later in this series of articles.

Immutability, or Not

This means it’s hard to change any information the previous block without changing the hash information in the header of all subsequent blocks.  However, it doesn’t take very long for a computer to recalculate this information and change all the block headers up the chain.  So the claims you’ll see that the blockchain is ‘immutable’ are not really true, or at least are only true if certain other conditions hold.  I’ll discuss this in more detail later.

Distributed Ledger = Blockchain

The ledger is effectively the same thing as the blockchain, at least for Bitcoin.

We’ve said the ledger is just a big book that contains the current owner of every coin and the payment history of that coin.  This information can be worked out from all the payment information contained in the blocks of payments we are adding.  There’s no need for any other information to be stored.

In particular, there’s no balance information directly stored in the Bitcoin ledger, for example.  In fact the Bitcoin ledger does also contain some information separate from the payment information about which payments have unspent amounts in them, but this is really an optimization to remove the need to search through the ledger every time a payment is made.

Terminology

So the blockchain is just a chain of blocks, it isn’t really immutable, and it’s the same thing as the Bitcoin ledger.  It’s really just a data structure.  You may be wondering how this relates to all the hype about how the blockchain will change the world.  I’ll discuss this further in a later article, but the short answer is that these authors are largely using ‘blockchain’ to mean ‘something like the Bitcoin ledger but maybe not Bitcoin’.

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