or — what’s going on behind bitcoin and all these price graphs

I wrote a piece last weekend trying to put bitcoin’s price history into perspective —

I decided a few days later that it might be a good idea to help illustrate bitcoin’s foundation a bit better for those who might not have a really well-rounded understanding of some the technology / economic structure behind it. Basically, what’s behind these price line graphs?

Here’s my rough attempt at breaking down / simplifying how bitcoins are created over time and some very high level descriptions and illustrations about how bitcoin transactions and the blockchain come into play in this structure.

One of the great and powerful things about bitcoin which has attracted the attention of many (including some of the largest financial institutions in the world) is what is called the blockchain. As an open-source software project, the initially anonymously published (pen-named) bitcoin code is viewable by anyone — and thus has been heavily scrutinized, admired, and imitated from individuals and organizations around the globe. One of the major innovations — the blockchain — the foundation of the currency, is what allows bitcoin to function in a completely decentralized fashion. The blockchain is a public ledger that is maintained by people/groups called miners (nodes) who broadcast bitcoin transactions to the bitcoin network (other miners/nodes) in exchange for a shot at receiving some bitcoin (details to be explained). This public ledger contains every public bitcoin transaction that has “ever” happened in the history of bitcoin’s existence. Since this ledger is totally public and all the details of every transaction are all agreed upon by the majority of the network, anyone can explore and sift through the details of every bitcoin transaction that has ever happened.

Thus, it’s easy to see how the idea behind this technology — a public, accurate, global ledger system — could lead to major innovation in fields like finance and accounting, where debts, invoices, settlements, payments, etc. could never be lost, misplaced, or tampered with and could also be verified nearly instantly by multiple parties. Sending and receiving funds can happen with any amount of money, at any time, nearly for free, and extremely quickly — all executable without the need of any financial intermediary.

So, let’s explore this blockchain. The blockchain is organized how you might’ve guessed — as a chain of blocks. These blocks are just collections of bitcoin transactions that happened during that time period, and the chain keeps the blocks together in chronological order. There are various services available to help you search the blockchain without actually downloading the entire, massive thing (although you can feel free to). I’m going to use one called blockchain.info in this piece for no other reason besides it’s an older name that I’ve used before.

So let’s look more at how all this actually works and fits together. As I stated in my last piece, bitcoin was first created in late 2008. Let’s search the blockchain to make sure I got my facts straight.

As you can see here — https://blockchain.info/block/000000000019d6689c085ae165831e934ff763ae46a2a6c172b3f1b60a8ce26f — and below, the 1st block (Block #0) took place on January 3, 2009. Looks like the original “white paper” (the first “formal” description of bitcoin) was released around the end of 2008, but the 1st block wasn’t actually “mined” until January 3, 2009.

There’s a lot of technical information in this picture, but besides the date, I’m going to focus on the “Block Reward”. As it says on the bottom of the table on the left, the 50 BTC (50 bitcoin) “Block Reward” is what the miner of this block got for “mining” this block, or putting the block and all its details into the blockchain :) As confirmed on the bottom of the screen, you can see this block marked the “Genesis of Bitcoin”.

So these blocks basically contain all of the transactions that occurred on the bitcoin network in the last approximately 10 minutes. To be a miner (run a “node”), it requires basically running the bitcoin software and attempting to broadcast transactions to the network in the form of putting a new block onto the blockchain. This requires electricity at a minimum, which means it’s not really economically worth it to be a miner unless there is some sort of incentive structure for doing so, which was achieved through transaction fees (which are why I always say it’s “essentially” free to send bitcoin — the miners can set a small fee to broadcast transactions and include them in a block, which usually equates to an amount less than a couple cents given today’s rates) and these “Block Rewards”. I’m not going to focus on the transaction fees, however I’d say a major takeaway after learning about the “Block Reward” structure over time is to realize how these transaction fees will likely need to make up a larger part of the incentive for miners in the future.

So back to these cool “Block Rewards” you can get for putting the latest block of bitcoin transactions onto the end of the pre-existing blockchain. When the genesis block was mined in January 2009, the 50 bitcoin reward was worth about $0.00 (if there was even a person or place that would’ve bought them from you). If you got 50 bitcoin today that’d be awesome — you could sell them for about $12,000 (I’m going to use approximate bitcoin prices in USD from coindesk.com/price herein). As I said earlier, these blocks are designed to show the bitcoin transactions from just the last 10 minutes as well, so “Bitcoin Rewards” are being generated constantly and frequently. With a competition for this much money going on, as you may have guessed, mining bitcoin has become extremely competitive over time, and now is mostly done in “mining pools” (groups of people who basically team up to mine and split the rewards) and specialized warehouses with specialized hardware that do nothing but mine bitcoin 24/7. Bitcoin’s software is also specially designed to adjust the difficulty of putting a new block into the blockchain such that despite how many people/pools/etc. are trying to mine bitcoin (the next block), a new block will be solved/added to the blockchain about every 10 minutes on average.

As I’m typing this on Sunday (6/21/2015) afternoon, the most recent block was Block #361946, as can be seen here — https://blockchain.info/block/00000000000000000e767c8f9949a59560d608486502099e6a362371e01a1eb7 — and below.

So, between 1/3/2009 (the 1st/genesis block”) and 6/21/2015 (today), there have been 361,947 blocks. Between 1/3/2009 and 6/21/2015 there have been about 3,398,400 minutes. Thus, there’s been an average of a new block about every 9 minutes and 23 seconds — not too far off from the 10 minute goal per block that the software is trying to dynamically update the block difficulty for.

Just like in the other block, I’m again going to focus on the “Block Reward” — here you can see its “25 BTC”, or half of the 50 rewarded in the genesis/1st block. What’s up with that? The “Block Reward” actually changes over time based upon rules set in the software. There are about 525,000 (525,600) minutes in a year, or 52,500 blocks (assuming 10 minutes per block) in one year. So, every 4 years we’d expect the blockchain to have an additional 210,000 blocks. According to the rules/software behind bitcoin, every 210,000 blocks (which should equate to about every 4 years) the “Block Reward” halves.

To confirm, lets again check the blockchain, here — https://blockchain.info/block/00000000000000f3819164645360294b5dee7f2e846001ac9f41a70b7a9a3de1 — and below.

As we can see, the “Block Reward” was “50 BTC” on Block #209,999. We can also see that this block was put into the blockchain on November 28, 2012 — a little less than (but close to) exactly 4 years from the mining of the genesis block.

To see the block reward halving in the blockchain (and the only halving that’s taken place yet), we can see Block #210,000, here — https://blockchain.info/block/000000000000048b95347e83192f69cf0366076336c639f9b7228e9ba171342e — and below.

As we can see, the block reward was 25 bitcoin, and the block reward will be 25 bitcoin until Block #420,000, which will have a reward of 12.5 bitcoin.

Here are some rough graphs to illustrate some of this information, starting with the past, present, and near future. Note: these values have been rounded slightly to ease illustration.

We know the genesis block was mined on January 3, 2009, but we’re going to assume that the genesis block was mined a few weeks earlier in 2008 to help out the nice even x-axes herein.

As we can see, during the 1st four years, the block reward was 50 bitcoin, as illustrated by the green circles shown each year. Right around 4 years and 210,000 blocks later, we can see how the block reward halves to 25 bitcoin like we confirmed earlier in the blockchain. As also explained previously, despite what’s going on with the block reward, the number of blocks in any time period should stay constant and linear at right around a new block every 10 minutes. Today, in 2015, like we’d expect, the reward is 25 bitcoin and we’re right around block 360,000. At block 420,000 in the not too distant future, we’ll see the next block reward halving when it drops down to a 12.5 bitcoin reward.

Since we know the schedule for blocks and block rewards going forward, we can easily model out the future approximate timing of block rewards, the number of blocks, and the number of bitcoin that have been mined.

Based on the block reward schedule starting at 50 bitcoin and halving every 210,000 blocks (that occur approximately every 10 minutes), we can illustrate the total amount of bitcoin that will have been mined at various dates in the future, as shown below.

As we can see, the total amount of bitcoin that will ever exist are about 21 million, which can be divided down into .00000001’s to accommodate sending precise values despite the underlying exchange rate. What may be surprising to some is the rapid rate at which we approach the 21 million which will ever exist.

Here’s a graph showing how the block reward and total number of blocks move relative to the date over the block reward halving schedule — all the way to 2140 (or about 7 million blocks, and remember that’s about 70 million minutes).

Here’s the block reward schedule versus the total number of bitcoin mined over time.

In both of these it’s easy to see how quickly the block reward falls to merely a fraction of a bitcoin.

And for those who prefer the raw data/source/calculations.

As we can see, in 2015 we’re still mining for a chance at a 25 bitcoin reward. Using today’s exchange rate that’s a little over $6,000. In less than 60,000 blocks we’ll find ourselves at the next “halving” at which point the block reward will half to 12.5 bitcoin. It will be very interesting to watch how the market/price moves in anticipation/reaction to this event — the 2nd halving to have ever occurred in bitcoin’s history, and this one with many, many more interested parties observing. In the 2030’s miners will be competing for less than a 1 bitcoin block reward, and as we can easily see moving downward in the chart, bitcoin’s future economics and incentive structure will be an entirely different ballgame.

Alex Sunnarborg

Disclaimer: In January 2015, I co-founded a company to help those who would like to dip their toes into buying, holding, and using (if you’d like) bitcoin while mitigating some of the fears of bitcoin’s previously crazy price volatility by using a DCA-esque structure connected to spending habits. The company is called Lawnmower — a mobile app available for iOS & Android — the links to each and more are available on our main page — www.lawnmower.io. I also own bitcoin as a result and separately from the use of the app. I hope everything is presented in an objective manner, but in the CYA spirit, nothing presented represents the viewpoints, opinions, etc. of Lawnmower, Inc. or any other corporation and all data/charts/analyses are for illustrative and discussion purposes only and should not be construed or interpreted as advice.