Earlier in this series, we spoke about how Bitcoin’s creator, Satoshi Nakamoto, set out to invent a system that overcomes the core liability of private ledger systems: a central point of failure.

Satoshi’s solution was to create a public time-stamping server that could be operated by a distributed network of computers. The concept of making the Bitcoin ledger public was both simple and brilliant!

Putting the solution into practice, however, would require Satoshi to resolve another significant problem.

This is an extract (Chapter 3) from our new eBook, "What is Bitcoin? 11th Birthday Edition".

You can order your free copy by heading over here.

The Conundrum: Recruiting a Network without Reintroducing Central Control

Imagine you thought up a solution to the biggest dilemma of your career, and the only snag is that executing your plan depends on recruiting participants from around the world to dedicate their time and resources to your cause.

In the case of Bitcoin, the network’s operators would have to contribute their computing equipment and energy to verify transactions, record them to the ledger, and maintain the integrity of the ledger’s data.

So, what’s in it for them?

Why, of course! You’d have to offer some form of pay, an incentive to make it worth their while. And, the bigger your budget, the bigger the size of your ‘rent a crowd’.

But there’s another snag. In Bitcoin’s case, the whole point of the system was to eliminate a central party with the power to manipulate the system. And so, you see, funding the network out of your own pocket is out of the question as it would mean replicating the core flaw of private ledger systems: a central point of control.

As long as there’s a person or entity holding the cheque book, the system is only as strong as this weakest link.

Bitcoin’s Secret Sauce: A Self-Executing Economic Incentive System

“If a ledger were to be funded via external sources the funding could simply be cut & the ledger disappear. The genius of Bitcoin is that it’s a ledger that economically sustains itself and therefore has no central point of authority or control.” - Sir Toshi via Medium

The only solution would be to set up the network so its funding could originate from a neutral source. And so, Satoshi resolved the problem by designing Bitcoin to have an incentive system built right into it so that it would be controlled by the rules of the Bitcoin protocol itself!

By setting out the rules of ‘the game’ beforehand, the system can self-execute its reward system. Here’s the game plan:

Users submit transactions to the network via a transaction processor (a miner). The processor validates the transaction and queues it for publication to the next batch of transactions (the next block). Across the system, miners compete to solve the upcoming block’s hashing problem. The first processor to find the correct solution publishes the new block as the latest addition to the blockchain and broadcasts it to the rest of the network. The block contains the following data:

As header, the solution to the hash problem of that particular block,

The previous block’s hashing solution to ensure the order of the blocks are written in stone,

The new batch of validated transactions,

A special transaction that attributes the block reward (a set amount of newly issued coins plus transaction fees) to the creator of the block.

If a majority of processors recognise the new block as the first to find the solution and are satisfied that all the transactions within are valid, the network accepts it and starts working on the next block’s hashing problem.

The Big Wins of Bitcoin’s Reward System: Sustainability & Security

By writing Bitcoin’s incentive system into the rules of the game, Satoshi managed to eliminate even himself as a potential point of failure.

But that wasn’t the only element of genius baked into Bitcoin’s incentive system...

Sustainability

“None of this would have worked without bitcoin, but it’s a wheel and I want to build a car.” - Craig Wright, aka. Satoshi Nakamoto.

The timespan of Satoshi’s vision for Bitcoin was second to none, and so he had to ensure that his experimental system succeeded for the long run. His vision entailed creating a single supercomputer network that enterprises from around the world could plug into. Creating a new and much improved version of the Internet was another one of the long-term plays that Satoshi had in mind.

If the network were to stand any chance of scaling to the capacity needed to realise these dreams, the incentive system would have to encourage immense growth. Here’s how Satoshi planned it out:

The block reward subsidy was a way to bootstrap the network while usage (and cumulative transaction fees) is low. As time goes on, the subsidy would be reduced at regular intervals. By growing the network’s use, the section of the mining reward made up of transaction fees could compensate for the loss. As the network’s computing capacity increases, transaction processors (miners) would also be able to execute more complex scripts which would allow them to charge even higher fees, enabling them to run a profitable business.

Scaling of the network’s capacity was designed to be a win-win - for Satoshi as well as the network’s operators.

Security

“Miners (nodes) have skin in the game unlike developers, and thus, are in competition for the block reward and transaction fees. The result is they will seek to maintain the protocol and not to debase and alter the currency.” - Dr Craig S Wright, aka. Satoshi Nakamoto

The next bit of genius of the incentive system is how it encourages its operators to remain honest:

Given the amount of work that transaction operators have to expend to solve the hashing solution, their only chance of remuneration is by winning the opportunity to publish the next batch of transactions and collecting the reward.

If a processor tried to include an invalid transaction, the rest of the network would reject his block EVEN IF he was the first to solve the problem. The result is a waste of resources.

Although it’s theoretically possible for an attacker to gain the support of a majority of the operators, he would have to choose between defrauding the network (and breaking its security model and token value in the process) or using his advantage to get the reward subsidy.

Playing by the rules would be much more advantageous.

Learn more:

[Blog] Bitcoin is all about incentives - Craig S Wright

[Podcast] Bitcoin Ideologies & Economic Incentives (Ep 1 Pt 1)

[Podcast] Bitcoin Ideologies & Economic Incentives (Ep 1 Pt 2)

[Podcast] Bitcoin Ideologies & Economic Incentives (Ep 1 Pt 3)

Bitcoin is First and Foremost an Incentive System

“Bitcoin takes human beings’ desire to profit and converts it into a security model. It’s genius! It’s our greatest mechanism of protection.” - Michael Hudson

The word ‘honest’ appears 17 times in the Bitcoin whitepaper. And yet, of all the participants in the network (users, miners, developers), a central authority or ‘trusted third party’ is noticeably absent.

The marvel of Satoshi’s creation is that it enforces honesty through an incentive scheme that makes it more worthwhile to play by the rules than to play dirty.