As of March 2018, it’s estimated that 17 million Bitcoins are in circulation.
Unlike fiat currencies that are introduced into circulation by their issuing central banks, Bitcoins are generated mathematically as a biproduct of Bitcoin transactions themselves.
Because electronic money does not involve a physical exchange like cash, it needs a way to digitally verify transactions. Typically, this is achieved with a centralised ledger, i.e. a long list of transactions controlled by a central authority.
This authority is a 3rd party (like a bank or credit card company) whom all other parties trust to confirm that, when they receive electronic funds, those funds are valid and will be accepted in future. Because the 1st and 2nd party — the payer and payee — both trust the 3rd party, they can go on transacting safe in the knowledge that the 3rd party is keeping track on an agreed ledger.
With Bitcoin however, there is no 3rd party. Instead the ledger is openly distributed so that every user of the currency can see it. It is broken up into blocks of chronological transactions, and each block is verified using cryptography — essentially a series of extremely difficult and unpredictable mathematical puzzles that prove that the transactions in that block are valid. Each block contains a numerical link to the previous one chaining them together, which is why this distributed ledger is known as a “blockchain”.
Solving the puzzle to validate blocks is very processor-intensive and requires a lot of computing resources and power, and so to incentivise the subset of users on the Bitcoin network who perform this cryptographic task with their expensive computers, every time a user solves a block of transactions they receive a certain number of Bitcoins as a reward.
This is how Bitcoins enter circulation – they are generated and dispensed as a reward for the effort it takes to validate the public record of Bitcoin transactions, or the blockchain. Whenever a file of transaction data is approved, a block is added to the blockchain, and a number of Bitcoins are created.
Essentially, trying to add blocks to the blockchain is like entering a lottery, and the more people that enter the lottery, the more likely they are collectively to find the solution to a block more quickly. In order to ensure Bitcoins are generated at a regular pace, the difficulty of the blockchain puzzle is adjusted based on the amount of people trying to solve it, so that, on average, a new block is added – and therefore new Bitcoins are created – every ten minutes. This rate is meant to approximate the production of commodities like gold, which is why the people adding blocks to the blockchain are known as “miners”.
In the early days, miners were rewarded with 50 Bitcoins each time they validated a block of transactions. However, the aim of Bitcoin was to introduce a predictably scarce currency, and so with every 210,000 blocks that are added to the blockchain, the reward is halved. Currently the block reward is 12.5 Bitcoins, and it’s estimated to reduce to 6.25 Bitcoins in 2020.
This halving will keep occurring until the 6,930,000th block (currently projected to be added in 2140), when the reward will reach zero. This means that there will be a finite number of Bitcoins in circulation, 21 million to be precise.
However, when a block is approved, the miner receives a transaction fee as well as their Bitcoin reward. As time goes by and more people transact in Bitcoin, the opportunities to approve transactions and obtain the fee will increase. This offsets the falling value of the Bitcoin reward, and maintains the incentive among miners to validate transactions.
This controlled system of supply is essential to the proper functioning of Bitcoin.
Firstly, the complexity of Bitcoin mining creates confidence in the system: confidence that the transactions are approved correctly, and confidence that the Bitcoin supply is legitimate.
Also, the creation of new Bitcoins is part of a virtuous cycle. By using validation as a means of production, those who want to generate Bitcoin must maintain and develop the system, rather than defrauding it. It’s this system that incentivises and ensures correct validation where the checks and balances of traditional banking are missing.
The limited supply of Bitcoin also ensures it functions as a genuine commodity and store of value. Bitcoin is not backed by a scarce physical asset, such as gold, so it relies on its limited supply – or scarcity – to give it value.
Since the supply of Bitcoin is also generated at a regular and predictable rate, Bitcoin is perhaps closer to the traditional “gold standard” than fiat currencies, which central banks can create as and when there is economic need. This regulated supply removes the risk of sudden inflation or deflation, so people can be confident transacting in it day-to-day.
Its secure, decentralised system, limited supply and maturity in a crypto world, has ultimately made Bitcoin the reserve currency for a new class of digital assets. As a result, it’s now frequently listed alongside the dollar and the yen in currency tables.
When Bitcoin arrived on the scene in 2009, it was watershed moment for digital currencies. Its Blockchain technology solved a decades-old puzzle in how to generate a dependable supply of cryptocurrency and authentically sustain it in the long term. And while Bitcoin has certainly evolved, it has functioned reliably for almost a decade.
Kate Baucherel BA (Hons) FCMA is a business development and strategy consultant specialising in emerging tech, particularly blockchain and distributed ledger technology. She has held senior technical and financial roles in businesses across multiple sectors, leading several enterprises through start-up and growth.