By Philippe Nadouce
The slowness of bitcoin is well known and criticized (“Bitcoin can’t scale”) but what is often ignored is that if Satoshi decided that a block should be discovered roughly every ten minutes - to pace the production of bitcoins -, it is for several good reasons. Bitcoin slowness is a feature, not a bug. In this article, we will develop this assertion and explain what the difficulty adjustment is.
Regarding Difficulty Adjustment (DA), most often we are given the following definition: to ensure bitcoin blocks are mined roughly every 10 minutes, the bitcoin source code adjusts the difficulty depending on the number of miners competing to resolve the puzzle triggered by the algorithm. This event happens every 2016 blocks (about every two weeks).
This definition may be a little complex for those new to bitcoin, so let’s put it in layman’s terms.
The bitcoin network is completely decentralized, meaning that it is not run by any third party or, I like to add, by any human consciousness. The overarching authority here is in the source code: it’s an algorithm. Few people know that the creation of bitcoins is the result of a game that humans (‘miners’) play with the bitcoin algorithm hard-coded into the heart of BTC. What is this game about? Simple. Miners must find a secret number chosen by the algorithm. To find it, they must buy very powerful computers called ASICs: a hardware whose only characteristic is to calculate numbers very quickly. In other words, ASICs are calculators on steroids: very stupid but very powerful.
Miners must spend a lot of money; they must buy large quantities of ASICs (roughly $2000 a piece) if they want to be competitive. But the expenses do not stop there, once the computers are purchased, engineers must connect them. You must employ staff, rent offices and workshops, and, finally, pay huge electricity bills (electricity makes up around 80% of a miner's operating spendings.)
Let's say that you have overcome all these constraints and that you are now a miner. You are now an entrepreneur struggling to survive in a highly competitive environment.
What is the game about?
You now control toys that have cost you millions. You must use them to play with the bitcoin algorithm and if you win, this algorithm will reward you with 6.25 bitcoins (this quantity will be halved in 2024.
Since no one controls the bitcoin network, the machines and math must maintain the production of bitcoins as planned by its designers. But life is unpredictable, and machines are still very stupid. This is the reason why a block is created every ten minutes, to allow time for the machines to rectify the problems if there were any.
But how to maintain the pace of bitcoin creation if the number of miners connected to the network is constantly changing? The Difficulty Adjustment (DA) feature is taking care of the issue.
It happens every 2016 blocks, remember. Let's say that there are 100 computers playing the game and looking for block’s creation. The difficulty adjustment dictates how hard it is to find the mysterious number. The week after when we reach the end of the 2016 blocks period, 50 computers are added to the network. The algorithm will have to recalculate the difficulty considering the number of computers connected to the network to maintain equal opportunities in this purely probabilistic environment, for all miners to continue to have, on average, 10-minutes block times.
Another example, imagine that we have an incredible innovation in energy consumption, ten times more efficient than what we have today. We would expect bitcoin mining to go up ten times for the same cost. It is therefore reasonable to expect a gigantic amount of hash flooding the network.
The difficulty adjustment ensures that this acceleration would not speed up bitcoin blocks’ creation over time in any kind of significant way, and that the internal metronome of the system will keep its pace. Similarly, if we were 10% short of computing power, the difficulty would adjust by about 10% in the difficulty target.
Enforcing the monetary policy imbedded in bitcoin
The bitcoin miracle occurs through the conjunction of the following two processes: Proof-of-Work (PoW) and Difficulty Adjustment (DA).
The high level of security provided by PoW and the guardian role played by the Difficulty Adjustment (DA) allows the source code to maintain the creation of coins without problems. This number of coins created/minted is halved every four years. Thanks to these mechanisms we can project numbers into the future and determine with absolute certainty the quantity of bitcoin in circulation at any date until 2140. Without DA the 21 million bitcoins would be created in an anarchic manner.
Why is it so important to have such a predictable money creation process? Jeff Booth states that when you control the ability to print unlimited amounts of money, you distort money, markets, and people’s earning potential, and alter their purchasing power by printing away their savings and their ability to make decisions. Bitcoin is giving balance and predictability; the rule embedded in the code is law. And, as far as bitcoin monetary supply is concerned, nations and their peoples know for a fact that there will only be 21 million BTCs.
Thus, in April 2022, on-chain records showed that 19 million bitcoins were mined into existence and there are 1.88 million BTCs left to mint today (December 2022). The next halving is expected to happen roughly around April 20, 2024. At the time of writing, miners receive a 6.25 BTC reward per block. After the 20th of April 2024, the block reward will be halved to 3.125 bitcoins. Around 91,000 bitcoins are left to mine until then. Thanks to the embedded predictability in the bitcoin code, we can also determine bitcoin’s inflation rate per annum. In 2022 the rate was 1.73%. Post-halving 2024, it will go down to 1.1%. The rate will sink below 1% in 2025 and by the following halving, in 2028, the issuance rate will be roughly 0.5%. Moreover, after 2021 and 2022 crazy Western monetary expansion, it becomes impossible to estimate what will be the inflation rate per annum from 2023 onward.
DA evolves as a dynamic parameter which is reset every 2016 on average. When the bitcoin network is minting new blocks in less time than the required 10 minutes, the algorithm will adjust the difficulty to a greater degree when the period of 2016 is over. So, if the blocks are created faster than expected, (In less than 10 minutes) the DA will also increase. Conversely, if the network is minting new blocks in a time greater than 10 minutes, the DA will be reduced as the blocks are created more slowly.
When the price of bitcoin is high, the miners get higher profits. On the contrary, if bitcoin is near the bottom of a bear market, some miners might go bust or leave the network, thus decreasing the hash power and with it the DA.