Unlike a fiat currency, which can be printed in infinite numbers by a central bank, bitcoin can never be inflated by printing. The most important and debated consequence of a fixed and diminishing monetary issuance is that the currency will tend to be inherently deflationary.
Deflation is the phenomenon of appreciation of value due to a mismatch in supply and demand that drives up the value and exchange rate of a currency. The opposite of inflation, price deflation means that the money has more purchasing power over time. Many economists argue that a deflationary economy is a disaster that should be avoided at all costs.
That is because in a period of rapid deflation, people tend to hoard money instead of spending it, hoping that prices will fall. Bitcoin experts argue that deflation is not bad per se. Rather, deflation is associated with a collapse in demand because that is the only example of deflation we have to study. In a fiat currency with the possibility of unlimited printing, it is very difficult to enter a deflationary spiral unless there is a complete collapse in demand and an unwillingness to print money.
Deflation in bitcoin is not caused by a collapse in demand, but by a predictably constrained supply. In practice, it has become evident that the hoarding instinct caused by a deflationary currency can be overcome by discounting from vendors, until the discount overcomes the hoarding instinct of the buyer. Because the seller is also motivated to hoard, the discount becomes the equilibrium price at which the two hoarding instincts are matched. It remains to be seen whether the deflationary aspect of the currency is really a problem when it is not driven by rapid economic retraction.
In the previous chapter we looked at the blockchain, the global public ledger list of all transactions, which everyone in the bitcoin network accepts as the authoritative record of ownership. All traditional payment systems depend on a trust model that has a central authority providing a clearinghouse service, basically verifying and clearing all transactions.
Bitcoin has no central authority, yet somehow every full node has a complete copy of a public ledger that it can trust as the authoritative record. The blockchain is not created by a central authority, but is assembled independently by every node in the network. Somehow, every node in the network, acting on information transmitted across insecure network connections, can arrive at the same conclusion and assemble a copy of the same public ledger as everyone else.
This chapter examines the process by which the bitcoin network achieves global consensus without central authority. Emergent, because consensus is not achieved explicitly—there is no election or fixed moment when consensus occurs. Instead, consensus is an emergent artifact of the asynchronous interaction of thousands of independent nodes, all following simple rules. All the properties of bitcoin, including currency, transactions, payments, and the security model that does not depend on central authority or trust, derive from this invention.
In the next few sections we will examine these processes and how they interact to create the emergent property of network-wide consensus that allows any bitcoin node to assemble its own copy of the authoritative, trusted, public, global ledger. In Chapter 5 , we saw how wallet software creates transactions by collecting UTXO, providing the appropriate unlocking scripts, and then constructing new outputs assigned to a new owner.
The resulting transaction is then sent to the neighboring nodes in the bitcoin network so that it can be propagated across the entire bitcoin network. However, before forwarding transactions to its neighbors, every bitcoin node that receives a transaction will first verify the transaction. This ensures that only valid transactions are propagated across the network, while invalid transactions are discarded at the first node that encounters them. Each node verifies every transaction against a long checklist of criteria:. Note that the conditions change over time, to address new types of denial-of-service attacks or sometimes to relax the rules so as to include more types of transactions.
By independently verifying each transaction as it is received and before propagating it, every node builds a pool of valid new transactions the transaction pool , roughly in the same order. Some of the nodes on the bitcoin network are specialized nodes called miners. In Chapter 1 we introduced Jing, a computer engineering student in Shanghai, China, who is a bitcoin miner.
Unlike Jing, some miners mine without a full node, as we will see in Mining Pools. However, the arrival of a new block has special significance for a mining node. The competition among miners effectively ends with the propagation of a new block that acts as an announcement of a winner.
To miners, receiving a new block means someone else won the competition and they lost. However, the end of one round of a competition is also the beginning of the next round. The new block is not just a checkered flag, marking the end of the race; it is also the starting pistol in the race for the next block. After validating transactions, a bitcoin node will add them to the memory pool , or transaction pool , where transactions await until they can be included mined into a block.
The arrival of this block signifies the end of the competition for block , and the beginning of the competition to create block , By now it has collected a few hundred transactions in the memory pool. Whatever transactions remain in the memory pool are unconfirmed and are waiting to be recorded in a new block. This block is called a candidate block because it is not yet a valid block, as it does not contain a valid proof of work. The block becomes valid only if the miner succeeds in finding a solution to the proof-of-work algorithm.
Prioritized transactions can be sent without any fees, if there is enough space in the block.
The priority of a transaction is calculated as the sum of the value and age of the inputs divided by the total size of the transaction:. The size of the transaction is measured in bytes. The first 50 kilobytes of transaction space in a block are set aside for high-priority transactions. This allows high-priority transactions to be processed even if they carry zero fees.
Some miners choose to mine transactions without fees on a best-effort basis. Other miners may choose to ignore transactions without fees. Any transactions left in the memory pool, after the block is filled, will remain in the pool for inclusion in the next block.
Eventually a transaction without fees might reach a high enough priority to be included in the block for free.
Bitcoin transactions do not have an expiration time-out. A transaction that is valid now will be valid in perpetuity. However, if a transaction is only propagated across the network once, it will persist only as long as it is held in a mining node memory pool. When a mining node is restarted, its memory pool is wiped clear, because it is a transient non-persistent form of storage. Although a valid transaction might have been propagated across the network, if it is not executed it may eventually not reside in the memory pool of any miner. Wallet software is expected to retransmit such transactions or reconstruct them with higher fees if they are not successfully executed within a reasonable amount of time.
You can see this block in the blockchain using the Bitcoin Core client command-line interface, as shown in Example The first transaction added to the block is a special transaction, called a generation transaction or coinbase transaction. Unlike regular transactions, the generation transaction does not consume spend UTXO as inputs.
Instead, it has only one input, called the coinbase , which creates bitcoin from nothing. The output of the generation transaction sends the value of The fees are calculated as:. The reward is calculated based on the block height, starting at 50 bitcoins per block and reduced by half every , blocks. Because this block is at height ,, the correct reward is 25 bitcoins.
The initial subsidy is calculated in satoshis by multiplying 50 with the COIN constant ,, satoshis. This sets the initial reward nSubsidy at 5 billion satoshis. Next, the function calculates the number of halvings that have occurred by dividing the current block height by the halving interval SubsidyHalvingInterval.
In the case of block ,, with a halving interval every , blocks, the result is 1 halving. The maximum number of halvings allowed is 64, so the code imposes a zero reward return only the fees if the 64 halvings is exceeded. Next, the function uses the binary-right-shift operator to divide the reward nSubsidy by two for each round of halving. In the case of block ,, this would binary-right-shift the reward of 5 billion satoshis once one halving and result in 2.
The binary-right-shift operator is used because it is more efficient for division by two than integer or floating-point division. Finally, the coinbase reward nSubsidy is added to the transaction fees nFees , and the sum is returned. As you can see in Example , the generation transaction has a special format. We examined transaction inputs in Table In a generation transaction, the first two fields are set to values that do not represent a UTXO reference.
Generation transactions do not have an unlocking script a. Instead, this field is replaced by coinbase data, which must be between 2 and bytes. Except for the first few bytes, the rest of the coinbase data can be used by miners in any way they want; it is arbitrary data. Currently, miners use the coinbase data to include extra nonce values and strings identifying the mining pool, as we will see in the following sections. The first few bytes of the coinbase used to be arbitrary, but that is no longer the case. The first byte, 03 , instructs the script execution engine to push the next three bytes onto the script stack see Table A The next three bytes, 0xb04 , are the block height encoded in little-endian format backward, least significant byte first.
Reverse the order of the bytes and the result is 0xb44 , which is , in decimal. The next few hexadecimal digits are used to encode an extra nonce see The Extra Nonce Solution , or random value, used to find a suitable proof of work solution. Note that the libbitcoin library contains a static copy of the genesis block, so the example code can retrieve the genesis block directly from the library. To construct the block header, the mining node needs to fill in six fields, as listed in Table At the time that block , was mined, the version number describing the block structure is version 2, which is encoded in little-endian format in 4 bytes as 0x The block header hash for block , is:.
The next step is to summarize all the transactions with a merkle tree, in order to add the merkle root to the block header. The generation transaction is listed as the first transaction in the block. Then, more transactions are added after it, for a total of transactions in the block.
The node then fills in the difficulty target, which defines the required proof-of-work difficulty to make this a valid block. The encoding has a 1-byte exponent, followed by a 3-byte mantissa coefficient. In block ,, for example, the difficulty bits value is 0xa30c.
The first part 0x19 is a hexadecimal exponent, while the next part, 0x03a30c , is the coefficient. The final field is the nonce, which is initialized to zero. With all the other fields filled, the block header is now complete and the process of mining can begin.
The goal is now to find a value for the nonce that results in a block header hash that is less than the difficulty target. The mining node will need to test billions or trillions of nonce values before a nonce is found that satisfies the requirement. Throughout this book we have studied cryptographic hash functions as used in various aspects of the bitcoin system. In the simplest terms, mining is the process of hashing the block header repeatedly, changing one parameter, until the resulting hash matches a specific target.
This feature of hash functions means that the only way to produce a hash result matching a specific target is to try again and again, randomly modifying the input until the desired hash result appears by chance.