Bitcoin Difficulty Adjustment

Bitcoin is understood by many to be a form of hard money. Its robust network and limited supply provide it with technical and economical characteristics unlike that of any other asset class, whether physical or digital.

At the heart of this innovative digital currency is the Bitcoin difficulty adjustment parameter, an ingenious mechanism that helps maintain bitcoin’s predictable supply, regardless of the demand.

Bitcoin’s Predictability

Throughout the years, BTC has risen dramatically, with the current price sitting at .... Huge increases in ownership, transactions and even nation state adoption have piled pressure on to its network, but remarkably, the bitcoin supply schedule has continued to remain perfectly intact.

When Satoshi Nakamoto designed Bitcoin, they fused the concept of cash payments with the properties of a scarce precious metal, and encoded a hard cap limit of 21,000,000 digital units. This scarcity by design eventually earned Bitcoin the term “digital gold”.

In addition to this scarcity, Satoshi included a precise software mechanism that would serve to bring predictability to the supply schedule. This baked-in predictability enables users to know the emission rate up until the mining of the last bitcoin, which is estimated to occur in the year 2140.

Bitcoin Block Times

Considering Bitcoin’s hard cap limit of 21,000,000 BTC, it makes sense that the rate of emission needs to be steady too. Failure to control the emission rate would simply result in yet another currency falling victim to hyperinflation.

In order to design a suitable emission rate, Satoshi decided on a block production time of 10 minutes. That is to say, newly mined bitcoin are rewarded to successful miners during the creation and timestamping of each new block of transactions. The 10 minute target is an average; the precise time of each new block depends on when the miner cracks the puzzle.

When the network launched in 2009, 50 bitcoin were rewarded per block. At the time of writing 6.25 bitcoin are released every 10 minutes, in combination with each new entry on the Bitcoin blockchain. This change in reward is part of the disinflationary emission process known as the Bitcoin halving, where mining rewards get cut in half once every four years.

Increasing Bitcoin Hashrate

As bitcoin miners compete with each other to unlock block rewards, they may wish to get an advantage over their competitors by using additional machines, using more powerful computers, or even partnering up with other miners to create profit sharing mining pools.

Over the years, miners have moved from simple personal computers to sophisticated hardware such as application specific integrated circuits (ASIC) in order to increase their odds of earning bitcoin rewards. These machines are expensive, high-maintenance units that are dedicated to performing one task and one task alone: mining bitcoin.

Introducing additional and more powerful computers increases the total amount of computations working on the proof-of-work puzzle at any given moment in time. This combined effort of computing power is known as the Bitcoin hashrate. At the time of writing, the Bitcoin network is running at around 250 million terahashes per second (TH/s). Considering that one terahash equates to a trillion calculations, it’s mindboggling to see how high the Bitcoin hashrate has risen over the years.

You would think that the addition of all these extra computers would only help crack the puzzle quicker, leading to a much faster emission of new bitcoin. Don’t worry, Satoshi thought of this inflationary risk. This is precisely where Bitcoin difficulty adjustment comes into play.

Bitcoin Difficulty Adjustment

Let us think about how other commodities or precious metals are produced. As gold increases in value, miners are incentivized to increase their production and reap higher profits. Every now and then, new sources are found, leading to an increase in the known supply. Despite being a scarce asset, gold’s production changes year on year depending on demand or discovery and cannot be said to be truly predictable over a long time frame.

As a digital asset with true scarcity, Bitcoin is known for its fixed supply. In order for the currency to keep its promise of being hard money, the emission rate also needs to remain predictable, no matter what the current market price of the currency.

Satoshi had the foresight to place a mechanism into the software that changes the difficulty of the mathematical puzzle depending on the level of computation on the network. Should more miners join the network, the complexity of the puzzle increases. The reverse happens if miners chose to power off their equipment.

This automatic adjustment is a critical component of the protocol and helps keep the block production time to 10 minutes on average. The adjustment itself occurs approximately once every two weeks, after a Bitcoin difficulty epoch of 2,016 blocks has passed.

Blockchain.com is an excellent resource for those of you wanting to take a closer at look at how the Bitcoin hashrate and difficulty adjustment have progressed over the years.

Increased Security

The higher the value of the coin, the more miners choose to participate to earn rewards, which increases the total hashrate of the network. The remarkable thing about the difficulty adjustment is that while the supply stays the same, the network automatically increases its security as any bad actors wishing to manipulate the network need increasingly larger amounts of computation power to pull off a 51% attack.

Bitcoin’s network was at its most vulnerable during its early days due to the small number of amateur miners using far less sophisticated machinery. Charts that measure metrics back to these days show some noticeable discrepancies in the block times as the network found its feet organically.

More recently, in 2021, a significant drop in Bitcoin hashrate occurred when China outlawed cryptocurrency mining in favor of its own central bank digital currency (CBDC). The difficulty adjustment adapted perfectly to this temporary drop in hashrate, keeping the supply rate to a predictable level while miners and their equipment relocated to more favorable environments.

Time and again, Bitcoin difficulty adjustment allows the currency’s economic properties to adapt efficiently to unforeseen network circumstances.

Some Key Bitcoin Figures

Bitcoin difficulty adjustment helps to maintain the predictability of a digital asset with a limited supply. In order for this to work, there are some key numbers that are permanently engrained into the Bitcoin ethos:

• Maximum supply: 21,000,000 bitcoin
• Block time: 10 minutes on average
• Bitcoin epoch: 2,016 blocks (approximately 2 weeks)
• Halving cycle: 210,000 blocks (approximately 4 years)
• Production of final bitcoin: 2140 (approximation)

Satoshi’s Brilliant Foresight

Satoshi Nakamoto combined several elements such as decentralization, proof-of-work, cryptography and digital signatures to combat the double spend issue that would have otherwise ruined any attempt at creating a digital currency in the era of internet copy-paste.

However, it is the subtle yet powerful application of difficulty adjustment that arguably gives Bitcoin the economic characteristics of a truly hard asset and excellent store of value.