Blockchain
Understanding its role in blockchain
Block rewards play a critical role in the tokenomics of a cryptocurrency. Read on to find out what a block reward is and what role it plays in managing blockchain protocols.
The explanation of the block reward is quite simple. It is a form of incentive given to network participants called miners or validators to verify and add new transactions to a blockchain.
Miners are responsible for discovering new blocks in the blockchain, and these rewards serve as a way to encourage them to participate in the network and protect it.
Network participants who verify transactions in Proof of Work (PoW) networks, such as Bitcoin (Bitcoin), are known as miners. In test of the bet (PoS), they are called validators or stakers.
In the Bitcoin ecosystem, the block reward incentivizes miners to direct computing power towards securing the Bitcoin network. This reward reduces by half every four years or every 210,000 blocks in what is known as Bitcoin halving. Miners also receive transaction fees as part of the reward for ensuring the integrity of the Bitcoin network.
The reduction in block rewards is part of Bitcoin’s mechanism to slow the introduction of new coins into the circulating supply, which helps fuel the cryptocurrency’s deflationary monetary policy.
Types of block rewards
To better understand what a block reward is, you should know that it is mainly composed of two components: the block subsidy and the transaction fees. Block grants are new tokens introduced into the blockchain and given to miners for their work in discovering new blocks, confirming transactions, and securing the blockchain. Transaction fees, on the other hand, are money paid by users of a blockchain network to validate their transactions.
Each cryptocurrency has its own validation process and reward system. Bitcoin, for example, as stated earlier, uses the proof-of-work system for its block rewards. It is the original consensus mechanism used by cryptocurrencies, including Ethereum (ET), in its early days.
Here, miners compete to solve complex mathematical puzzles to validate transactions and create new blocks. The miner who solves the puzzle first receives the block reward, consisting of newly minted coins and transaction fees.
In other consensus mechanisms, such as proof of stake, validators propose and validate blocks based on the number of tokens they hold and are willing to provide as collateral. They then receive rewards in the form of additional tokens, which are usually the native cryptocurrency of the blockchain they are on.
The more tokens a validator stakes, the higher his or her chances of being chosen to create a block, and unlike PoW, PoS networks often have a fixed annual percentage reward for validators.
The combination of mining rewards and transaction fees creates a strong incentive structure for miners, promoting network security, decentralization and transaction validation.
Together, these elements provide the economic framework that keeps cryptocurrencies decentralized and in line with miners’ incentives for the overall well-being and functioning of the blockchain.
How block rewards work
Block rewards work differently depending on the consensus mechanism of a blockchain network. A consensus mechanism is a fundamental protocol used in blockchain systems to achieve agreement, trust, and security across a decentralized computer network.
There are several consensus mechanisms in use in the blockchain space, but the two best known are the aforementioned PoW and PoS, whose participants are known as miners and validators.
How Do PoW Miners Earn Block Rewards?
When proof-of-work miners, like those on the Bitcoin network, confirm transactions, they are grouped into blocks and a new block is added to the previous set of blocks on the blockchain.
There are currently 19,695 million Bitcoins in circulation out of the 21 million that will exist at some point. This means there are less than 1.3 million Bitcoins yet to be mined.
The process of acquiring block reward in PoW networks begins when miners collect pending transactions. They then perform computationally intensive calculations known as hashing to find a specific value or nonce that, when combined with the block’s data, produces a hash with particular properties, such as a certain number of leading zeros.
The first miner to find a valid nonce that meets the difficulty criteria broadcasts the new block to the network. When other network participants approve the integrity of the nonce, the successful miner receives a block reward consisting of newly minted coins specific to that blockchain.
For example, Bitcoin miners get their rewards in the form of BTC, while Litecoin (LTC) miners receive block rewards in the form of LTC.
Additionally, miners collect any transaction fees users pay for including their transactions in the block. The total reward, which consists of a block subsidy and transaction fees, is then credited to the miner’s wallet.
The block reward amount is calculated based on preset formulas that consider various factors such as network activity, mining difficulty, and consensus mechanism.
When networks receive high amounts of transactions, participants earn higher rewards. Likewise, if extraction becomes more challenging, the reward may increase.
The block reward in the blockchain varies, as each network has its own reward structures. Some blockchains have fixed rewards, meaning the same number of tokens are awarded as a block reward each time, while others gradually decrease the reward over time.
For example, Bitcoin undergoes a halving approximately every four years, and each halving reduces the block reward given to miners. The latest halving event occurred on April 19, 2024 and reduced the amount of BTC successfully received by Bitcoin miners to 3,125 BTC for each block discovered.
When the last BTC is mined by 2140, it will signal the last block of Bitcoin reward that each miner will receive, and from there on, miners will only earn transaction fees because new Bitcoin can no longer be mined.
For now, however, Bitcoin miners will continue to earn the block reward determined by the halving plus transaction fees accrued by people using the network.
The role of block rewards in Bitcoin tokenomics
A Bitcoin block reward is important because it serves as an incentive for miners to secure the network. Each new transaction confirmation adds to the longer transaction chain. As a result, this ensures that miners only maintain the correct chain of blocks in the network.
Additionally, block rewards control the issuance of new currencies. The block reward system, by determining how new coins circulate, plays an essential role in the monetary policy of the Bitcoin protocol, creating deflationary pressure by slowing the rate at which new coins enter circulation.
The regular reduction of the Bitcoin block reward is one of the ingenious features of Bitcoin, which has helped it increase in value over the years as the growing demand has been met not only with a fixed coin supply but also with a slowdown of new coins. entering circulation. This has resulted in upward pressure on prices.
How do validators earn bulk rewards in PoS networks?
In a PoS network, validators stake the network’s native token to take part in the blockchain’s consensus protocol to verify and process transactions.
Validators are then randomly selected to propose and validate new blocks based on the number of tokens they hold in the network. The more tokens a validator stakes, the higher its chances of being selected to create a block.
Additionally, the amount paid to validators depends on the percentage of the total staked amount of coins they hold. The more coins they stake, the higher their share of the block prizes paid.
The block reward depends on the specific blockchain, as different PoS chains pay different block rewards.
Validators are typically chosen deterministically or pseudo-randomly to ensure a certain level of fairness. When their turn comes, they propose a new block containing a batch of transactions. Other validators then verify the proposed block to ensure its correctness, and if the block is valid, it is added to the blockchain.
Validators then receive block rewards for their participation, usually consisting of additional native PoS blockchain tokens minted specifically for this purpose.
It should be noted that most networks have some form of sanctions in place to protect themselves from validators acting maliciously. If they act dishonestly, for example, by engaging in double signatures, censorship, or other violations, a significant portion of the staked tokens could be lost in what is known as slashing.
Another point to note is that validators can manage their own nodes or allow others to delegate tokens to them. Delegators entrust their tokens to validators, who then share the rewards with them.
The system is popular because delegated tokens often contribute to the validator’s total stake and increase his chances of being selected to propose a new block. It also allows those who do not hold significant amounts of tokens to still earn block rewards.
Final thoughts
Hopefully, the meaning of block reward is now clearer to you and you can see the vital role it plays in the cryptocurrency economy, especially in systems like Bitcoin, where miners or validators play a crucial role.
These rewards not only incentivize participants to secure the network, but also control the introduction of new coins, shaping overall monetary policy.
The mechanisms vary between Proof of Work and Proof of Stake networks, but they share the goal of maintaining the integrity of the network while rewarding participants for their contributions.
This dynamic interplay between rewards, consensus mechanisms and network security forms the backbone of cryptocurrency ecosystems, ensuring their continued functioning and growth.