What is the Difficulty Adjustment?
The difficulty adjustment explained in 60 seconds.
The total supply cap of Bitcoin is 21,000,000 coins (current supply is ~ 19,690,000 coins).
This is an overview of the issuance schedule:
This chart may raise some questions.
Such as:
- If more people mine Bitcoin, why don’t the remaining coins get mined at a faster rate? (i.e., reach 21-million hard cap well before 2140)
- If mining machines become more efficient, will coins get mined faster?
- What happens when the dollar value of Bitcoin is less than the cost of mining Bitcoin? (i.e., Bitcoin mining becomes unprofitable)
These questions can be answered using the contextual lens of the “Difficulty Adjustment Algorithm.”
This is not as complicated as it sounds. It is the adjustment of how hard it is for miners to mine Bitcoin based off the last 2,016 blocks of transactions.
Picture this:
Miners compete to produce Bitcoin blocks by throwing darts at a giant dartboard with as many landing spots as there are atoms in the universe (technically 2²⁵⁶ landing spots).
But if more miners come online to throw darts or get really fast at throwing darts, then Bitcoin would be produced too fast i.e. 21M cap would be realized next week.
In order to counteract this, the size of the bullseye is adjusted automatically by every Bitcoin participant (nodes and miners running Bitcoin software), recalculating the size of the new bullseye given the last two weeks of mining data.
If blocks were coming faster than 10 minutes on average, the bullseye shrinks to make it harder to hit.
If slower, it expands to make it easier.
This keeps Bitcoin production on schedule regardless of the miners joining or leaving the network, or an increase in machine efficiency.
Per Satoshi in the Bitcoin Whitepaper, “To compensate for increasing hardware speed and varying interest in running nodes over time, the proof-of-work difficulty is determined by a moving average targeting an average number of blocks per hour. If they’re generated too fast, the difficulty increases.”
How does the algorithm know how long it took for miners to produce 2,106 blocks?
Let’s look at a block:
Each block header has a timestamp (Bitcoin “blockchain” is also called a “timestamp server”).
When the algorithm processes the timestamp data from the last 2,016 blocks, it can figure out if it took longer or shorter than 10 minutes per block.
As you can see, the chart looks like a staircase because the level of difficulty is fixed for 2 weeks before it is adjusted again.
What If Bitcoin Mining Is Unprofitable?
If the dollar exchange rate of Bitcoin were to drop 99% tomorrow, every single miner would have massive negative margins. Almost every miner would drop offline. The level of difficulty would significantly adjust to make it easier, and Bitcoin would go back to being profitably mined on CPUs.
What does this mean for miners?
As competition to add a block increases, the difficulty also increases, making it harder for all miners to find the acceptable hash. Hashrate & Difficulty move in tandem:
The newest and most efficient ASICs can bear this increased difficulty better than older machines.
The variable difficulty of mining based on competition brings up a couple of key concepts to grasp.
- Bitcoin is a one-of-a-kind asset because no matter how much work is done to produce more units, the programmed issuable units remain the same.
Increased competition cannot add to the global supply.
If more people mine a precious metal or rock, more mines are built, more efficient extraction technologies are developed, and more deposits are discovered, increasing the total supply.
But if more people mine Bitcoin, despite the increased number of mining facilities and the capability and efficiency of new-gen miners, that same amount of Bitcoin is extracted.
- The more Bitcoin one miner produces the less another will.
Increased competition reduces the output of existing miners.
Whenever a mining operation expands, they are effectively looking to capture productivity from all other operations. There can only be 1 winner per block.
Bitcoin mining is the pinnacle of free-market competition and losing is not sustainable.
In short, new-gen machines are shadowing older machines, although at a diminishing rate. The difficulty adjustment is what keeps the supply on schedule, further motivating miners to maximize productivity to remain profitable.
