Understanding its role in blockchain

Block rewards play an integral role in the tokenomics of a cryptocurrency. Read on to learn what a block reward is and what role it plays in the execution of blockchain protocols.

A announced 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 on the blockchain, and these rewards serve as a way to incentivize them to join and secure the network.

In proof-of-work (PoW) networks such as Bitcoin (BTC), network participants who verify transactions are known as miners. In proof of stake (PoS) networks, these are called validators or stakers.

In the Bitcoin ecosystem, the block reward incentivizes miners to direct their computing power towards securing the Bitcoin network. This reward is halved every four years or every 210,000 blocks in what is known as the Bitcoin halving. Miners also receive transaction fees as part of their reward for securing the integrity of the Bitcoin network.

Reducing block rewards is part of Bitcoin’s mechanism to slow the entry of new coins into the circulating supply, which helps reinforce the cryptocurrency’s deflationary monetary policy.

Block reward types

To better understand what a block reward is, you need to know that it basically consists of two components: block subsidy and transaction fees. Block subsidies are new tokens introduced to the blockchain and given to miners for their work discovering new blocks, validating transactions, and securing the blockchain. Transaction fees, on the other hand, are the money that blockchain network users pay to have their transactions verified.

Each cryptocurrency has its own verification process and reward system. Bitcoin, for example, uses the proof-of-work system for block rewards, as mentioned before. It is the original consensus mechanism used by cryptocurrencies, including Ethereum (ETH) in its early days.

Here, miners compete to solve complex mathematical puzzles to verify transactions and create new blocks. The first miner to solve the puzzle receives the block reward, which consists of newly minted coins and transaction fees.

In other consensus mechanisms, such as proof of stake, validators propose and verify blocks based on the number of tokens they hold and are willing to offer 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 deposits, the higher their chance of being selected to create a block, and unlike PoW, PoS networks generally have a fixed annual percentage reward for validators.

The combination of mining rewards and transaction fees creates a solid incentive structure for miners, promoting network security, decentralized management, and transaction verification.

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 do block rewards work?

Block rewards work differently depending on the consensus mechanism of the blockchain network. Consensus mechanism is a fundamental protocol used in blockchain systems to ensure agreement, trust, and security on a decentralized computer network.

There are various consensus mechanisms used in the blockchain space, but the two most well-known are the previously mentioned PoW and PoS, whose participants are known as miners and validators.

How do PoW miners earn block rewards?

When proof-of-work miners, such as those on the Bitcoin network, confirm transactions, they are packaged into blocks and a new block is added to the previous set of blocks in the blockchain.

There are currently 19.695 million of the 21 million Bitcoins in circulation. This means there are still less than 1.3 million Bitcoins to be mined.

In PoW networks, the process of earning block rewards begins when miners collect pending transactions. They then perform computationally intensive calculations, known as a hash, to find a specific value or one-off that, when combined with the block data, produces a hash with specific properties, such as a specific number of leading zeros.

The first miner to find a valid nonce that meets the difficulty criteria publishes the new block to the network. Once other network participants confirm 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 receive their rewards in the form of BTC, while Litecoin (LTC) miners receive their block rewards in the form of LTC.

Additionally, miners collect transaction fees paid by users in exchange for their transactions being included in the block. The total reward, consisting of the block subsidy and transaction fees, is then transferred to the miner’s wallet.

The block reward amount is calculated according to predetermined formulas that take into account various factors such as network activity, mining difficulty, and consensus mechanism.

When a high amount of transactions occur on networks, participants receive higher rewards. Likewise, if mining becomes more challenging, the reward may increase.

Block reward in blockchain varies as each network has its own reward structure. Some blockchains have fixed rewards, meaning the same number of tokens are awarded as a block reward each time, while others gradually reduce the reward over time.

For example, Bitcoin halving roughly every four years, and each halving reduces the block reward given to miners. The most recent halving event occurred on April 19, 2024, reducing the amount of BTC successful Bitcoin miners received for each block discovered to 3,125 BTC.

Once the last BTC is mined up to 2140, this will signal the last block reward Bitcoin any miner will receive, and after that, miners will only earn transaction fees as new Bitcoins can no longer be mined.

However, for now, Bitcoin miners will continue to earn the block reward determined by the halving, as well as the transaction fees accrued from people using the network.

The role of block rewards in Bitcoin tokenomics

The block reward in Bitcoin is important because it acts as an incentive for miners to secure the network. Each new transaction confirmation is added to the longest transaction chain. Ultimately, this ensures that miners only support the correct blockchain on the network.

Additionally, block rewards control the issuance of new currency. The block reward system plays an important role in the monetary policy of the Bitcoin protocol by determining how new coins circulate, 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 and has helped its value increase over the years as increasing demand is met not only by a fixed supply of coins but also by a slowdown of new coins. enters circulation. This caused upward price pressure.

How do validators earn block rewards on PoS networks?

In a PoS network, validators stake the network’s native token to participate in the blockchain’s consensus protocol to verify and process transactions.

Validators are then randomly selected to propose and verify new blocks based on the number of tokens they hold on the network. The more tokens a validator stakes, the higher their chance of being selected to create a block.

Additionally, the amount paid to validators depends on the percentage of the total amount of staked coins they hold. The more money they deposit, the higher their share of the block rewards paid.

Since different PoS chains pay different block rewards, the block reward depends on the specific blockchain.

Validators are often chosen in a deterministic or pseudo-random manner to ensure a certain level of fairness. On their turn, they propose a new block containing a series of transactions. Other validators then verify the proposed block to verify its validity, 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 tokens of the PoS blockchain minted specifically for this purpose.

It is worth noting that most networks implement some form of penalties to protect against malicious actions by validators. If they engage in dishonest behavior such as double-signing, censorship, or other violations, then a significant portion of their staked tokens may be lost in a process known as slashing.

Another thing to note is that validators can run their nodes or allow others to assign tokens to them. Delegators entrust their tokens to validators, and they share their rewards with them.

The system is popular because transferred tokens often add to the validator’s total stake, increasing their chances of being selected to propose a new block. It also allows those who do not hold a significant amount of tokens to still earn block rewards.

final thoughts

Hopefully now the meaning of block reward is more clear to you and you can see the fundamental role it plays in the cryptocurrency economy, especially in systems like Bitcoin where miners or validators play a very important role.

These rewards not only incentivize participants to ensure the security of the network, but also shape overall monetary policy by controlling the launch of new coins.

Mechanisms vary between proof-of-work and proof-of-stake networks, but they share the goal of preserving network integrity while rewarding participants for their contributions.

This dynamic interaction between rewards, consensus mechanisms, and network security forms the backbone of cryptocurrency ecosystems, ensuring their continued operation and growth.