The Blockchain Lottery: How Miners Are Rewarded

In their new book Bitcoin for the Befuddled, Drs. Conrad Barski and Chris Wilmer use non-technical language and clear, step-by-step approaches to explain the ins and outs of bitcoin. Here, they provide an overview of the "blockchain lottery" and the process of how miners are rewarded.

As an incentive for users to update the blockchain as frequently as possible, Bitcoin uses a lottery-based reward system. Many people become miners and try to be the first to add a block to the blockchain. Then, based on some probability, a winner is chosen and gets to add a block.

What is the purpose of using a lottery like this to run Bitcoin? Well, let’s imagine Crowley wants to buy a $10,000 car from Clarice. Using traditional currency, two people engaging in this transaction would probably go to a bank and have the money transferred between their bank accounts (or use a cashier’s check, which is analogous to this; see Figure 2-10).

They would do this at a bank because they need a trusted third party (a “banker”) that manages a “money ledger” and moves the money on the ledger from one person’s account to another. The banker’s job is to make an announcement that Crowley and Clarice can trust; that is, to affirm that the ledger has been updated correctly. (The banker may or may not be sporting a monocle, wearing a top hat, and smoking a cigar.)

With Bitcoin, we also need a person to adjust a ledger, which in this case means adjusting the blockchain by adding a block to it. It turns out anyone can fill this role, as long as he is not connected with either party in the transaction, because that could lead to a conflict of interest. Picking a person randomly through a lottery helps accomplish this. So with Bitcoin, a lottery picks a random miner, who then announces to the network that certain Bitcoin transactions are valid (see Figure 2-11).

Of course, there’s always a small chance this miner does know one of the persons involved in a recent transaction. This is why blocks are arranged in a chain: In roughly 10 minutes, when the next lottery winner is announced, this winner also confirms, as part of her announcement, that she agrees with all the transactions of the previous lottery winner (see Figure 2-12).

In the process, each winner in the Bitcoin-mining lottery receives a reward, which is a certain amount of bitcoins. The reward includes all of the transaction fees for the transactions in that block, which motivates miners to collect as many transactions into a block as possible, increasing their reward. To be eligible for the reward from the next block, which is added 10 minutes later, a miner needs to have the latest copy of the blockchain to participate in the next round. This process is done automatically by open source Bitcoin-mining software that runs on computers controlled by the people involved in mining. Because of this incentive structure, thousands of miners constantly help process the transactions of Bitcoin users, making sure that the blockchain is always up-to-date.

The reward lottery is run by the community; no central authority exists to choose a winner. We’ll skip the technical details for now and just say that miners generate random numbers continuously, until they find a winning one. This takes about ten minutes. The community then verifies (also through cryptography) that the number found by the individual miner is the winner, and the miner adds a new block to the blockchain and collects the reward. When this happens, the phrase commonly used is that a miner has found a block.

Bitcoin for the Befuddled by Conrad Barski and Chris Wilmer is available now through No Starch Press. CoinDesk readers can enter 'COINDESK' at the checkout to receive a 40% discount on their purchase.