How Bitcoin Mining/Block Rewards Work

Many people new to Bitcoin in 2018 are just buying and holding it, but quite a few are getting involved with Bitcoin mining.

In this guide we're going to explain how Bitcoin mining rewards workl covering what a block reward is, how it's calculated/created, and how money is split between mining pools/individual miners.

There are two aspects of mining where you get money, the block reward and transaction fees. The block reward part is often called 'coinbase', so you may see these terms used interchangably - not to be confused with the Coinbase exchange. Both of these rewards are given in Bitcoin.

What are block rewards?

A Bitcoin block is 1MB in size, and Bitcoin transactions are stored inside these blocks (each time someone sends Bitcoin, a new transaction is added). If a miner mines a new block, they're given a reward in the form of the block reward (coinbase). This is the main incentive for Bitcoin miners, as the block reward is 12.5 BTC as of writing this, or around $150,000, a significant amount of money.

The block reward is halved every 210,000 blocks, which is approximately every 4 years (as Bitcoin's block time is 10 minutes per block). You can see Bitcoin's code for this here. When Bitcoin was created the Block reward used to be 50 Bitcoin, and is now 12.5 BTC. This decrease in block reward means that over time less and less new Bitcoin are created, which combined with increased demand is theorised to keep pushing Bitcoin's price up - so in principle the USD value of the block reward should be similar in 10 years time. When the block reward has halfed 64 times, the block reward becomes 0.

This block reward has to be claimed by miners, where they add it as the first transaction on a block. It has no inputs, but has an output to the miner's wallet address. Here is an example on a block explorer (it should be the first transaction in the list).

What are transaction fee rewards?

When sending Bitcoin, a fee needs to be paid by users called a transaction fee. This exists to incentivise miners to include transactions in mined blocks. It's effectively a bidding war to get your transaction into a block, where whoever pays the highest fee is processed first.

This transaction fee is given to miners, so essentially the more congested the Bitcoin network, the more money miners earn. This fee is essentially an extra payment sent with any Bitcoin transaction, and can be worked out by subtracting the outputs from the inputs of a transaction. As the block reward (coinbase) reduces over time, if Bitcoin price doesn't increase at the same rate - these fees can provide an incentive for miners to continue mining.

How do pools distribute rewards?

So when you start mining, you might have a dream of getting say 13-14 BTC in a week. You need to be aware that there is a huge number of people competing to create new blocks. By creating a new mining pool by yourself, the chance of getting this block reward is extremely low - although if you did get it by chance, you'd get a significant reward. Instead, most miners join an existing mining pool, where they'd get a more steady income rather than having to wait years for a single block reward. Mining pools are large groups of miners, where if any one of them creates a new block the reward is shared based on how much work each miner contributed.

Work is defined in hash power or hashrate, which in general means how many guesses can be made per second for the required hash. The split between miners differs between mining pools, we're going to use Slushpool as an example in this guide, but you can see how other pools work here.

How does Slushpool distribute rewards?

Slushpool, which has 10.5% of Bitcoin's total hashpower at the time of writing this (June 25th 2018), distributes rewards based on its miners submitting proof of the work they're doing. For example if the goal is a hash that consists of 18 zeros, a miner can submit any time after they've found the first 8 - which would prove that they've done work to get this far. They'd need to get all 18 zeros to win the block, but it would at least prove the miner is putting the effort in and so should be rewarded for it. The split is counted by the amount of work they have proved vs the total work proven by all the miners in the pool.

When you mine in a pool like Slushpool you often need to pay a fee on any rewards you get. Slushpool fees for example are 2%. Keep in mind though that Slushpool shares both block rewards and transaction fees with miners. Some pools that don't charge any fees only share block rewards, so although you're not paying a fee, you might actually earn more coins in Slushpool. The most profitable pool at any point in time varies.

Lets step back a moment though, now that we know how much work everyone's done - how is the reward distributed? The block reward for the miner who was lucky enough to find it would be very large, a lot more than the miner will see as a return from the pool in the short term. What stops the miner taking that reward and leaving as if they were in their own pool? Well the blocks are pre-built by the pool. Everything except the nonce (the value in the block that miners change to get a hash with a certain amount of preceding zeros) must stay the same. One would assume that the pool can then just verify the nonce, and rewards wouldn't be awarded if the user changes the address (as the hash won't pass when being verified by the pool) - incentivising miners to follow the pool's rules (although we are yet to find documentation on this).

How are Rewards Split Between Pools?

This part is nice and simple. Whichever pool guesses a Block's hash first wins the Block reward. The more hashing power a pool has, the higher the probability that the pool will succeed. Extend this over a long period of time, then the reward split between pools should be similar to the share each pool has of total hashpower. Slushpool for example, which currently has 10.5% of hashpower - should receive around 10.5% of block rewards and 10.5% of transaction fees.

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