TFTC: A Bitcoin Podcast - The Difficulty Adjustment (and Target) | Pierre Rochard, Center of Hash E006

Episode Date: September 2, 2025

Pierre Rochard, CEO of the Bitcoin Bond Company, discusses the functional importance of bitcoin’s difficulty target and adjustment, how it works at a technical and practical level, and why it is relevant collectively to the energy consumed by the bitcoin network, transaction finality and the issuance schedule of bitcoin’s fixed supply. https://www.nasdaq.com/articles/bitcoin-magazine-launches-bitcoin-corporations-show-hosted-pierre-rochard-ceo-bitcoin-bond https://www.linkedin.com/company/the-bitcoin-bond-company/

all right pierre thanks for doing this on short notice of course always happy to come chat feel like um as i was telling you before that feels like a hold my beer type episode but i'm also really excited for it we're going to talk about the difficulty target yep and the difficulty adjustment what it is its significance to the network and how it works and we're going to describe it like we're five so that everybody can understand um before we get into that though if you could share in your words how you think about the function of mining and the mining function relative to other network nodes that are non-mining yeah great question so um i think that the mining function is really dual purpose so there's two functions to it

and I think that sometimes they get conflated a little bit. So first of all, the biggest from an economic perspective is about issuing new Bitcoin onto the ledger. So there's this issuance schedule with the halvings that looks at what block height are we at and so how much new Bitcoin are we creating every 10 minutes. Now, I use these words loosely. I know that our friend Phil would say that they're incorrect words

because the issuance schedule was set on day zero, back at end of 2008, beginning of 2009, whenever Satoshi coded it. He released it in January 2009. The issuance schedule hasn't changed since then. And so really from an accounting perspective, you could think of it as a transfer from this um uh retaining pond uh this this uh you know set of 21 million bitcoin onto uh spendable utxos yeah so like phil has this idea that and we recorded with phil two episodes ago this is episode six he recorded episode four um that all the all 21 million bitcoin already exists i personally it's like i agree with that but i also think it's easier to conceptualize that the bitcoin are being issued like like you the the term that you used or that

they're entering circulation however you want to describe it i think entering circulation uh it should be compatible with phil's view yeah um because uh so now the the other part of it too is that the, if we, I think it is, he's making a very important point because when you hold one Bitcoin, you hold a maximum of one out of 21 million. So you own a fixed percentage of the supply and can't get diluted out of that. And so when people say, they talk about like Bitcoin inflation, like, I don't think that's the correct term to use. In fact, I would argue Bitcoin's neither inflationary nor deflationary it just has a fixed supply of 21 million and so uh then you know if we think about deflation more loosely of okay putting aside the monetary policy what

happens in practice yeah some people lose bitcoin uh and so there's you know deflation in that sense but that's uh unverifiable we don't know how much bitcoin has been lost exactly there's heuristics of estimating that. But in any case, that's the first function of Bitcoin mining is, and doing it in a way that is competitive. Because if we look at the history of monetary economics, even if we look at gold, the way gold enters into circulation historically has generally been through a minting process. And so you take raw metal and you put it through this minting function and then it comes out as spendable coins um and that historically what rulers do what states and sovereigns do is they want to monopolize that and so they take over the mints and they decide when

to mint yeah and how much to mint and whose face to put on it yeah uh and and yeah how much and what the percentages should be of of the the coinage uh and you know that's where we get into currency debasement so um it's really important to have if we're going to have a decentralized system for the issuance of the asset to also be decentralized and uh the only way to have that in practice would be to have it be competitive um you could also look at more modern alternatives like for example what ethereum did with their pre-sale competitive in the sense that anybody can participate correct yeah permissionless yeah um not not that everybody is participating which would be more of an egalitarian spin on it but really it's about equality of opportunity that

um you know from day zero uh all the bitcoin that have entered into the utxo set have done it through a process that anyone could have participated in and entering into the utxo set also for more common parlance entering into the circulating supply yeah yeah um and then beyond the issuance so go forward say like when all 21 million bitcoin are in circulation what function are miners providing in that world but they're doing it today as well but then how does that also distinguish say from how a non-mining node secures to help secure the network so uh yeah to your point we don't really have to go i don't think that we have to go far in the future to to see this function because this has also been around since day zero which is about

essentially providing a sequence function for transactions, meaning that how do we figure out if somebody tries to spend the same Bitcoin twice, which one is valid and which one is invalid? And so if you look at the today's banking system and you go and try to spend the same dollars twice, they will decline the second charge based on a clock that they have in their system. And so the bank is the one that's ordering the transactions to figure out, OK, which one are we going to decline and void? So obviously, we can't do that in a decentralized system. So what the mining function is, is akin to a decentralized clock that is ticking every 10 minutes and creating batches of transactions such that if a transaction already spent an output in the past, going forward, if somebody tries to spend that same output, it would be marked as invalid and that transaction would fail to be included in a block and fail to be broadcast out to the network. functionally how how do we coordinate all the activity that might be happening in the network

at any point in time with when people don't know each other um and they're in different corners of the world but need to know which transactions happen first exactly right and then within there how do you think about the mining function specifically to final settlement because i think that they're related yeah they are so um the the way that miners get paid for including a transaction is through the transaction fee. So if you're sending Bitcoin, you have to send a little bit less than you are unlocking. And that little residual difference goes to whichever miner includes it in a block. And so the transaction fees are really the sum from all of the transactions included in a block get added to that new issuance, which if you go into the source code,

it's called the subsidy i don't like that terminology i think that's one of the worst words satoshi picked up but uh because that has all sorts of connotations in economics what would have been a better word um you know i would have put new issuance or uh um yeah um yeah you know then then we could get to into maybe phil would have better uh terminology for not significant to this conversation but i'm just curious yeah um because uh you know subsidy implies like the government, like subsidizing something. But I do think that if you look at the white paper, the reason why Satoshi used that word subsidy is because in his mind, it was subsidizing people running Bitcoin nodes, because at the time, those two functionalities

of mining and operating a node were so intertwined that they were essentially a bundle in Satoshi's mind and when you read the white paper it seems like you know he is bundling those two functions together um not completely though because he does in the white paper talk about network nodes that are distinct from mining nodes so already he was starting to draw a distinction uh between those two functionalities um but uh if if we think about today how is uh how is the software architected you've got people will talk about a bitcoin mining company all right that has lots of mining rings and um is that a miner well in the parlance of satoshi it's interesting because for the most part they don't even need to operate a bitcoin node why because that mining rig is connecting

to a third party mining pool, and that mining pool can be operating a Bitcoin node. And that mining pool actually is under no obligation from a technical perspective to be operating a mining node. In fact, if we go look at the history of Bitcoin, there was this thought of what was called SPV mining, where you're not running a full node. And it was like headers first spv mining and the idea was to to make it so that you could um it be as efficient as possible in constructing your block template so that you're not having to to have the full verification um and then uh that got exploited uh and so how was it exploited this is something i don't i don't remember this or maybe it predated my time yeah um i i'd have to refer back to greg maxwell post

on this because, you know, he's obviously OG legend in Bitcoin history. But to get into specifically how it was exploited, but he was pointing out that, like, here's why you shouldn't do this is because of this happened in the past. But I think it proves an important point, which is that Bitcoin mining pools operate a Bitcoin node for the same practical reasons as anybody else, which is to verify that the history of the chain is valid and that they have valid transactions and that their reward is valid. And so every Bitcoin block has a transaction that is very special. It's called the Coinbase transaction.

Brian Armstrong stole that name to benefit his company. but uh yeah it actually confuses a lot of people when you're explaining technically how bitcoin work and you talk about the coinbase transaction they think that it's a transaction from coinbase good name for a company but you know yeah i still think it shows a lack of ethics uh just clobbering the namespace um and that transaction's special because it doesn't have any inputs so it's not unlocking any existing outputs um but it does have outputs and so those outputs are, if you sum up the quantity of Bitcoin being locked up in those outputs, that's going to equal or be less than, which is interesting, to the sum of the transaction fees and the subsidy.

It can actually be less than, and there's cases where miners have left Bitcoin on the table due to bugs in their software. And so that's where actually we're going to have less than 21 million bitcoin uh because of that historically some miners have accidentally not minted the correct amount of bitcoin they were supposed to the the asymptotic top was always going to be slightly less is that correct and then for a number of reasons and then but and then this what you mentioned specifically lowers it slightly yeah yeah so like one of the reasons is like if you just model out the ideal issuance curve and you assume like full supply it is not 21 million it's like, uh, 0.99999997, uh, you know, right below 21 million. Um, yeah. And then, um, a lot of

people, and I don't think that you agree, but I want to just ask the question. You don't think of that, what Satoshi called the subsidy as a security budget. So, or do you? Well, it depends because I've, I've heard compelling arguments that it adds to the security budget. And I've heard compelling arguments that it subtracts from the security budget. And I fall more into the latter camp. Now, when we think about security, first of all, that terminology is so broad because there is security of private keys, which has nothing to do with transaction fees and the subsidy, right? It has to do with, you know, what Unchained does, what lots of, you know, people self-custodying do and all this. So, you know, there's that. And then there's also

the security of the network from DDoS, for example, from, you know, malicious actors where really the role of Bitcoin nodes is very important and the role of transaction fees and the subsidy are secondary. So really when people talk about the security budget, what they should be talking about is transaction finality and right just use that terminology interchangeably when really i think that then it causes it's basically like a source of fud because now you're playing up transaction finality to be the security of the system kind of broadening the scope of it where like i'm like that's not really appropriate right and transaction finality is so important because in the example you were given before where it's important to know which

transaction happens first is also important if i send you a bitcoin and you give me your car then i couldn't end up with my bitcoin and your car right so like classic double spend would be that yeah i received i thought i received the bitcoin and let's say three blocks have gone by so i got three confirmations so it was included in a block three blocks ago um i give you the car you drive away, you drive to your mining facility, you rewrite the ledger history to remove that transaction, and ideally put in a different one that, you know, still goes to your wallet. And then that means that when I look at my wallet, that balance is now zero. And so now you have the car and the Bitcoin. And so I think that's called a Finney attack is kind of the

the, the, the word for that. But so it's really important to not have that happen because then that would undermine people's ability to use this as a monetary system. And the, so when we think about the subsidy versus transaction fees, really in the security budget, we're asking the question of how do we prevent that from happening? There's other attacks. So you could imagine There's attacks where you just mine empty blocks and you don't include any transactions. And so you're essentially preventing anybody from transacting on the network and that maybe that would cause the price to crash or something like that. And then there's attacks where and so that's that's really a denial of service type attack on transactions. There's also attacks where you're stealing revenue from other miners.

and so you could have a minority of the hash rate that is selectively revealing their chain to take revenue away from miners but all of these things i think are very much more theoretical than they are practical um and we can get into that but just in terms of the security budget the second point i want to make is that not only is the word security like overblown the word budget is also very misunderstood because people think of they'll post a chart of transaction fees historically and they'll you know the transaction fees are going down and the subsidy is going down in bitcoin terms yeah in nominal terms uh and then they'll say well look bitcoin security budget is decreasing well a budget typically when you think about budgeting you're thinking about the future

you're not looking at the past and so um one is that if if we did have a budget back then and we said okay the budget is 50 bitcoin every 10 minutes right that's what it was in 2009 and so now we with the first halving in 2012 uh now we need 25 bitcoin of subsidy and 25 bitcoin transaction fees. We didn't get that. Even back first having, there was no way the transaction fees were making up for the decrease in the subsidy. Somebody could say, oh, well, Bitcoin is less secure at that point. I would say, if you come under budget, that's probably a good thing because that means that the transactors got what they needed, transaction finality, at a lower cost than they expected whether it's in the form of dilution of issuance or in the form of transaction fees

and so i really see like mining from a user bitcoin user perspective is a cost center right like we have to put up with the fact that we have to give miners money uh it's not like to get transaction finality yeah it's not something to be celebrated of oh we wasted a ton of money on mining to get the same amount of finality yeah i look at it as like an efficient network should be able to do the same function for less and less of the overall output over time and that and i'm curious here is that what it like because i i personally think the idea of security budget is um like in a in a nominal term or an absolute term is is a misnomer because it's like well what ensures transaction finality.

It's just a nominal amount of currency. The value of that is dependent on how much people value it. So it ultimately becomes how much and how many people value Bitcoin that determines the value of what miners are being paid at any time, as well as the amount of transaction activity. But then it's what ensures transaction finality. And that to me, it seems like that is a function of decentralization.

I view it this way, is that the true security budget is how much would people be willing to pay to get into the next block? And so it really is about contention at the tip. And it's about potential fees. And you can't see that, right? So you can't see that unless you were to say, all right, I'm going to start mining empty blocks. And I'm going to see what happens. because the way transaction fees get set is in the mempools so each bitcoin node or you can actually run a bitcoin node without a mempool so you know but if you're running a mining pool you're going to want to know what are the transactions competing to get into the next block in order to make your block template and you're going to rank order them by what is their

fee rate and so if there's a lot of demand for block space there's a lot of transactions transactions and the network is getting, you know, quote unquote congested, uh, fee rates go up. And historically during times where, for example, at end of 2017, uh, during that bull market up to $20,000, uh, that was the top we thought we were euphoric at the time today would be depressed at 20. Um, the, the, we're depressed at 108,000, we'd be depressed at 20,000 for sure. Yeah. So at the time, transaction fee rates went sky high. And so it was just because of how much demand there was for block space. And that is kind of the revealed preference. But that preference is hidden in times where you don't have a lot of demand to get into the next block.

And so the real security budget is actually unknown because it's really about what are people's subjective preferences about transaction finality in the extreme scenario of like they're all bidding against each other. They're all bidding against each other. And then what what prevents them from essentially redoing the work? Well, so then on the hasher side or on the mining side, they're looking at, okay, well, what maximizes my expected value? Assuming they're rational, right? And so if they're going to look at two different block templates, one has lots of transaction fees by including transactions. The other is empty because, you know, that would be censorship, right? They're trying to exclude transactions. the rational one would try to include as many transactions as possible um and so then if there

is let's say there was like 60 of the hash rate that was mining empty blocks all of these transactions are accumulating in the mempool and causing transaction fees to increase until basically until you have either defectors from that 60 of hash rate being like that's a lot of money to leave on the table, like we're, you know, we're going to point our hash rate to an honest node, or new hash rate comes online. And that's actually really important that the entry into the set of hash rate is permissionless. And so even if somebody has 99% of the hash rate, they can't stop new entrants from coming in. And so that's really a huge difference with proof of stake, for example where they actually can stop stakers because staking itself is a transaction hashing

is not a transaction and so that's another like huge difference when we think about pure for stake versus proof of work um but uh the so the there's a huge cost attached to being an attacker i think is the underlying premise of proof of work. And that's really what, then if you look at it from a game theory perspective, if you as the attacker know that your attack can be undone by others, you're just not even gonna bother.

You're gonna find other ways to attack. And there's lots of other ways to attack Bitcoin than to just do the brute force method of 51% attack that are less expensive. In fact, people talk about, oh, what's the cost of renting hash rate, right? Well, it would be less expensive to do a cyber attack or to have insiders at pools collude.

See, but even there, what ensures the collusion? Because that's where I get to decentralization necessarily being part of what ensures the finality of So there might be an incentive to potentially attempt to collude, but if each individual actor represents a smaller share, their own expectation of what they could influence diminishes and diminishes. Do you think that that... So I think Bitcoin mining is always decentralized. Let's take the Reduxio ad absurdum of there's one dude in his parents' basement in his underwear. He's mining on his laptop.

He has 100% market share because the year is 2200, all the subsidies gone, and transaction fees are extremely low. And so economically, the only thing that's justified is one guy mining on his laptop. And he's clearing the whole world's economy on his laptop, or providing final settlement services for it. uh and then he's like okay well i'm going to start censoring some transactions and so some transactions start getting left in the mempool and those transactors rationally they start bidding up their transaction fee using rbf using child pays for parent and so they're they're starting

to like put chips on the table of hey whoever create an incentive for somebody else to come along so somebody else whips out their laptop and there's nothing that that first person can do to stop the second person from coming in and taking that money and contributing hash rate. And so even though he had 100% market share and everybody on Twitter could be saying, hey, Bitcoin mining is centralized. This is a huge problem. Well, it's not really a problem until he effectuates and abuses that power. And then it's a self-resolving problem because there's a market mechanism and the transaction fees going up that will then cause somebody to enter the set of hashers all right so now um that meant that like i understand the framework that that

that you have there um you mentioned before you know the second function being the ordering of transactions now i want to dive in to the um the hold my beer discussion of trying to explain in a way that is digestible but i do want to get into the technicals of how of what the difficulty target is what difficulty adjustment is and how it plays into because if we if we start from the idea that if i send you a bitcoin i send somebody else the network needs to know which one of those happens first and one of them needs to be processed for transaction finality or for final settlement um and and another one invalidated all you know in the in this scenario you just described for for just illustrative purposes of discussing the incentives

setting that one aside but going to this world of there's a lot of people out there running bitcoin mines all over the world practically speaking every state in the country every country in the world wherever there is excess power all of these miners and you mentioned they're all competing with each other in your words describe the before we get into the technical of how the difficulty adjustment works and the difficulty target what the significance what it is, and its significance to the network in ordering blocks? So it's really a way of getting the... So, I mean, first of all, on the subsidy is that you want to prevent seniorage.

And so those monopoly profits from issuing new currency, you want there to be a cost associated with that. And the only way to have that is to have competition over it. Um, and then what form that cost takes for Bitcoin mining is essentially the consumption of energy and of semiconductors. Um, the, on the transaction side, uh, you know, the, the importance there is to make sure that, uh, we don't need to have a proof of authority of some kind of centralized clock that is saying, okay, whose transactions come in first.

You know, Wells Fargo, very recently, they entered into litigation over this because they were reordering people's transactions to maximize overdraft fees. Oh, I remember this. So whoever controls the clock actually has a lot of control over the user experience of the system, right? And that conceivably, they would also be in a position to give themselves more Bitcoin. Um, and so it's really, uh, yeah, the, now the, the other part that we have to keep in mind is that when they find a, uh, when they mine a block, they're not, um, imposing it on the network. They're actually proposing it to the network.

And so all the Bitcoin nodes, when they receive that block, they make sure that not only is the proof of work part of it valid, which we'll get into soon, but they also make sure that all the transactions are valid and that there's a list of rules of the Bitcoin protocol that are being followed, including the new issuance, the block size limit. And that is, and, you know, this gets into kind of the area where there's a lot of debate going on right now about, you know, is Bitcoin just a database or is it money? Well, the rules that the Bitcoin nodes are filtering with, to use a letter term, they're really optimized to create a transactional monetary system. You know, they're really, that's what their intent is. It's not any other kind of intent.

And one that also, and here's where we enter into tension, is censorship resistant. So, for example, like the block size limit, on one hand, you've got people like Roger who will say, well, you're censoring transactions that could go into making that block bigger by having the block size limit. But the counter would be that the block size limit allows for one, low cost of operating a Bitcoin node, which you don't want to censor Bitcoin nodes, because if you censor Bitcoin nodes, then there's no way to verify the monetary supply. there's no way to be self-sovereign um and it also alleviates the problem of censorship of

network traffic so a smaller block can fit through the tor network for example more easily than a large block uh and so uh it's there there's always going to be competing claims of this person censoring me and the the rhetoric being no i'm trying to make it more censorship resistant uh and so you know that's hopefully that triggers everyone um where were we i feel like it should have triggered we covered a lot of basis of like triggerable offenses yeah so now bringing it to yeah and i think it was you made an important um comment about the blocks being proposed and that the individual blocks have a number of rules that determine validity and that they check to see each node checks to see in a block that is proposed by a miner

are all the transactions in it valid is the amount of bitcoin being issued or entering circulation is it consistent with the fixed supply schedule of 21 million but then there's the difficulty target it does does this block meet the difficulty so what is the difficulty target well sorry i wanted to make one additional historical note on the blocks being proposed, because we actually have a case study of a block was proposed by a pool where they included the fees and the subsidy in the Coinbase, but they had a bug in their software such that they didn't include any transactions. And so for any node verifying it, it seems like they were trying to inflate the supply of Bitcoin because they were adding the fees without there being transactions to, you

know to pay for those fees uh and the bitcoin nodes all rejected it as invalid okay i remember this block but i did not remember i didn't i did not realize that that was the uh that was the issue with it so so so the other nodes interpreted because the transactions weren't there but the fees were that all of those fees were the um subsidy basically subsidy because they weren't actually validating the transactions they were in the block right uh and so it what it proves is that even though this block had the most work and even though you could say oh you know that if the miners are in charge that block would have gotten into the blockchain but the reality is that the miners are not in charge so even if they've got the most hash rate the most work if they have

an invalid block then it got discarded and that mining pool received zero revenue right and then and part of that there was that they're competing with each other and that they don't have an because they're distributed and they don't know each other in part they don't have an incentive to let somebody else have or get a reward that doesn't have valid work right uh it's or invalid work well it's it's a bit of a prisoner's dilemma like if you don't include a transaction in your block to collect that fee you know somebody else is going to and so then you have the game theory incentive of including it in right and but you made a comment that i is getting to the to the the heart of it which is something so it's not enough to have the most work

or the longest proof of work it all everything also has to be valid right but explain the concept of the most work right so most work um you could so let's let's talk about the difficulty because um essentially when when satoshi launched bitcoin he was mining on his pentium 4 and let's say the second person comes online and starts mining so when he launched bitcoin let's say it's there's and the way that the nodes calibrate things that we want to block every 10 minutes and so let's see where to start the explanation it's kind of a chicken and egg thing Let's start it with what is the difficulty. It's a number that you're trying to get under as the miner.

Because let's think about what mining is, first of all, hashing. Okay, so a hash function, you take a piece of data, you pass it through a hash function, and you essentially get a cryptographic fingerprint of that data that's specific to the data you put in. so if you put the same data in through the same hash function you will get the same output it's deterministic it could be like for simplifying terms so they know it's not this simple but you put you put a string of information in and outputs nine and then you put a string of information in and outputs eight you know it could be you put a string of numbers in it could be 100 right and in in practical reality it's 256 zeros and ones right yeah uh shot to 56 is the hashing

function that bitcoin mining uses so when you say getting under is that you're putting the information in and continuing to try to hit a number that's below a certain number yeah uh you you can think of it like uh at a hawaiian luau party right you're like trying to get under the bar right uh i forget what that if it gets lower and lower it gets harder and harder yeah exactly the difficulty increases um and it's probabilistic so if you think about 256 zeros and ones So a hash function is random. So if you put in different data, even if it's different by a tiny bit, then the output is completely randomly different.

And so when we're doing this with Bitcoin mining, the input data is what's called the block header. So the block header is information about that block metadata that includes what's called the merkle root which is the sum of all of the transaction hashes so and describe that in a way that somebody um could interpret basically an easy way to summarize all the transactions right in the block that's right and in a way that if you change one of the underlying transactions well now that hash is going to be completely different and so this is when people talk about bitcoin being immutable. The immutable nature of Bitcoin's blockchain is really enforced by the cryptography

of the hash functions. When your wallet creates a Bitcoin transaction and broadcasts it out to the network, it'll give you a transaction ID. That transaction ID is a hash of the data in that transaction, which includes the inputs that are unlocking the Bitcoin that have your digital signature that you signed with your private key and it has the outputs of where those bitcoin are going um and the the addresses that those bitcoin are going to so you we can start with thereof you you take that transaction id and then when the the mining pool is choosing all of the highest fee-paying transactions, it combines all the transaction IDs into one hash, and it does this through a cryptographic process called a Merkle tree. And so that's why the terminology is the

root, is because you're summarizing all of the transactions and you're fingerprinting all of them into a very compact format that way the train the the block header is very small relative to the whole block so a whole block could be as big as four megabytes the block header is a tiny fraction of that because the the the merkle root is summarizing all the transactions in in that block header you also have the previous block header so um that is where we get into the blockchain because that's how you chain the blocks together is by embedding the previous block header into the next block header and so that way um everything is interrelated and you can't go back and change Bitcoin's past

without also changing everything that follows it. And you know the, and the significance of that is knowing the state of ownership at any point in time and how it changes. Yes. So now you know, what are we building on top of with this block?

We're not building on top of any other block header. We're building on top of a specific one, Um, which actually is, is an interesting contrast with, uh, uh, proof of stake where you can actually, uh, build on top of an infinite number of, uh, previous, uh, blocks, if you want to call them. Anyway, uh, this is going to turn into like a trashing proof of stake, uh, episode, but, um, so the, when, when, you know, okay. So if we go back to day zero,

Satoshi created the Genesis block. That's actually the only block that was not mined. But I want to reassure our listeners, the 50 Bitcoin in the Genesis block are unspendable. Right. Okay. So let's not get into a pre-mine conversation. Like, yeah.

19.9, some odd million, 50. Yeah. First block, not mined, but can't be spent. Can't be spent. Invalid. all right now but but but coming back to okay so you're you're got the each block having a block header that points to the uh the previous block header summarizes all the transactions basically and what the version of the of the longest you know kind of proof of work up at

that point in time but then coming back to okay we've got this difficulty target you know what you know what does it what role does it play yeah in basically coordinating the network function so the block header has the difficulty target in it as well it's called n bits and this represents and so this this can be calculated by any node you don't have to be a miner to calculate what the difficulty should be what you do is you look at the past 2016 blocks and so okay if we say there's a block every 10 minutes that means there's 144 blocks per day and multiply 144 by 14 days then you get to that 2016 blocks okay so that's something really important yeah because this would and we're actually jumping ahead a little bit but i but i think there's

no way to have a linear discussion about this which is that this was the part in mastering bitcoin by antinopolis where because i had this question like okay well without relying on a single source of truth or an oracle to tell you what happens first how does each miner arrive at what the difficulty target was so you had mentioned difficult target being you know a number when you put in a certain amount of data into this hash function inputting that data set and it generates a random output and then you check to see if it's below and if it's not you keep going but then maybe like talk in a little bit more detail this idea that the miners are basically looking at all the blocks proposed

seeing the rate at which they're seeing them and then how they actually get to the same target yeah so um the on day zero satoshi just picked an arbitrary difficulty of well what did he reasonably think maybe he probably did some testing of like how many hashes can i generate with my pentium 4 in 10 minutes and then using that to calibrate the initial difficulty level then fast forward two weeks later now i say two weeks let's say more hash rate came online and so instead of 14 days it was 12 days still 2016 blocks but because um basically if we think about okay what's the probability of finding a number below the threshold of the target um the more attempts you have at doing that the greater the probability that you're going to find a winning

hash and the faster yeah you would find it a good metaphor is essentially asking you to flip a coin heads or tails and asking you to get heads five times in a row and if you don't get it five times in a row then you've got to start over right so if you get it two times in a row and then you do tails you start over and you've got to get sequential five times in a row. If you're really flipping that coin very quickly, you're going to get to a result faster. If there's two people flipping a coin, they're going to get to the, one of them's going to win more quickly than if there's just one person flipping a coin, right? And then if I want to slow you guys down, I'd say, all right, get ahead six times in a row. I've increased the difficulty. If I want to speed things up,

then i'd say all right get it four times in a row and so it really is uh a a question of statistical probability um of how quickly are you going to find that winning combination and that's that's the intuition behind uh creating a way to calibrate that decentralized clock that is decentralized so when the nodes look back at the past 2016 blocks they calculate okay what is the time at which i saw the most recent block and what's the time that i saw the first block in that set of 2016 and so then get let's get an average of the difference between those and that should be 10 minutes and if it's less than 10 minutes then i'm going to increase the difficulty such that we get back to an average of 10 minutes and so deterministically now okay so

now the both okay so that's really important um but explain the significance of the 10 minute going back to like why why um why not five minutes why not 15 minutes or in you could talk about it either in relation to security and orphan blocks or just in terms of like the pulling forward of all the issuance of Bitcoin? Yeah. So the way that Satoshi set to issue Bitcoin, I think there's two lenses to look at it through.

One is that it's arbitrary. You've just got to have some kind of schedule that gets the Bitcoin out into circulation in a way that's competitive, right? And so he could have made it so that within the first two weeks, all the 21 million Bitcoin got mined. For whatever reason, he wanted to spread it out over several decades. Now, half of the Bitcoin got mined, you know, in the first four years.

And so it definitely was front loaded in terms of the issuance. um and and then it tails off until the year 2140 but really in by the 2030s 99 of the bitcoin will be on the ledger and so um you can see that as like okay well that's that's arbitrary uh maybe the environmentalist would say that he should have front-loaded it more because if he had done that we would actually have less electricity consumption into bitcoin mining today than we do have and so uh like what elizabeth warren should be advocating for is a soft fork to remove the subsidy today uh and that would actually be uh feasible and i actually i don't know i don't know if i don't know well of course not socially feasible changing the rules on all these guys who are running all

this power to to get that subsidy but i don't know if i follow the the idea that it would reduce because it just comes back to how much people value no because look like if bitcoin's not under attack then transaction fees are low and if there's no subsidy then the top line revenue for the mining industry is low and so it just justifies a low amount of power consumption right but then if the nominal amount declined and it was just transaction fee was but you know eight billion people started valuing it then wouldn't it well i'm just saying all else equal yeah yeah yeah if we had mass adoption then yeah i agree that the transaction fees would go up unless you know some brilliant let's say tomorrow some big brilliant bitcoin protocol developer

comes up with some cryptographic magic that makes it so that the efficiency of using block space increases a million fold and and we get eight billion people on chain but we only need like 400 kilobytes per block and so transaction fees are de minimis right like and then we had no subsidy then the power consumption of bitcoin's proof of work would fall to almost zero and i would argue bitcoin is just as secure as it was today um i'd have to think about that because ultimately like again in my framework you've gotta you have to have currency that's valuable to pay a wide number of of participants and that the more distributed and the more decentralized it is yeah yeah that the more decentralized it is the the the more reliable

final settlement is and the more you can pay people for power more places the more distributed it becomes but setting that aside because we don't want to give senator warren any ideas i'm happy to give her lots of ideas i know she she has very little follow-through yeah honestly it would be good for bitcoin because it would make more people understand it But coming back to the idea of the target and basically each miner, it's basically like if the blocks are being found faster, then each miner individually looks at the rate in which they saw the last 216 blocks and adjusts back to say, you know i saw the last two 2016 in nine minutes i need to make it you know 10 divided by nine harder to then have the next and the significance of that is it basically ensures that one there's the that um there's a period of time in which that subsidy is distributed those those decades

that you didn't mention it out yeah um and then there also is a security component of the 10 minute not in the sense of the security budget but in terms of the ordering of like what's the probability that a block is found at the exact same time probabilistically that could create a split in the network there yeah so there's that um and so you want to have enough time for blocks to propagate globally um so that also you know if you have lots of hash rate in north america if if you had a shorter block time then there would be an incentive to co-locate and hash rate would become geographically concentrated due to the block interval but 10 minutes is long enough to get from texas to tokyo you know in fact obviously if you look at the speed of fiber

optics like it gives you lots of wiggle room uh right but then at any at any interval if it was probabilistically 10 minutes or if it was probabilistically 9 minutes or 11 minutes there's some medium where if if it's probable that it's going to take 10 minutes that that it's also possible that two two miners find it in very short period of time simultaneously but that happens right yeah it does yeah but but am i wrong in thinking that or at least this has been my understanding that that the difficulty um and it being set at that um it's not that it doesn't happen it's going to happen but with a certain frequency and if it was every say two minutes it might happen in greater frequency than if it was ever 10 minutes just probabilistically

yeah um that's that's right um i don't i think i in my mind it really is about uh leveling the playing field from a a global uh block uh propagation perspective is yeah the the other part of it too is on a practical level like we're already you know we've got hundreds of thousands of blocks like from a software perspective if you had like every one minute you'd have 10 times more blocks and that just it just adds to the overhead of operating a bitcoin node if you've got even if if they had like if you also cut the block size limit in by 10 um you're just increasing the amount of like metadata overhead that the the node has to to deal with um smaller issue but the only caveat i want to add is that in the the the difficulty is really being set by the bitcoin

nodes and so when a miner proposes a block it's going to make sure that it's going to calculate the difficulty so uh use a little bit more specific language where you say the nodes are setting it well the the nodes are looking at the past 2016 blocks every 2016 blocks and that if a miner proposes a block that has an incorrect n bits in it that it would get rejected as invalid right so you could be a non

mining node you're calculating independently independently the frequency with which you saw the last 2016 blocks and it's actually not what you saw because the the timestamp is included in the block

I was going to get there I was going to ask the question because I remember learning this but then the question is technically each miner might see a block at a slightly different point in time

so describe how they're able to get to the actual right amount because it makes a difference let's say you're mining and you put a time stamp in your block header that's like two days in the future nodes would reject that

as invalid you have to be but if you put it five minutes in the future it's fine there's so there's a there's a limit to how far into the future you can put your time stamp and so that helps keep things honest uh and then also you can't and so for does that mean and um that is it is it five minutes or is it is that i don't know what the exact threshold is yeah okay because i was wondering if like someone's hashing if if like their template if they haven't found a block in that didn't really just update for they have to eventually update yeah the template um the other part is that you you can't have it be so far in the past before the previous block now my

understanding is that it can be the time stamp of your block can be slightly before the time stamp of the previous block and so you've got negative time between some blocks where you know you would where you still like the if i my understanding of that is i times i timestamp something um i don't know what time it is but i i timestamping two o'clock you timestamp something 202 because you're just yeah uh estimating it can it needs to be in this window you actually solve a block propagate it that's timestamp 202 i then get really lucky solve a block the next block within the window and it's uh it has a timestamp of two o'clock and then like technically my blocks after yours but your time still valid even though yeah things are okay but now get back to how if that's the case

and you know the time stamps aren't precise people are are um ordering yeah 2016 blocks and looking backwards to see what was the well because there's limits on how imprecise they can be over an average of 2016 blocks that would not have an effect okay but but am i right to say that if ever if everyone calculates their own difficulty target do they actually get to the exactly precise same number um i'd have to double check that i'd have to double check that My understanding is that they do, but I'm now like trying to, that was one thing that was, you know, mind boggling, but yeah, because if you, if, if you weren't at that exact same number,

then a certain number of times, somebody would think that they had a probabilistic block that was that met the target. So I, I, I, I want to more confidently say that the NBITS is global and is the same for everyone because the time stamps even if with the wiggle room we talked about it's in the block header and it's hashed and it's global as well so everybody's comparing the same time stamp yeah so maybe and then then it might be there's a time stamp of the 2016 block and there's a time stamp

of the first one and they might use and then they subtract those and then they divide by 2016 and then they see how many minutes yeah okay so and now i always try to now make it relatable right because you can like start zeroing in but like the important thing is there's a mechanism to to allow everyone within the network independently from each other to sequence blocks but then readjust as more essentially power comes online or less or less to adjust and synchronize the network such that on average the blocks come through every 10 minutes and that it doesn't materially pull forward the issuance of the supply or materially slow right if for a period of time

the hashrate comes off. Now, in a practical setting, the Bitcoin hashrate has increased significantly over the past, since inception. And so as more work, as the difficulty target is going down,

the amount of work to hit the target is going up what in your how do you think about contextualizing the significance of more work coming online not translating to either you know faster time or more of the currency units yeah so um because of this exponential increase in in hash rate we're living in the future so we've got blocks arriving that if you had just done you know i don't even know what the block height do we have a block clock in here we do have a block clock but is this working it's not on uh current block height it swaps all right well um you know we're we're uh i'm trying to think of what this the this moscow time right now logan what block height are we at

okay 912 297 so if you look at i think it was january 2nd 2009 was the first block and if you multiplied 912 by 10 minutes you know it's probably several years maybe in the at least months uh in the future um but uh that's why you should not rely on bitcoin's decentralized clock to you know get on time to your wedding right like it's it's it's not a clock for that it's only about making sure that we're not double spending bitcoin um and so the when we think about like proof of work i think that a really important intuition is that the work is being done by the bitcoin miners and so let's say you know we're at uh one zeta hash uh per second right and so we're generating this astronomical amount of hashes um put that into context because

most people yeah maybe i mean bitcoin miners would understand maybe what a uh x a hash or zeta hash is are we at a zeta hash but anyways almost that's distracting yeah it's almost counter the point um equate it in power or um well okay so let's we we can we can do metric system education on this podcast right yeah uh so one kilo hash would be a thousand hashes per second right uh a mega hash is a million a giga hash is one billion uh a tera hash is one trillion so the latest generation of miners they might be in the ballpark of like 100 to 500 tera hash per second of trillions of hashes per second okay so that would be 500 trillion yes let's see like Trillion's the number of the people.

Yeah. Already, like, we're talking about the federal budget deficit. Yeah, which no one can conceive of how large that actually is. Yeah, yeah. It's phenomenal. Now, then if we go to one petahash, so multiply that by 1,000, and then... Okay, so that's quadrillion. Yeah.

And then you get to exahash, that's quintillion. And then zetahash. So today we're probably at like 800X a hash. Yeah. Higher, I think like 900. One way to think about it is that there's millions of Bitcoin mining rigs out there that are hashing to get to that. And each one of those is consuming or requires power to hash.

Yeah, so then if we translate it into energy talk, we're probably around 22 gigawatt hours of like over an hour, 22 gigawatts. Right. Right, and maybe a way to think about that is that to solve the next, assume that it was, for a round number, let's assume it's 20 gigawatts, that it would require running, probabilistically, it would require running 20 gigawatts of power for 10 minutes to solve the next block. Divide the 20 by 6, and that's...

No, you're right, you're right. For 10 minutes, yeah, it doesn't matter. It would require 20 gigawatts to solve the next 10. And that if 10 more gigawatts of power came online, for a period of time, the blocks would be found sooner, but then it would adjust to say, hey, for the next, you know, probabilistically you need to run 30 gigawatts of power

to solve the next block. Yeah. And then part of that work like that like you know this is a hard way to ask the question but it's like you're out there mining you might know a friend that mines but you don't know who's you know in terms of like identity solving these blocks and the in each difficulty or the next block and and the next 10 minutes and the next time for the 2016 but you need a way to know that others are actually doing the same work that you're doing or that or that they're relational to each other

that basically if like you can't fake power i'm trying to find some way to to explain that where um you might be slightly better be able to produce power at cheaper costs or set up your mind marginally you know better but we're all essentially competing against the same game that that is competed on the margin such that if you're producing work i know that the work is comparable to the work that i'm doing but then explain that and the concept of this coordination function of we're all doing work and we're all validating each other's work to then sequence blocks which ultimately add up to the highest level idea that we're facilitating a currency system and and needing to know who um who has the money at what time and that people can't spend it

but kind of like just maybe you know kind of going back up a level we've been deep down in the weeds we've kind of figured out how with with no central coordination miners have this way to figure out how much work must be done to consider the block valid in addition to all the transactions being valid pointing at the right version of history but then you know like the connection between okay if you zoom in too close you're like but why are you consuming all of this power like fit that into um the functioning of the broader network so they're they're they're consuming all this electricity to generate all of this astronomical number of hashes and then every 10 minutes they find one hash that actually has value and that one hash is what we call the proof right so the

all of the work gets discarded because uh it's it's not valid hashes but they needed it to find that one valid hash the proof and then when they broadcast that valid hash all the bitcoin nodes can verify that that hash is valid using very little electricity. So there's this huge asymmetry between you're consuming all this electricity to propose a block and it takes a tiny, minuscule fraction of that to verify that what you did actually is correct.

And then, so that applies to... everyone in the network can rely upon it as good right because if you're if you're mining this and this is the real you know the reason you want to run a bitcoin node as as a mining pool is that if somebody sends you a block header and a hash and you don't verify it using your own node and you start building on top of it you could be building on sand right because it could be an invalid uh hash in which case when you find your valid hash and you broadcast it out to the network all the nodes are going to say no that's not valid because everything about it is fine except for the hash that you included in your block header because ultimately when you were basically looking

at the past we're further further in the future uh if you were if you were building on an invalid blocks yeah yeah and and they so there's there's a hole in the history that you're trying to build on right um contrast that with xrp where they lost the first 30 000 blocks that doesn't matter it's gone do you know why yeah he's creating more of it yeah yeah it's fine there's no mining and then that comes into this idea that you can't you can't produce bitcoin without a massive amount of work and that you know because you said it's basically like you do all this work to you know think about it's like 20 gigawatts of power running concurrently you know and obviously i'm using that number to yeah to give some order of magnitude but it's

constantly changing power is coming offline power is coming online more power is coming machines are getting more efficient so we don't actually know how much power but let's also contextualized 20 gigawatts that's approximately uh one-third of texas electricity grid yeah at its peak yeah at its peak yeah yeah we're pushing it uh but broadly speaking on average peaking like the spring or something you know so the it's it's a lot of electricity but at the same time it's not like we're you know using all the electricity on the planet no no i don't want to present that but But that it is a significant amount and that what it does to that process

is it clears all of the value, a clearing from the perspective of everyone who sent money and bid enough to be in that next block, which you communicated the significance of that bidding process, that now we can get on to clearing the next financial transactions.

I would argue, more importantly, so if 95% of the Bitcoin mining revenue comes from the subsidy then what that represents is that we have destroyed the value of the subsidy by consuming it instead of having that be a monopoly profit of seniorage and so you know the fact that if we look at like a natural gas power plant they essentially we've burned natural gas in order to exhaust out the new issuance and not allow any single participant to you know profit off of that that from a monetary system perspective that's how we maintain the morality of the system because now um i'm trying to i'm trying to wrap my head around it it's that

effectively i'm trying to um reconcile that idea is that you're putting some cost to it yeah so you're saying exhausting it but it's like it's ensuring that there's some cost to it versus there being no cost to it correct because there's because there's one scenario where there's no cost to it which is the the senior age the the central bank the trust that third party can just create the money yeah and that we're maybe not destroying the value of the subsidy we're unlocking we're giving it to somebody but we're ensuring that they put in work there yeah their profit margin is approaching zero but there is some profit motive to actually do the operation and some are going to be better than others right some are going to mine at a loss some are going to

mine at a huge profit but that on average the average miner should be basically a break even the median minor or well the the marginal minor really is going to be a break even right yeah and that it you know in one way you could create think about is race the bottom on the other side it is as it commoditizes yeah it should become a very stable activity that has a very slim margin but reliable low return um but in the greater context of how do you coordinate a monetary system that everyone can participate in permissionlessly and you need to reconcile that what transactions happen first everyone has to propose that but then everyone else has to validate it and you need a way to order and you need a way for

you know imagine a thousand people that don't know each other to look at each other's work and know that they did something in relation to the amount of work that was required and that's all i mean that at its core is this idea of the difficulty target and then the adjustment the difficulty adjustment being how do we um basically gate or synchronize as things speed up or slow down to ensure that we're kind of within a frequency. That's right. Without the difficulty adjustment, if we'd stayed at the initial difficulty, we'd be finding a block like every second, right? Um, but more realistically, what would have happened is that we would have speed run all of the subsidy blocks. And, uh, today, you know, the, uh, and if you, and if you're

finding a block every second it's more likely that people are finding blocks concurrently distributing and then the network can't reconcile which one of these actually did happen and you can't have a block size limit because in order to say we're only going to have this many megabytes per day you have to have two limits one you have to limit the number of blocks per day and two you have to limit the size of each block that's a very important point and so that's the those two things go hand in hand as well because it ensures that there's scarcity of yeah after all of the bitcoin is issued or entered circulation that there's something to to create uh prioritization or to to require that people bid on the space well so you would still have that in the sense that um

you'd still have people using like child pays for parent to to to keep their order uh correct i know but if but if if it was like every second it's like if time wasn't a limiting factor then it's functionally infinite right and so to me the bigger problem would be that only google amazon and and apple could run a bitcoin node because of the resource usage yeah because you'd just be adding more data right yeah with greater frequency at which you're changing the state of the network the the faster it is the more you're yeah compounding yeah and they'd be the only ones that'd be able to mine too like it would and then they would decide on the monetary policy okay and so now last question and this is going to bring it back up to to a high level

a lot of people think about will describe the difficulty adjustment and or the difficulty because like all the times people say difficulty adjustment but it's like if you don't have a concept of what the difficulty target is yeah yeah then how can you have a concept of adjusting it yeah um so those two things difficulty target and definitely adjustment as being one of the most profound pieces of the puzzle that Satoshi put forward in taking other puzzle pieces that had preexisted over those 30-some-odd years where cryptographers and cypherpunks were trying to figure out

how to make a digital money system work. Dhruv Bansal, friend, co-founder of Unchain, before an idea and it's interesting coming from him because he was someone that I think has come around to the monetary side but started from the technology side

has a physics background when he did his deep dive on the history of Bitcoin and what Satoshi what he theorized Satoshi must have been thinking that in Drew's mind

he thinks that Satoshi he must have figured out that he needed a fixed monetary policy to make all the incentives of the network work. And then once he would have figured that out, then he would have needed a way to meter the distribution and that the difficulty adjustment and target would have logically followed that. What do you think?

Do you think that... Well, you could... I think the incentives would still work even if there was not a limited supply. In the sense that if there was no halvings, I think the incentives would still work. Well,

if there were no halvings, you think the incentives would still work? Yes. It's so... Wait, are you saying if there was no fixed supply that there would... It's still a... There's no ceiling, but

obviously they couldn't create more than 50 Bitcoin per 10 minutes. no no what uh what i'm saying is like because even if even if there weren't havings but you still had the difficulty adjustment you'd still need a way to a meter to ensure that it all just didn't yeah you'd still have a difficulty adjustment yeah but do you think that that the the fixed supply was came first in terms of uh in order to make this whole thing where i need to fix supply and now i'm just talking about how i distribute it because you could still have the difficulty adjustment you could say 50 every minute and adjust difficulty or well until we

get to 21 million yeah or i i would argue that if we if we look at the white paper that he started with okay we've got a centralized time stamping server how do we make it decentralized and centralized in the sense of like this is the way the central bank works yeah we've got a server you know how do we how do we get this guy out of here he's got the proof of work part from adam back right and then he's adding in the difficulty adjustment um and that the issuance is he's thinking okay well how do i get the bitcoin onto the ledger he thinks of this clever hack of oh i'll add it to the transaction fees as so that's the way i read the white paper and that's where he says oh well the issuance it can work like uh gold mining uh and uh that uh and and that's

he was the first person to call it mining um but in that context in that paragraph when he talks about it's like gold mining he's specifically talking about the new issuance he's not talking about the transaction ordering but like the white paper doesn't say anything about 21 million doesn't say anything about i don't think it even says anything about so it was only in the code it's in the code yeah and then the white paper like his intent is to prove that he solved the double spending problem on the transaction side not that solving the double spending problem was necessary in order to secure a fixed supply monetary policy one of life's great mysteries i don't think it's such a mystery he wrote the white paper right i mean but he but he wrote the

code first true but and he didn't he's communicating to the world of like what has he accomplished to him the value of what he and look i think we can today we can debate whether it was the most important thing or not right because what i was put before was actually yeah yeah not what we think is the most important but what you know what he thought was what he thought or the sequence with it which he put these things together and that drew you know in his mind thought that he must have put the the 21 million together and in an interesting point i think rob warren put out a thread about this so that um both way die and um i think nick zabo both um initially when they saw the 21 million fixed supply they thought that that was what was going to cause it to yeah to

never work so there could be an an idea that he realized that but also realized that people would just you know discount it so maybe just didn't emphasize that it was critical to the whole thing working in the white paper but um yeah i think it's you know bitcoin's working and that's the most important thing but i do think it's it's interesting to think about them in relation to each other of you have the monetary policy and then you have the the difficulty target and adjustment that you know helps distribute it i think that each other um satoshi's intent was to incentivize early adopters with this this bait of the subsidy and then he he saw a necessity of phasing it out because at some point either it's taken off or it hasn't and so that is really i

think his his thought process on well what he writes in the white paper yeah and what i think drew would say there is that um the the only way to value to value it people needed to have some way to um you know how many there would be and then if you um if you come to that conclusion then um the most logical thing is that hey people value dollars we don't know how many there are Yeah, but if he started with the idea that it would always be infinite, then it would be that much harder. Look, so, I mean, as I mentioned, like, on one hand, like, we can say, oh, you know, the issuance schedule, it's all arbitrary. He could have done anything. I would argue that there's a tremendous amount of wisdom in what he ended up doing.

Right. Yeah. And so, you know, the four years between the halvings, the halvings, the 21 million, like, that number. uh yeah there's there i think that the the mimetic value of it is is tremendous yeah well people might need to listen to this one a few times like understanding the difficulty adjustment is not easy but it is critical to understanding really how the network works um and and how the miners are able to work all in unison and reach a consensus um and so i appreciate you coming downtown we'll talk about the doom spiral oh yeah yeah we can do an episode on that yeah yeah for

sure there's always gonna be once in a while uh a death spiral yeah every time the the rate of issuance gets cut in half so if you're willing to do that yeah we can you know we'll look at the calendar because we should definitely yeah that'd be fun talk about how we how we know that that uh there won't be death spirals every four years every four years all right well beer thank you thank you all right