Difficulty Adjustment 101
Bitcoin uses a Proof of Work consensus mechanism to verify transactions and secure the network, while allowing it to remain decentralized.
Bitcoin's mining difficulty is one of the key aspects of this process, but what exactly is it, how does it work and why is it important?
What is Bitcoin Mining?
To understand Bitcoin mining difficulty, you should first understand how mining works.
Bitcoin mining is the process by which the Bitcoin network is secured, transactions are validated, and new Bitcoins are created.
New Bitcoin transactions are broadcast to the entire network and grouped together. Validators, known as "miners", select transactions from this pool to form a "candidate block".
Miners use specialized computers to solve the complex cryptographic puzzles. In order to do that, miners need to generate the correct hash, which requires a substantial amount of computational power (hashrate). The first miner to solve this puzzle updates the ledger and is rewarded newly minted Bitcoins (and transaction fees). This incentivizes miners to continue securing the network.
What is Bitcoin Mining Difficulty?
"Bitcoin mining difficulty" refers to the degree of difficulty of the cryptographic puzzles that need to be solved before a block can be added to the Bitcoin blockchain.
It's calculated with a variety of formulas, but the most common is:
Difficulty Level = Difficulty Target / Current Target
In the above formula, "Difficulty Target" refers to a hexadecimal notation of the target hash, whose mining difficulty is 1, while the "Current Target" is the target hash – a number that is greater than or equal to a hashed block header – of the most recent block of transactions.
The network automatically adjusts the mining difficulty based on the time taken to mine previous blocks, adapting to changes in the network's hashrate. This ensures that new blocks are created approximately every 10 minutes, maintaining a steady issuance of new bitcoin.
This process will continue until Bitcoin's limited supply of 21 million BTC is in circulation.
Why Does Bitcoin Mining Difficulty Matter?
By automatically adjusting Bitcoin's mining difficulty, the network is able to maintain a consistent 10-minute block time. This allows for a steady, predictable rate of new blocks created and transactions validated. This fact, alongside the reduction of block rewards thanks to the Bitcoin halving, means that the remaining supply of Bitcoin will likely not be in circulation until 2140.
Also, by regulating the speed at which new blocks are added to the blockchain, the changing mining difficulty plays an essential role in supporting network security and decentralization. The difficulty level increases if miners find block solutions more quickly and decreases if they are found more slowly. This can prevent malicious parties overwhelming the network with excessive computational power, helping the blockchain to remain resistant to attacks.
How Does Bitcoin Mining Difficulty Adjustment Work?
Bitcoin's mining difficulty adjustment happens automatically every 2,016 blocks, which is approximately every two weeks.
The actual time taken to mine 2,016 blocks is compared to the expected time of 20,160 minutes. The ratio of these two figures is calculated, and then multiplied by the current difficulty level.
Once calculated, a new difficulty is implemented, which works by adjusting the target hash.
However, there are adjustment limits written into Bitcoin's code:
- Maximum increase: 300% change (4x harder)
- Maximum decrease: 75% change (4x easier)
In October 2024, Bitcoin's difficulty adjustment reached a record of 95.7 trillion [1], following a surge in the network's hashrate. The increase in difficulty can be attributed to additional computing power being used to mine Bitcoin and puzzles being solved more quickly.
Economic Implications of Difficulty Adjustment
Bitcoin's difficulty adjustment may potentially have real-world economic implications.
- Implications on BTC prices — When the price of bitcoin rises, more miners are incentivized to join. This, in turn, increases the network's computational power and raises the difficulty level
- Miner profitability — As difficulty increases, validating transactions becomes more challenging and uses more computational power, which can lead to reduced mining rewards and a negative effect on the overall profitability of mining operations
- Long-term stability of the Bitcoin network — Higher mining difficulty contributes to the network's security and decentralization, making it harder for malicious parties to control the majority of the network's computational power
Conclusion
Bitcoin's Proof of Work consensus is one of the foundational aspects of the blockchain. It ensures decentralization, network security and allows for the consistent issuance of Bitcoin. The difficulty adjustment of Bitcoin's cryptographic puzzles is therefore an incredibly important aspect of the network and supports Bitcoin's overall long-term sustainability.
[1] The Block; https://www.theblock.co/post/322443/bitcoin-mining-difficulty-hash-rate-all-time-high
