Ethereum Difficulty Bomb & Inflation Rate Explained
In this post, Shawn explains the Ethereum Difficulty Bomb. The recent debate around the Ethereum Inflation rate has many people discussing the current ethereum mining rewards & "difficulty bomb". But what is the difficulty bomb? Shawn explains it clearly and succinctly!
What Is The Ethereum Difficulty Bomb?
With Ethereum's Constantinople update coming up on January 16th 2019, there have been an increasing number of questions regarding Ethereum's "Difficulty Bomb". Most other explanations out there are either far too complex are simply wrong.
Ethereum Difficulty Bomb: The Simple Explanation
The Ethereum Difficulty Bomb simply refers to a tool within Ethereum. This tool allows the core Ethereum developers to adjust how difficulty it is for a miner to win a reward. Miners win rewards each time they create a new block and add it to the blockchain.
When the Ethereum Difficulty Bomb is set to "detonate", it will get exponentially difficult for miners to win rewards via mining. But why would the developers want this? Because eventually they will want miners to stop mining and start validating. Remember, Ethereum is set to transition from Proof of Work to Proof of Stake. There is no mining in Proof Of Stake. We will have validators instead.
Ethereum Difficulty Bomb: A Dis-Incentive For Miners
Even though Ethereum may switch to the Proof of Stake chain, the miners may continue mining on the Proof Of Work chain if not properly incentivised. In order to avoid security issues (like a fork), the developers wanted to give the miners a little "nudge" to switch to Proof Of Stake. The Ethereum's Difficulty Bomb would reduce their rewards on the Proof Of Work chain, and thus incentivise them to switch to the Proof Of Stake Chain.
Why Was The Ethereum Difficulty Bomb Delayed?
Unfortunately, the network upgrade to Proof Of Stake was delayed. And the entire point of the Difficulty Bomb was to incentivise miners to switch to Proof of Stake. So the Ethereum team decided to delay the difficulty bomb until Casper was ready.
Ethereum Inflation Rate & Difficulty Bomb
The delay, however, did not sit well with long term investors. Long term investors were looking forward to the difficulty bomb (and Proof of Stake). Why? Because lower Block Rewards would mean a lower Inflation Rate. This was going to be a very bullish update for long-term investors.
To understand this fully, let me quickly explain Ethereum's Inflation Rate. We will then discuss how the difficulty bomb & block rewards relate to it! Don't worry – I'll keep it super simple 😉
Ethereum Inflation Rate Explained
The past year has seen a back and forth debate between the miners and the rest of the community . The debate was about the current inflation rate in the Ethereum ecosystem. Essentially, the community wanted a reduction in the Ethereum Inflation Rate.
Ethereum Inflation Rate Definition (Quick'n'Dirty)
The speed at which each Ether loses it's purchasing power/value.
There are two ways the core-developers can decrease the inflation rate in Ethereum:
- Add A Difficulty Bomb in Ethereum
- Decrease the Ether Issuance to Ethereum Miners
In this post we'll be discussing the Difficulty Bomb. However, please note that the Difficulty Bomb's purpose is not ONLY to adjust the inflation rate.
Ethereum Difficulty Bomb: What Is It? (In Detail)
The Difficulty Bomb is sort of a "tool" within the Ethereum consensus algorithm. It allows the core devs to elegantly adjust how difficulty it is to create a new block. For example, the Difficulty Bomb can be set to "detonate" at a particular time-period. Upon detonation, it would get exponentially more difficult to mine a block as the days passed (more on why later).
However, to understand the Difficulty Bomb and it's implications – we need to first understand how blocks are actually created. It's actually quite simple. Let's go over it quickly:
Ethereum Mining: How Are Blocks Created In Ethereum?
Each time you send a transaction on the Ethereum Network, it is being broadcasted to the Ethereum Miners. Ethereum Miners pick up your transaction along with a bunch of other transactions – and put it into a "block".
But that's not the hard part. The hard part is getting the block approved by the rest of the network as "Valid".
To understand this bit, let's use my Lock & Key Analogy
Each miner needs lock the block before submitting it to the network. However, in order to "lock" the block, they need to find the key. A block is not deemed valid by the rest of the network until the minder "finds the key". (This is why you will find people using the phrase "finding a block".)
(Note: This is a simplified explanation. You can find my simple explanation on the PoW Puzzle here)
Once the key is found, the block will be added to the main Ethereum blockchain. The miner who "found the block" will get a reward issued to him.
Block Time & Difficulty Bomb in Ethereum Mining
However, finding the key is no easy task. It's much like trying to find a needle in a haystack: You could find it immediately, or it could take you a very long time. The time in takes to find the "key" or block – is known as the Block Time.
The time in takes to find a block is known as the Block Time.
In Ethereum, we don't want either of the two extremes. Of course, taking forever to find a block is not good. But, nor will finding it too soon. We want the time to be...just right. Like Goldilocks & her soup.
Fortunately, Ethereum can adjust the average time it takes miners to find a block. It can be adjusted to either decrease the block-time or increase the block time.
An adjustment to increase the block-time is known as a difficulty bomb
Why is it called the "difficulty bomb". Because Ethereum will make it more difficult to find the needle in the haystack. Another way to look at it is this:
The time it takes a miner to find a block will increase. Hence, it gets more difficult for him to earn his rewards.
We will discuss how this is adjusted in another post. For now, this is all you need to know 🙂
Conclusion: Difficulty Bomb, Ethereum Inflation & Prices
The Difficulty Bomb in Ethereum can/will be used to adjust the time it takes a miner to find a block. This has a direct impact on Ethereum's inflation rate since it reduces the speed at which miners receive rewards. This, in turn, will reduce the total expected supply of Ethereum for the years to come. If supply goes down, prices will go up. If prices go up – then purchasing power of each Ether increases.
As of this writing, the average time it takes a miner to find a block in Ethereum is around 14 seconds. Remember, new Ether is issued to the miners as a reward each time a new block is created/validated. A difficulty bomb will decrease the rate at which these rewards are handed out And, in turn, reduce the inflation rate in Ethereum.
Ethereum's Casper was supposed to include a difficulty bomb along with Proof of Stake. As of now, both Casper and the difficulty bomb have been delayed.
Get my upcoming eBook for Free!
"The Mango Guide TO Understanding Blockchain"
Offer Valid For FIRST 500 registrations only