Episode 18 - Blockchain Economics: Part 2 (Rewards)
The blockchain grows when new blocks are added. The creation of new blocks requires validation of transactions and including them in blocks by the blockchain nodes. Block rewards are a way to incentivize the nodes for creating new blocks and contributing to the decentralization and security of the blockchain.
Another reason for block rewards is the need to have the cryptocurrency in circulation. For any financial system to work, there must be enough currency in circulation so that the goods and services could be easily priced and bought/sold. The balance of supply and demand for currency is essential.
Block rewards are a mechanism to pump newly minted currency in the system. For example, in Bitcoin, for every newly added block, some new bitcoins are minted and given to the miner of that block. This way, while the nodes are incentivized for adding blocks, new currency also comes in circulation.
The block rewards are not constant forever. Their value depends on the amount of currency currently in circulation, and the amount that needs to be in circulation (demand). Based on the supply and demand of the currency, the block rewards can change. Over a period of time, the block rewards are reduced and tend to go towards zero.
When the block rewards reach zero, the transaction fee becomes on the only incentive for the nodes. Hence the value of the transaction fees is also impacted by the value of block rewards. Transaction fees will be detailed in the next episode.