Who pays the miner?

No doubt that miner work for profit, but who pays for it?

A bitcoin’s rules allow that a miner who creates a valid continuation of the block chain includes a transaction that benefits the miner with new bitcoins aka. subsidy and with fees offered by transactions within the block.

The source of fees is explicit and clear. Every transaction within the block pays the difference of the sum its outputs and inputs to the miner of the block.

The source of new bitcoins is however not visible, they are just granted to miner out of nothing. New coins have significant value, where does that value come from?

Thermodynamics of wealth

A source of value is capital inflow into the bitcoin economy. Someone who already possessed wealth in an other currency buys the new coins. We see fluctuations of bitcoin’s price as a consequence of capital in- and out-flows. Those movements are rather severe and thereby hiding the answer to our question.

What if capital inflow into the bitcoin economy is zero, who pays for new coins then? This is not unlikely, we get close to it during dull days and there are many days where capital flows out of bitcoin. Mining would not stop as a consequence of no inflows, but the wealth that new bitcoins represent would have to come from within the bitcoin economy. Why? Because wealth, just like energy, can not arise from nothing. In absence of an external source someone within the bitcoin economy have to get poorer so the miner gets more wealthy.

Before we answer who pays, let’s quantify the wealth increase of the miner. Mining is a costly business to run. A miner will have to pay for electricity, amortization, labor, research, financing etc. The miner will only become wealthier if bitcoins mined worth more than the sum of these costs. Therefore we need a source of wealth that equals to miner’s profit and not revenue.

A miner who is not profitable does not get wealthier and there is no need for capital inflow or anyone to become poorer to offset it.

Above arguments are easier to follow if one considers that all costs of a miner have to be paid for with bitcoins the miner produces. This remains true even if bitcoins have to be traded for fiat currency first.

The miner trades some bitcoins with those who supply electricity, labor etc. Those resources are consumed (destroyed) in course of the production and their loss cancels out the wealth of the spent coins that are now owned by the resource supplier (or someone who gave fiat for them on the way to supplier).

In contrast wealth represented by coins that the miner kept after paying for production resources represent wealth that is not offset by resource consumption.

Dilution

Observe that number of bitcoins in circulation also might have increased in the process. This is the case until subsidy runs out.

If the miner was profitable then loss of resources consumed in production is less than the value represented by the new coins. This means the purchasing power of a single bitcoin must fall.

Thereby all bitcoin holder jointly pay for the profit of the miner.

For illustration, let us assume that it costs 3400 USD to produce a bitcoin and the current market price for it is 8400 USD. This means the miner spends only 0.40476 bitcoin to produce a bitcoin.

At current schedule, miners altogether will mine 12.5*6*24=1800 bitcoins a day. 1,800 * (1-0.40476) = 1,0714 bitcoins represent wealth in excess of burned resources.

The purchasing power of bitcoin is diluted proportional to current coins in circulation with 1,0714 / 17.89 million that is with ca. 5 USD

On the long run

Miners profit is constantly under pressure through new entrants and technology improvements, therefore profitability is expected to be low on the long run. Profit rate should still remain positive as no one assumes the associated operational risk for no return. Those who are not profitable will leave.

Consequently dilution will stay with us to some extent until there are new bitcoins available to mine.

Fees do not dilute purchasing power of holders as profits in them are paid by those who transact.

Conclusion

New coins dilute purchasing power of bitcoin holders to the extent that their production is profitable. Profitability of miner and hence dilution is expected to be low on the long run, but is rather significant nowadays.