How does new cryptocurrency come into existence?
There are approximately 29 billion coins in circulation in the UK and the Royal Mint can make 850 new coins per minute. In the US between June 2019 and June 2020 5.1 billion notes, worth approximately $226.3 billion were printed — primarily $100 denomination notes.
Governments control the creation of money and can choose to print and mint as much as their economic policies demand. However history is full of examples where governments have abused this power or failed in their fiduciary duties, and the economic consequences of this have been clear. In 2019 Zimbabwe experienced hyperinflation of up to 622% and shoppers frequently experienced the price of good changing between the shelves and the checkout. The Zimbabwean dollar was re-denominated 3 times and a $100 trillion note was issued. In 2018 inflation in Venezuela exceeded 1,000,000% and food prices were doubling every 19 days.
This approach to money creation and management is seen by many within the crypto industry as a defect of fiat, and has led to the popularisation of memes with the phrase ‘Money printer go brrrr’.
As such the decentralised nature and fixed supply of cryptocurrencies is often heralded as a signal for success. However, not all cryptocurrencies have the same approach when it comes to asset creation, so let’s dig into a number of examples to understand how new cryptocurrency comes into existence….
Often referred to as digital gold, bitcoin has a fixed supply of just under 21m bitcoins which are deterministically created in a process called mining.
Roughly every 10 minutes, members of the bitcoin network (called miners) each select transactions to include in a block and compete against each other to solve a mathematical puzzle first. This is a processed called Proof-of-Work. The winner gets their block of transactions added to the blockchain and is rewarded with 6.25 bitcoins as well as the transaction fees for transactions within their block.
However, unlike the transaction fees which come from users sending bitcoins to one another, these 6.25 bitcoins are newly created. They have literally been brought into existence with the mining of the block and have no prior history or been owned before. This block reward, received by the miners through a coinbase transaction, is the only way new bitcoins come into existence.
But the number of bitcoins created in the block reward is not a static amount — in fact when the bitcoin blockchain was released the block reward was 50 bitcoins! So how come miners now get just 6.25 bitcoins and who decided to reduce it?
The answer is the bitcoin code.
The software is programmed to deterministically reduce the block reward by half every 210,000 blocks (roughly every 4 years) in order to create a controlled supply of new bitcoins entering the system. This event is referred to as a halving, with the most recent occurring on 11th May 2020, the next expected to occur in May 2024, and the final one predicted to be in May 2140. This means the total number of bitcoins which will ever be created is just under 21m (20999999.9769 to be exact) and they enter the ecosystem at a predicable rate.
Litecoin, bcash, zcash and other forks of bitcoin take the same approach to new assets being created; with a fixed supply and deterministic rate of creation. However due to codebase modifications, these protocols may create new assets at a faster speed or be within a different block reward era.
“Escape the arbitrary inflation risk of centrally managed currencies” Satoshi Nakamoto 2010
The Ethereum blockchain takes a similar approach to asset creation as bitcoin, also using the Proof-of-Work approach, and creating new assets every time a block is successfully mined. However unlike bitcoin with its 21m total supply, there is no absolute limit for the number of Ether which can be created.
Instead there is an annual creation limit of 18 million ether, with 5 ether being created every new block (mined roughly every 13 seconds). Of these, 2 ethers are won by the successful miner and 2–3 ether are available to share with any miners who were able to successfully find a solution to the mathematical puzzle but did not come first in the race. These can be thought of as ‘runners up’ prizes — officially called uncle rewards.
The current circulating supply is c.114m ether, however with no ‘official’ method to generate this value there was a heated twitter debate in Aug 2020 with many parties struggling to reach consensus about the precise number of ether in circulation.
Another difference in asset creation between Bitcoin and Ethereum is the latter’s use of a premine — the generation of new assets before the launch of the network to the public. As such, the Ethereum Foundation (the team who created the network) premined 12m ether to distribute to developers and early contributors of the project, as well as 60m ether which were sold in exchange for bitcoin. This process was called a pre-sale and had the intended purpose of building up the community ahead of the network’s main launch — it’s now better know as an ICO (Initial Coin Offering).
However with Ethereum 2.0 now officially in the first stage of Serenity, the network is moving away from a Proof-of-Work based system and towards a Proof-of-Stake model where network participants use their ETH as collateral for the opportunity to validate transactions. In reward and recognition of keeping the network in consensus, stakers are rewarded with new Ether and potential return on investments above 10%.
Launched as an ERC20 token on the Ethereum blockchain in 2017, Tether is a stablecoin which aims to maintain a peg with a number of fiat assets, including the US dollar. It does so by claiming to be backed 1-to-1 with the fiat equivalent, so for every new tether printed, one dollar is said to be held in custody.
Tether currently reports $24.5billion is held in it’s reserves, although there’s been much speculation about whether this reported figure is accurate, especially considering the revelation within court documents in 2019 that only 74% of tether’s token supply was cash backed. This month a record breaking $2trillion worth of tether was printed, reportedly driven by growing uncertainty in local banks and currencies as well as bumper trading in cryptoassets due to rising prices.
So how is new USDT minted?
These are referred to as Tether Treasury addresses and are used create and destroy USDT.
Depending on the value of the transaction, if someone wants a significant amount of USDT they can pay Tether directly in their fiat currency of choice and tether will mint an equivalent amount of USDT using the `mint` functionality of the USDT smart contract. (The below is the event log for 400m new USDT being created)
If they require a modest amount of USDT then they can source it directly from an exchange who provide liquidity by matching up buyers and sellers, as well as adding their own USDT which they source directly from Tether.
USDT is removed, or ‘burnt’ from the ecosystem in a similar way. If someone wants to redeem their fiat currency, they simply send their USDT to a Tether Treasury address and the USDT is removed from the ecosystem, or for smaller amounts they sell directly to an exchange who update their liquidity reserves or match with a buyer.
There are a number of other ERC20 tokens which make use of the mint functionality:
Like USDT, DAI aims to maintain a peg with the US dollar and users collateralising their ETH within the MakerDAO smart contract in return for DAI tokens. Every time ETH is locked into what’s called a Collaterized Debt Position (CDP), new DAI tokens are minted by the MarkeDAO contract.
In Decentraland users can buy LAND, a non-fungible token similar to CryptoKitties or CryptoPunks which they build upon to create a community-led virtual world. The native asset MANA is used to buy land at a fixed rate of 1 LAND = 1,000 MANA, as well as all goods and services. Initially it was envisages that there would be an 8% inflation to keep LAND prices from growing exorbitantly, however this was scrapped following a community vote in 2018 and now a total fixed cap of 2.6 billion.
SNT tokens on the Status network are used as a governance mechanism as well as a utility token for user-generated content and to power the host of services available. Whilst there is a finite total supply of SNT, new tokens can be minted by the status controller address to add liquidity into the ecosystem.
The EOS blockchain boasts impressive transaction speeds with 0.5 seconds for confirmation and 2 minutes for irreversible block confirmation (vs bitcoin’s 10 minute blocks and 1 hour finality) as well as no transaction fees and a decentralised app ecosystem running on top. This is possible because the EOS network only needs to reach consensus across 21 validators, named Block Producers. These BPs are responsible for building and validating blocks of transactions and for this are rewarded with new EOS tokens.
In order to become one of the 21 BPs, you must have a sufficient number of votes from members of the EOS community who stake their EOS tokens and the top 20 are automatically chosen while the 21st one is chosen proportional to the number of their votes relative to the other producers. This called a Delegated-Proof-of-Stake model.
Blocks on the EOS blockchain are created in rounds, so every 126 seconds, 252 blocks are created as well as 195 new EOS tokens. This means 26,716 new EOS tokens are created daily, equivalent to an annual inflation rate of 1%, and these funds enter what’s called the Block Producer Fund. This is distributed to both the active BPs (those in the top 21) as well as the non-active BPs; with 25% of funds being distributed as block pay and 75% being a voting bonus. This equates to active BPs receiving 318 new EOS tokens per day via block pay and 200 new tokens per every 1% of the total votes they have received, as a voting bonus.
That’s a lot of numbers! Let’s break that down into an example…
Active Block Producer
An active BP (inside the top 21) with 2% of the vote (N.B the top 21 BPs all currently have >2% of the vote) would receive:
318 new EOS as block pay + 400 as a vote bonus (since its a 200 EOS per 1% of the vote) = 718 new EOS per day (worth just over $2,000 at today’s price).
Non-Active Block Producer
A non-active BP (outside the top 21) with 0.75% of the vote would receive;
0 EOS as block pay (since they’re not actively mining blocks) + 150 as vote bonus = 150 per day (worth just over $400)
The compensation for non-active BPs recognises their efforts in contributing to the ongoing running of the ecosystem and ensures that wealth isn’t centralised in only the active BPs.
Lumens are the native asset of the Stellar blockchain and unlike the above assets which are mined or minted, instead 100 billion lumens were created at the launch of the Stellar network with an annual inflation event of 1% to bolster supplies. The Stellar community voted to end this inflation mechanism in October 2019 and in November 2019 the Stellar Development Foundation (SDF), who support the development and growth of the ecosystem, decided to burn 50 billion lumens in order to have a total cap which better reflected anticipated needs.
Only 22 billion lumens are within the open market and the SDF retains the other c30 billion XLM which they can use to develop or promote Stellar, as well as gradually releasing to the market. As such, all XLM which will ever exist are already created and sit within SDF managed accounts to be used and released as need.
There are plenty of other approaches that networks take to the creation of their cryptoassets, however the above cover the standard models of Proof-of-Work, Proof-of-Stake, Delegated-Proof-of-Stake, Minting and Pre-mines.