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Blockchain technology allows align incentives among network participants by rewarding desired behaviors with tokens.
But it’s not just about fostering cooperation. Game theory allows us to design incentive machines that cannot be turned off and that resemble artificial life.
Emerging Optimization
Game theory provides a robust framework for analyzing strategic interactions with mathematical models, which is particularly useful in blockchain environments where multiple stakeholders interact according to a set of predefined rules. By applying this framework to token systems, developers can design systems that influence the emergent behaviors of network participants. This ensures the stability and efficiency of the ecosystem.
Bond curves
Linkage curves are a tool used in token design to predictably manage the relationship between token price and supply. Essentially, a bond curve is a mathematical curve that sets the price of a token based on its supply. The more tokens you buy, the higher the price goes, and vice versa. This model encourages early adoption and can help stabilize a token's economics over time.
For example, a bond curve could be designed to slow the rise in prices once certain milestones are reached, thereby preventing speculative bubbles and encouraging steadier, more organic growth.
The case of Bitcoin
Bitcoin's design incorporates game theory, notably through its consensus proof-of-work (PoW) mechanism. Its reward function optimizes security (hashrate) by optimizing maximum power consumption. Therefore, optimizing to achieve its legitimate goal of security also inadvertently optimizes for corruption of the natural environment. Another emerging outcome of PoW is the creation of mining pools, which increase centralization.
The Paperclip Maximizer and the dangers of the blockchain economy
What is the link between historical AI and decentralized economies? Blockchain-based incentive systems cannot be turned off either. This means that if we design an incentive system that optimizes toward the wrong goal, we might not be able to change it. Bitcoin Criticisms argue that the PoW consensus mechanism optimizes the destruction of planet Earth.
Layer 2 solutions
Layer 2 solutions are based on the idea that the security provided by this core of certainty can be used as an anchor. This anchor then supports additional economic mechanisms that operate off the blockchain, thereby extending the utility of public blockchains like Ethereum. These mechanisms include state channels, sidechains, or plasmas, each providing a way to transact off-chain while still being able to fall back on the anchored security of the main chain if necessary.
Conceptual Example of State Channels
State channels allow participants to carry out many transactions off-chain, with blockchain serving as a safety net in the event of dispute or malfeasance.
Let's take the example of two players, Alice and Bob, who want to play a game of tic-tac-toe with stakes in Ethereum. The naive approach would be to interact directly with a smart contract on every trip, which would be slow and expensive. Instead, they can use a public channel for their game.
- Open channel: They start by deploying a “Judge” smart contract on Ethereum, which holds the stake of 1 ETH. The contract knows the rules of the game and the identity of the players.
- Play the game: Alice and Bob play the game off-chain by signing each move as transactions, which are exchanged directly between them but not broadcast on the blockchain. Each transaction includes an occasional notation to ensure movements remain in order.
- Chain Closure: When the game ends, the final state (i.e. the sequence of moves) is sent to the judge's contract, who pays the stake to the winner after confirming that both parties agree on the result.
A threat greater than execution
If Bob tries to cheat by submitting an old state in which he won, Alice can challenge this during a contest period by submitting a new signed state. The judge's contract can verify the authenticity and order of these states due to occasional cases, thus ensuring the integrity of the game. Thus, the mere threat of execution (submitting the state to the blockchain and exposing fraud) secures off-chain interactions.
Game theory in practice
Understanding the application of game theory in blockchain and token ecosystems requires an structured approach to analyze how stakeholders interact, define possible actions they can take, and understand causal relationships within the system. This structured analysis helps create effective strategies that ensure the system works as intended.
Stakeholder analysis
Identify stakeholders
The first step to effectively applying game theory is to identify all relevant stakeholders within the ecosystem. This includes direct participants such as users, miners and developers, but also external entities such as regulators, potential attackers and partner organizations. Understanding who the stakeholders are, what their interests and capabilities are is crucial to predicting how they might interact within the system.
Assessing incentives and capabilities
Each stakeholder has different motivations and resources. For example, miners are motivated by block rewards and transaction fees, while users seek fast, secure, and cheap transactions. Clearly define these incentives helps predict how changes to system rules and parameters might influence their behaviors.
Define action space
Possible actions
The action space encompasses all possible decisions or strategies that stakeholders can employ in response to ecosystem dynamics. For example, a miner may choose to increase computing power, a user may decide to hold or sell tokens, and a developer may propose changes to the protocol.
Constraints and opportunities
It is essential to understand the constraints (such as economic costs, technological limitations and regulatory frameworks) and opportunities (such as new technological advances or changing market demands) within which these actions take place. This helps model potential strategies that stakeholders could adopt.
Causal relationship diagram
Interaction mapping
Creating a diagram representing the causal relationships between different actions and outcomes within the ecosystem can shed light on how complex interactions unfold. This diagram helps identify which variables influence others and how they do so, making it easier to predict the results of certain actions.
Analyze the impact
By examining causal relationships, system developers and designers can identify critical points where small changes could have significant impacts. This analysis is crucial to improve the stability of the system and guarantee its efficiency.
Feedback loops
Understanding feedback loops within a blockchain ecosystem is essential because they can significantly amplify or attenuate the effects of changes within the system. These loops can reinforce or counteract trends, leading to rapid growth or decline.
Strengthening loops
Reinforcement loops are feedback mechanisms that amplify the effects of a trend or action. For example, increased adoption of a blockchain platform may lead to more developers building applications on it, which in turn leads to further adoption. This positive feedback loop can generate rapid growth and success.
Death Spiral
Conversely, a death spiral is a kind of reinforcing loop that leads to negative outcomes. An example could be the increased cost of transaction fees leading to a decrease in blockchain usage, which reduces the incentive for miners to secure the network, further decreasing system performance and adoption by users. Early identification of potential death spirals is crucial to maintaining ecosystem health.
Conclusion
The fundamental advantage of token-based systems is that they can reward desired behavior. To take advantage of this possibility, token engineers pay special attention to optimization and designing incentives for long-term growth.
FAQs
- What does game theory contribute to blockchain token design?
- Game theory optimizes blockchain ecosystems by structuring incentives that reward desired behavior.
- How do bonding curves apply game theory to improve token economics?
- Linkage curves set token prices that adjust to changes in supply, strategically encouraging early buying and penalizing speculation.
- What benefits do Layer 2 solutions provide in the context of game theory?
- Layer 2 solutions leverage game theory by creating systems where the threat of reporting fraudulent behavior ensures honest participation.