Cryptocurrency game theory for beginners
You may have heard of game theory referenced in relation to cryptocurrency, but what exactly does that mean? The study of human behavior and construction of mathematical models of interactions between people started in the 1950s. Through the decades this field has been applied to many different disciplines, from public policy to biology.
Game theory has long been used to predict economic behavior, but it was the anonymous founder of Bitcoin, Satoshi, who first applied the concepts to constructing an economic system.
It’s a natural progression for information technology, since the algorithms that are programmed into systems are essentially mirrors of many game theories about human interaction. What Satoshi did is create a reward system as an incentive for people to participate in the system.
Since game theory has been used to model so many different activities and behaviors, we can’t give you a full rundown of all the various factors. Frankly, not all of them apply to cryptocurrency, but we will go over some of what does.
There are five main game type concepts within game theory, which describe the conditions of a given scenario, or game. They are:
Cooperative or non-cooperative
In cooperative games, players are compelled to act through a binding agreement, where in non-cooperative games, the players lack a binding agreement and therefore act out of pure self-interest.
Normal form or extensive form
Game theory is graphically represented by a results matrix if the game is normal form, or a decision tree for extensive form games. Normal form typically is a one-move game with a set number of strategies, where extensive form games encompass a number of sequential moves.
Simultaneous move or sequential move
This describes whether the players make each move blindly or simultaneously, or whether or not each player waits for the other to move before their ‘turn.’ Simultaneous games are typically presented in normal form, and sequential in extensive form.
Constant sum, zero-sum, or non-zero-sum
In a constant sum game, the sum of all outcomes across the players remains the same. In a zero-sum game, the gain of one player is always offset equally by the loss from another player. Non-zero-sum games are cooperative, where either every player wins or loses.
Symmetric and asymmetric
In symmetric games, the strategies employed by the players are shared. These are typically short games, as the longer a gain is sustained the wider the number of options/moves are possible. Asymmetric games occur when players all adopt different strategies.
Application to cryptocurrency
The ‘Nash Equilibrium’ is reached when each player would not switch their strategy if the strategies of the other players were revealed. An example of the theory in daily use is traffic lights. Self-preservation dictates that you stop at a red light, not because of the threat of a ticket but because you want to live.
Ideally, to successfully incorporate game theory into a cryptoeconomic model, you would want the Nash equilibrium to be present. It is in every player’s best interests to follow the rules of the network.
Bitcoin does this by rewarding participants for solving problems within the system. This means that the ecosystem is always supported by a cooperative team of users, who are working under a binding agreement. By contributing X, they receive Y reward. The rules of the game are clearly defined, and no central authority can change them once things are set in motion.
Because cryptocurrency miners are rewarded only for contributing valid blocks, there is an incentive for them to avoid any invalid block – discouraging attempts to manipulate the system. Though there is much talk of a ‘51% attack,’ where one actor could gain control of a majority of each decision point and affect the outcome, the likelihood is kept slim by the high level of difficulty to generate complete blocks.
The security and transparency of a well-engineered cryptocurrency are based on the strength of the game theory that went into their development. The more possibly strategies and deviations that are considered in the final design, the more robust and resilient the system will be.
Different games for different outcomes
Depending on the goal of a particular cryptoeconomic system, a different game theory can be applied. Generally, the future of cryptocurrency depends on the thoughtful application of game theory. By creating a system that is in the hands of the user-base as opposed to banks or governments, there must be equilibrium in the incentives for users.
There are many private company examples of how game theory can be asymmetrical. For instance the employee/employer relationship. Banks versus citizens is another example that comes to mind. But with cryptocurrency, the game theory can be designed such that users are incentivized to act in the best interests of the group as a whole.
While this is a worthy goal, it is certainly not easy and is going to be the subject of ongoing improvement as cryptocurrency develops more mainstream use.