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Game theory and the blockchain

http://fortune.com/2017/08/22/bitcoin-ethereum-blockchain-cryptocurrency/

 

Cryptocurrencies have undergone a bit of a boom in the past few months. The prices of Bitcoin, Ethereum, and Litecoin have skyrocketed and many people are investing in hopes of making money. Investors are in a frenzy speculating over their value and future as a viable currency. At the heart of many cryptocurrencies is the blockchain: a technology that could potentially revolutionize the world. The blockchain is significant because it is a decentralized store of information. In terms of crytocurrencies, it keeps track of transactions of the virtual money from the present all the way back to the beginning of the currency. The blockchain achieves this by acting as a ledger. It links information about transactions (blocks) together one after the other in a history of all previous transactions, thereby forming a chain. Thus, the blockchain records every exchange that ever happened with regards to a currency. This technology could be revolutionary to other industries because it would serve as a secure and decentralized way to store information, such as medical records or identity management.

 

One of the greatest achievements of the blockchain is its security. False transactions or information would completely undermine the purpose of the blockchain. However, it is secure by default due to the way it is set up and the tenets of game theory. First, a little more explanation on how it works is necessary. Assume we are dealing with bitcoin here. New blocks/transactions are added by miners who solve algorithms using computing power. These miners have an incentive to solve the algorithms because if they do they are rewarded with bitcoin. Now, if a miner solves an algorithm (thereby creating a new block) and decides to “cheat” by making some sort of false transaction, such as giving himself more bitcoin, then this new blockchain is temporarily true. However, the blockchain that is regarded as true is that with the most computational work put in, or the most blocks. Meanwhile, unfortunately for that miner, other miners are trying to solve the algorithms too in order to earn their reward. The one miner would need to stay ahead of the rest of the world and keep on solving the algorithms/adding new blocks in order to keep the money that he “stole”. Obviously, the rest of the world of miners will eventually catch up and exceed the computational work of that miner, thus nullifying his false transaction. The system works because the miners are all players with one dominant strategy: to solve algorithms, create new blocks, and get rewarded with money. With everyone having the same dominant strategy, an equilibrium is created that offsets any fraud and only accepts verified transactions. The only way for the system to breakdown would be to have massive collusion. This simply could not happen because of the sheer number of people mining and their dominant strategies to create new blocks and make money. That kind of collusion would have to be on a global scale and would be impossible. As a result, the blockchain remains protected. Game theory is integral to its security and ingenuity.

 

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