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How does Game Theory Relate to Cryptocurrency?

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According to this article Cryptocurrency is highly related to game theory. As a result, a new field, named crypto economics, has been created. As its name suggests, “crypto economics a combination of cryptography, economics and game theory incentive models incorporated into distributed blockchain protocols to create a secure, stable and sustainable system.” The most explicit example for such relationship comes from the famous cryptocurrency, Bitcoin.

For bloackchain networks like Bitcoin to remain secure and possess the ability to reach a certain amount of consensus on the blockchain, they must be able to continue working in the presence of errors or breakdowns. In other words, the must be Byzantine Fault Tolerant. To achieve this, “the decentralized nodes have to come to a majority agreement on the current state of the blockchain without trusting each other.”  In the case of Bitcoin, it solves this problem through its Proof-of-Work consensus model, where miners need to solve computationally intensive mathematical problems to win the reward for mining the next block. As result, incentive structures from game theory play a key role by encouraging players in the system to act honestly. For instance, miners’ economic incentive comes from the block reward if they solve the next round of mining for the next block. As they need to invest in resources such as electricity to win the block, their spending’s will become suck cost if they act maliciously and not getting the price. Since they are receiving the reward in Bitcoin, “it is in their best interest for the value of Bitcoin to increase and the network to remain valid and secure.” As a result,Bitcoin is constantly self-reinforcing a Nash Equilibrium state.

However, there is an empirical problem that many critics have laid out about crypto economics. Game theory models in these platforms can only be determined through practice. Some of the assumptions made by game theory models in cryptocurrency platforms revolve around a specific threshold of people acting honestly or dishonestly. Unfortunately assuming human behavior can be risky “especially when there is no precedent for the technology or models being implemented.” This topic is interesting because it related to what we have learnt in class about game theory. How people’s decisions depend not only on their own preferences but also are influenced by other people they are interacting with. In the case of miners, it is similar to Nash Equilibrium problems we solved in class, where people try to maximize their payoffs taking into account the decision of others. I believe that as this field continues to develop, we would be able to see a new concept in game theory.




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October 2018