How game theory ensures trust across nodes in a blockchain network.
Source: https://blockgeeks.com/guides/proof-of-work-vs-proof-of-stake/
Blockchain is a new and disruptive technology with the potential to change the way finance as well as other industries work. The problem with every new and disruptive technology is security. The two largest cryptocurrencies by market capitalization in the world right now are Bitcoin and Ethereum. They each approach security and integrity in their systems in technically different ways, yet fundamentally they are very similar. The way these networks ensure security is by using game theory and using different incentives to achieve an equilibrium that rewards good behavior and punishes malevolence. One of the greatest risks to the integrity of a network is double spending, a process by which a cryptocurrency is spent twice. While it is complicated and time consuming to attempt a double spending attack, there are definitely people out there with the motivation to carry them out. So what is holding them back?
Bitcoin, a cryptocurrency that sees over 1bn USD in value transacted across its network every day, needs a surefire way to protect against fraud. Bitcoin ensures security through a process called Proof of Work. In the Bitcoin network there are two kinds of people, users and miners. Miners use computers and are in charge of validating transactions, which are performed by regular users, compiling them in a block, and adding the block to the chain. Miners are rewarded for successfully validating transactions with real bitcoin as well as collecting a transaction fee. In order for a block to be accepted into the blockchain it must be approved by more than 50% of the network’s nodes, or computers. Malicious actors can perform a double spend by sending out two different transactions across the network and attempting to get them both approved, thereby spending one coin twice. Here’s where Bitcoin’s incentives and Proof of Work protocol kick in to achieve an equilibrium in the network. The catch is that mining is incredibly time consuming and inefficient, costing the miners lots of money in computing power and energy costs, so in order for someone to control 51% of the nodes and approve a malicious block, they would need the capital of either a massive corporation or a powerful country. If we think of this situation in terms of payoffs, if a malicious miner attempted to double spend and failed, they would receive a negative payoff because of the financial cost incurred by the attempt. There are also positive incentives, though, if miners approve valid transactions and receive Bitcoin as a reward. In fact in almost every case it is much easier and wiser to mine Bitcoin honestly as there is a huge economic incentive to do so. This leads to a natural equilibrium in which all of the nodes on a network work together to maximize their payoffs by mining Bitcoin and ensuring the collective safety and functionality of the network.
The second largest cryptocurrency, Ethereum, currently uses Proof of Work as well to validate the blockchain, but they are about to upgrade it to Ethereum 2.0 which uses a new validation system called Proof of Stake. In order to participate in Proof of Stake and become a validator on the network you must own at least 32 ETH (the crypto currency of Ethereum) and you must put it into the network as collateral. By putting money on the line, players are disincentivized from wrong doing because their malicious act could result in the loss of the money placed as collateral. Unlike Bitcoin, Ethereum validators do not receive direct cryptocurrency for their honesty, instead they receive yearly interest rates on the ETH they have staked. On a similar note, people are incentivized to stake their ETH in the network as that removes the coins from the pool of liquid cryptocurrency that can be traded, resulting in a scarcity of the coin and driving the price up. If someone breaches the system and performs a double spend there would be a scare in the community and the price of ETH would plummet, leaving anyone with stakes holding nearly worthless coins. Once again we can see how the combination of positive and negative incentives combine to create an equilibrium of honesty in the network that maximizes all of the players’ payoffs.