Application of Game Theory in Cryptocurrencies
In lecture, we learned about how cryptocurrencies such as Bitcoin have transaction fee payment systems that resemble discriminatory auctions. I’d like to expand on this topic by discussing the application of game theory in cryptocurrencies, specifically Ethereum.
Ethereum blockchain is designed as a public, decentralized network of distributed nodes: servers storing the entire history of transactions. Each new block added to the chain has to be agreed upon by all nodes, even though they cannot trust each other. Previously, the Ethereum blockchain ran on a proof of work system which protects the blockchain from false transactions by making the process of mining difficult and expensive through cryptography. It’s in the miner’s best interest to behave honestly under the proof of work system as acting otherwise would be wasteful. The disadvantage of proof of work is the amount of energy required at scale, as it only increases as more miners join the network.
After years of anticipation, the Ethereum merge took place last week which is an upgrade to the Ethereum blockchain. The merge transitions Ethereum to the proof of stake system which rewards nodes in the network that hold more currency resulting in a 99.95% reduction in energy consumption. Trust is built with nodes that are continuously contributing to the network and those who stake Ethereum earn Ethereum. There are some who argue that the proof of stake system is less secure since one could attack the network through a 51% attack. However, if investors were to lose faith in Ethereum and fork an alternate version, the Ethereum bought for the attack would be worthless. Proof of work and stake use game theory to ensure that it is in the best interest of everyone to contribute to the network.
Sources:
https://www.bitcoinmarketjournal.com/game-theory-behind-ethereum/
https://www.investopedia.com/terms/p/proof-work.asp