PrivacySwap’s Ask the Orb: Game Theory and Cryptocurrencies
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Game theory is essential to the evolution of cryptocurrencies and is one of the reasons why Bitcoin has survived for almost a decade despite repeated attempts to disrupt the network.
What is game theory?
Game theory is essentially applying mathematics to investigate human behavior based on rational decision-making. Because the “game” is supposed to be an interactive environment, participants are more likely to act logically when responding to game rules or the influence of other players.
The notion was first conceived in economics to analyze the behaviors of organizations, markets, and customers, but it is now widely used in numerous fields of study. As a result, game theory models can be used to explore the probable behavior of interacting agents and the possible results of their actions under established conditions. The models may also be applied in the broad study of politics, sociology, psychology, and philosophy.
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Game theory and cryptocurrencies
When applied to cryptocurrencies, game theory models play a significant role in building a secure and trustless economic system, such as Bitcoin’s. Bitcoin was created as a Byzantine fault-tolerant (BFT) system as a result of a harmonious combination of encryption and game theory.
The application of game theory in the context of cryptocurrency gave rise to the concept of cryptoeconomics, which is essentially the study of the economics of blockchain protocols and the potential consequences that the design of these protocols may present — as a result of its participant behaviors. It also considers the behavior of “external agents,” who are not actually part of the ecosystem but may someday join it in order to disturb it from within.
In other words, cryptoeconomics investigates the behavior of network nodes based on the incentives offered by the protocol, taking into account the most sensible and likely options.
Because the Bitcoin blockchain is intended as a distributed system with numerous nodes dispersed throughout the globe, it must rely on the agreement of these nodes to validate transactions and blocks.
However, these nodes are unable to trust one another. So, how can a system like this avoid malicious activity? How can a blockchain be protected from tampering with dishonest nodes?
The Proof of Work consensus mechanism is one of the most significant components of the Bitcoin network that protects it from fraudulent behavior. It employs cryptographic algorithms that make mining extremely expensive and time-consuming, resulting in a highly competitive mining environment. As a result, the design of PoW-based coins incentivizes mining nodes to act honestly (so they do not risk losing the resources invested). On the other hand, any harmful action is discouraged and swiftly punished. Mining nodes who engage in dishonest behavior will most likely lose a lot of money and be booted off the network. As a result, the most likely and sensible action a miner will make is to act honestly and maintain blockchain security.
Final thoughts
The general use of game theory is to model and investigate how humans act and make logical decisions. As a result, game theory models should always be considered while creating distributed systems, such as cryptocurrencies.
The Proof of Work consensus method was able to construct the Bitcoin blockchain as a decentralized economic system that is highly resistant to attacks due to a well-balanced blend of cryptography and game theory. The same is true for other cryptocurrencies, and game theory concepts also apply to PoS blockchains. The main distinction here is how a Proof of Stake blockchain handles transactions and block validation.
However, keep in mind that the level of security and resilience provided by a blockchain relies on its protocol and is directly proportional to the number of network participants. Larger distributed networks outperform smaller ones in terms of dependability.
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