Game Theory is a foundation in the development of digital currencies and is one of the reasons why Bitcoin has been able to thrive for more than a decade, despite countless attempts to disrupt the network.
What is game theory?
Basically, game theory is an applied mathematical method used to study human behavior based on rational decision making. This “game” is designed in an interactive environment, so that players tend to behave rationally when responding to game rules or to the influence of other players.
This concept was first developed in economics to investigate the behavior of companies, markets and consumers, but it is now widely used in other fields of study. Therefore, game theory models can be used as a tool to examine the potential behavior of relationship interactions, and the potential results that will be obtained, given a predetermined situation. This model can also be applied to political, social science, psychology, or philosophy.
The Prisoner's Dilemma
The prisoner's dilemma is one of the most popular examples of game theory models. This illustrates a scenario where 2 criminals (A and B) are being interrogated after being arrested. The two criminals were interrogated in two different rooms and could not communicate with each other.
Prosecutors try to convince criminals to testify against others to reduce their charges. If A testifies against B, he will be acquitted and B will be imprisoned for 3 years (and vice versa). However, if they both betray each other and testify against the other, they will both be imprisoned for 2 years. Finally, if both of them decide not to betray and remain silent, they will only be imprisoned for 1 year due to insufficient evidence.
Therefore, we will get results like this (based on each individual's personal decision):
Obviously, the best scenario is for A (or B) to betray and the other to be acquitted, but this would require one party to remain silent and there is no way to predict what decision either party will take. Faced with a reward, many prisoners who can think clearly will make selfish decisions and betray others. But if both A and B betray, then they will both stay in prison for 2 years, and this is definitely not the most satisfactory outcome. Therefore, the best choice for them, as a couple, is to stay silent and only get 1 year and not 2 years of punishment.
The prisoner's dilemma has different variations, but this simple story illustrates the idea of using game theory models to investigate human behavior and the most satisfactory outcomes based on their decision-making process with their clear thinking capacity.
Game Theory and Digital Currency
When applied to digital currencies, game theory models play an important role when designing a secure and trustless economic system, such as the Bitcoin system. The creation of Bitcoin as a Byzantine Fault Tolerance (BFT) system is the result of a harmonious blend of cryptography and game theory.
The use of game theory in the context of digital currencies is what gave birth to the concept of Crytoeconomics, which is essentially the study of the economics of blockchain protocols and the potential consequences that the design of those protocols can produce - as a result of the behavior of their participants. This is also considered the behavior of “external relations” who are not part of the ecosystem, and can result in joining a network only to try and disrupt the network from within.
In other words, Cryptoeconomics examines the behavior of network nodes according to the incentives provided by the protocol, considering the most rational and greatest possibilities.
Because the Bitcoin blockchain is designed as a distributed system - with many nodes spread across many different locations - the system needs to rely on the decisions of those nodes to validate transactions and blocks. However, these nodes do not really trust each other. So how does such a system avoid malicious activity?
One of the most important features of the Bitcoin network that protects it from malicious activities is the Proof of Work consensus algorithm. This application of cryptographic techniques makes the mining process very expensive and demanding, creating a very competitive mining environment. Therefore, a PoW-based currency architecture provides incentives to mining nodes to be honest (so that they do not take risks and lose what they have invested). On the contrary, any nefarious activity is highly discouraged and will quickly result in punishment. Mining nodes that exhibit dishonest behavior will lose lots and will be kicked out of the network. Therefore, the single most rational and possible decision a miner can make is to behave honestly and keep the blockchain safe.
Conclusion
A common application of game theory is to provide examples and examine how humans behave and make decisions based on clear thinking. Therefore, game theory models will always be referred to when designing distributed systems, such as in digital currencies.
Thanks to a balance of game theory and cryptography, the Proof of Work consensus algorithm can make the Bitcoin blockchain a decentralized economic system, which is highly resistant to attacks. The same is true for other digital currencies that game theory concepts also apply to PoS blockchains. the main difference is the way Proof of Stake blockchains deal with transactions and block validation
Please remember that the level of security and resilience a blockchain has depends on its protocol and is directly related to the number of participants in the network. A larger scale distributed network will be more reliable than a smaller scale one.
