Game theory is fundamental to the development of cryptocurrencies and is one of the reasons why Bitcoin has managed to thrive for over a decade, despite numerous attempts to disrupt the network.
What is game theory?
Game theory is essentially a method of applied mathematics used to study human behavior based on rational decision-making. Because the "game" is designed as an interactive environment, players tend to act rationally when interacting with the rules of the game or the influence of other players.
The concept was initially developed in economics to study the behaviors of businesses, markets, and consumers, but is now widely applied in many other areas of study. Therefore, game theory models can be used as tools to examine the potential behavior of interacting agents, and the possible outcomes of their actions, under predefined circumstances. The models can also be applied to the general study of politics, sociology, psychology and philosophy.
The Prisoner's Dilemma
The Prisoner's Dilemma is one of the most popular examples of game theory models. It illustrates a scenario in which 2 criminals (A and B) are interrogated after their arrest. Each criminal is interrogated in a separate room and is unable to communicate with the other.
The prosecutor tries to convince the criminals to testify against each other in order to reduce their sentences. If A testifies against B, he is released and B is arrested for 3 years (and vice versa). However, if the two betray each other and testify against each other, they are both arrested for two years. Finally, if both A and B decide not to betray each other and remain silent, they are only sentenced to one year in prison due to lack of sufficient evidence.
Therefore, the possible outcomes are as follows (based on their individual decision):
Clearly, the best scenario for A (or B) is to betray his accomplice to be released, but this requires the accomplice to remain silent and there is no way to predict what decision the latter will make. Faced with a reward, many rational prisoners would likely choose to act out of self-interest and betray their accomplices. But if A and B both betray each other, they would get 2 years in prison and that is not really the best outcome. Therefore, the best option for them, as a duo, would be to remain silent and be sentenced to only 1 year each instead of 2.
The Prisoner's Dilemma has many variations, but this simple story illustrates the idea of ââusing game theory models to study human behavior and possible outcomes based on the rational decision-making process.
Game theory and cryptocurrencies
Applied to cryptocurrencies, game theory models have an important role in the design of a secure and trust-free economic system, such as that of Bitcoin. The creation of Bitcoin as a Byzantine Fault Tolerance (BFT) system results from a harmonious blend of cryptography and game theory.
The use of game theory in the context of cryptocurrency is what gave rise to the concept of cryptoeconomics, which is, fundamentally, a study of the economics of blockchain protocols and the potential events that the design of these protocols may exhibit - due to the behavior of participants It also takes into account the behavior of "external agents" who are not really part of the ecosystem, but could possibly join the network only to try to disrupt it from within .
In other words, cryptoeconomics examines the behavior of network nodes based on the rewards provided by the protocol, focusing on the most rational and probable decisions.
Since the Bitcoin blockchain is designed as a distributed system - with many nodes distributed in different locations - it must rely on the agreement of these nodes for the validation of transactions and blocks. However, these nodes are not really able to trust each other. So how can such a system prevent malicious activities? How can we prevent a blockchain from being disrupted by dishonest nodes?
The Proof of Work consensus algorithm is one of the most important features of the Bitcoin network that protects it against malicious activities. It applies cryptographic techniques that make the mining process extremely expensive and demanding, creating an extremely competitive environment. Therefore, the architecture of PoW-based cryptocurrencies incentivizes mining nodes to act honestly (so as not to risk losing the invested resources). Additionally, any malicious activity is discouraged and promptly punished. Mining nodes that exhibit dishonest behavior will likely lose a lot of money and be kicked off the network. Therefore, the most likely and rational decision for a miner to make is to act honestly and keep the blockchain secure.
Conclusion
The general application of game theory is to model and examine human behavior based on their rational mind. Therefore, game theory models must be taken into account when designing distributed systems, such as those of cryptocurrencies.
Through a balanced combination of cryptography and game theory, the Proof of Work consensus algorithm created the Bitcoin blockchain as a decentralized economic system, highly resistant to attacks. The same goes for other cryptocurrencies and game theory concepts also apply to PoS blockchains. The main difference being how a Proof of Stake blockchain processes transactions and blocks validation.
Keep in mind, however, that the degree of security and resilience of a blockchain depends on its protocol and is directly linked to the number of participants within the network. Large distributed networks are more reliable than smaller ones.
