Bringing Your Digital Community To Life With Cryptoeconomics
Bitcoin’s greatest and yet least-talked about achievement was that of adding economic value to cryptography and computer science. The interdisciplinary nature of Satoshi Nakamoto’s technology also gave rise to the somewhat confusing term, “cryptoeconomics.” Like most marketing copy, the phrase is catchy but shallow. It infers the existence of a parallel world of economics made possible by crypto technologies.
In reality, however, it is merely referring to the development of the age-old mechanism of incentivization and systems design.
Consensus-Driven Activity
Let’s consider one of the building blocks of technical achievement that Bitcoin presents. The Byzantine General’s Problem offers an interesting thought-experiment in communal activity.
The premise follows the idea of a large, disparate army attempting to coordinate an attack on an enemy garrison. As the army is separated over many miles of territory, the generals in charge of each group need messengers to relay critical information. For the sake of the example, consider that the only two pieces of vital information are “attack” or “retreat.”
As the garrison is well-fortified, only a swift, collective decision made by the myriad groups will ensure victory. Attacking the stronghold one group at a time would spell defeat. Thus, the messengers play an essential role in the success of the campaign. Unfortunately, not all of the messengers can be trusted as it is suspected that some are traitors. This is the fundamental proposition of The Byzantine General’s Problem.
So, how do generals, all of which can be trusted to act in the best interests of the entire army guarantee the accurate transmission of their wishes? First, they must all agree that they are disseminating the same message.
If four generals in charge of four partitions of the army, none of them can act until it is certain that each of the other three generals has received the same message. If general A arrives at a sound solution, they must then disseminate this solution to the other generals. Before acting, general A must wait for a return confirmation from generals B, C, and D. These three generals, in turn, must wait for a secondary approval from general A that they are all pursuing the same plan of action.
This solution poses two immediate issues: complexity and efficiency. Even if one considers the already complicated consensus needed between four participants, the complexity increases by magnitudes each time a new participant is added. Second, the time required to confirm an action plan between four participants is also high. This figure would increase in proportion to the number of participants too.
In a time of war, such a consensus appears highly-flawed. It does, however, offer one key advantage.
In exchange for complexity and inefficiency, this variety of consensus provides near perfect certainty that the proposed solution is consistent among all parties. In the context of war, such certainty could be the difference between total annihilation and perfect triumph. Replace this metaphor with the world of distributed computing, and one begins to see the promise of Bitcoin and blockchain technology.
Instead of four generals, imagine there are thousands. And instead of a binary choice of “attack” and “retreat,” replace these two choices with a number exponentially larger than the number of atoms in the universe. The result is the consensus mechanism achieved by Satoshi Nakamoto and Bitcoin, also known as proof of work or Nakamoto Consensus.
At current, there are over 9,000 Bitcoin nodes all over the world; and that insurmountable figure larger than the number of atoms in the universe is a result of the cryptography backing Bitcoin, SHA-256. Quickly, the original Byzantine Generals metaphor pales in comparison to the complexity, efficiency, and certainty that Bitcoin encounters.
Each time a transaction is made on the Bitcoin network, all 9,000 nodes must verify with one another the integrity of this transaction before proceeding. Adversarial nodes may exist to disrupt this verification process, but if they are not in the majority, the network refuses their inputs. We will elaborate on this shortly.
In sum, with a honey pot of $210 billion and a sector frothing with multiple hacking attempts, Bitcoin appears an impenetrable fortress to even the world’s most powerful computers.
Incentivizing Security And Preventing Attacks
The security of Bitcoin’s network is due not only to the makeup of Nakamoto Consensus but the handful of incentives found therein. In the first, there is the miner’s reward, which acts as a bounty for the nodes that secure the network to behave honestly. At current, this reward is 12.5 Bitcoin, but this number will be cut in half in 2020.
For the scope of this article, we can label this kind of incentive as “positive.” A positive incentive within an economic context refers to one in which participants are rewarded for specific behavior. Conversely, there exists “negative” incentives or deterrents that prevent other varieties of behavior.
A non-technical example of a positive incentive could be enjoying a lower premium on your healthcare for regularly visiting the doctor. A negative incentive could be the fine incurred for speeding on the freeway. Alternatively, one can define a high barrier to entry as a variety of negative incentive. Attempting to launch a next-generation search engine, for instance, makes little economic sense as competing with Google would cost billions of dollars over a long period.
In the realm of Bitcoin, both types of incentives also exist.
The miner’s reward, among others, is likely the most potent incentive in the network. As for negative incentives, one need only consider the cost of attempting to hijack the network and potentially allocate funds freely. An entity would need to lance something called a “51% Attack” on the network to do this.
In essence, this attack would mean that an entity, or group of entities, would have to rent or purchase enough computing power to influence more than 51% of the nodes. Doing this would allow the owners full control of a network. It would also be incredibly expensive, depending on the network.
According to Crypto51, a site that highlights the cost of this attack on different blockchain-based networks, indicates that it would cost an attacker nearly $900,000 per hour to take over the Bitcoin network. For Ethereum and Litecoin, the figures drop significantly to ~$111,000 and ~$25,198 respectively.
The Rise Of Cryptoeconomics
To be clear, this description of all the moving parts within the Bitcoin network is incomplete. It does, however, reveal how computer science and economics begin to overlap. Solving The Byzantine General’s Problem was the first step in coordinating pseudo-anonymous communities to achieve a singular goal.
The Nakamoto Consensus then introduced both positive and negative incentives to ensure the perpetual achievement of this singular goal. Stepping back, the microcosm of decisions made by network participants reveals the digital equivalent of a carrot and stick. The reward for securing the network is the accumulation of more Bitcoin, and the risk of attempting to disturb this harmony is steep costs.
Economists, computer scientists, and other thinkers have already begun to develop this idea further. Many have already started experimenting with what types of incentives, both positive and negative, are possible. Some have encountered technical difficulties with blockchain technology itself, while others have bumped into fundamental truths about human behavior.
In either case, the ability to bring such studies to a fast-growing industry is inspiring. As our everyday lives hurdle toward digitization, everything from social media, marketing, the gig economy, and communication are all up for reinvention.
