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Fundamentals of Cryptoeconomics

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Fundamentals of Cryptoeconomics

  1. 1. Fundamentals of Cryptoeconomics Pranay Prateek
  2. 2. Why?
  3. 3. Why do Bitcoin miners follow the protocol rather than include transactions benefiting them? Afterall, no one directly controls them - No governance
  4. 4. Incentives
  5. 5. Outline ● What is Cryptoeconomics? ● Features of cryptoeconomic systems ● Modelling a cryptoeconomic system ● Mechanism Design ● Discussion of Casper protocol ● Mechanism design in blockchain projects ● Q&A
  6. 6. What is Cryptoeconomics? Crypto Economics is the application of incentive mechanism design to information security problems
  7. 7. Bitcoin as an instance of cryptoeconomic system What is the information security problem? Transfer of value in a trustless and decentralised manner Design ● Need to agree on a universal - Nakamoto consensus ● Uses tokens (BTC) to incentivise miners to keep the system running ● Proof-of-work as an anti-Sybil mechanism ● Following the protocol should be the equilibrium
  8. 8. Bitcoin Mining https://www.slideshare.net/wenyingng/bitcoin-20-47421199
  9. 9. Features of a cryptoeconomic system Stability - Is following the protocol an equilibrium Persistence - If the system falls out of equilibrium, does it recover Optimality - Does following the protocol maximise the quality of outcomes Robustness - Can the protocol withstand perturbations in player’s incentives Efficiency - Is the incentive mechanism economically efficient? Is it efficiently computable? [Vlad Zamfir, BIP’001]
  10. 10. Modelling a cryptoeconomic system 1. Level of coordination of participants 2. Budget and cost of attacks 3. Incentives 4. Attack Models 5. Consensus mechanism
  11. 11. Coordination Level and Cost Traditional Fault Tolerance Research (in context of distributed systems) Honest majority model - assumes at least 51% of participants are honest. Cryptoeconomic systems are more complex Parameters for examining fault tolerance 1. The level of coordination between participants 2. The budget of the attacker (maximum amount the attacker would have to pay) 3. The cost of the attacker (the actual cost incurred by the attacker)
  12. 12. Incentives 1. Payments, such as mining rewards 2. Privileges, which allow their holders to extract rents, such as transaction fees. Incentives dictate the behavior of the participants of the decentralised system
  13. 13. Attack Models Uncoordinated majority models ● Participants make independent choice ● No player controls more than given % of the network ● Participants are self-interested ● Not necessarily honest Coordinated choice models ● Actors are colluding Bribing attacker model
  14. 14. Schelling Coin game Property: provide the “true answer” to a given question eg. who won the election? Algorithm: ● Everyone votes 1 or 0 ● Majority answer is taken as correct ● Everyone who voted with majority given reward of P, all others get nothing [Vitalik Buterin, Cryptoeconomics]
  15. 15. Uncoordinated choice model Uncoordinated choice: you have the incentive to vote the truth, because everyone else will vote the truth and you only get a reward of P if you agree with them Why will everyone else vote the truth? Because they are reasoning in the same way that you are! You vote 0 You vote 1 Others vote 0 P 0 Others vote 1 0 P
  16. 16. Example : Bribing attacker model A model that starts off with an uncoordinated choice assumption, but also assumes that there is an attacker capable of making payments to actors conditional of them taking certain actions ● Suppose there are 2 outcomes 0 and 1 ● Briber asks everyone to vote for 1. If 1 is not the majority vote, then he will pay them P+e, otherwise nothing. [Vitalik Buterin, Cryptoeconomics]
  17. 17. P + epsilon attack Base Game With bribe A bribing attacker can corrupt the Schelling coin game with a budget of P + ε and zero cost! You vote 0 You vote 1 Others vote 0 P 0 Others vote 1 0 P You vote 0 You vote 1 Others vote 0 P P+ε Others vote 1 0 P
  18. 18. Possible attacks on Bitcoin network 1. 51% attack - Censorship 2. Selfish Mining attack - Needs only 25% collusion 3. Zeitgeist attack - This is a 51% attack where the attacker sets the block timestamps artificially to lower the difficulty
  19. 19. Consensus types Nakamoto Consensus - Doesn’t reach finality. There is always a chance of blockchain getting forked Practical BFT Consensus - Hyperledger, Stellar and Ripple Proof of Stake Consensus - e.g. Casper ● Slashing conditions ● Forfeiture of deposits ● Fully and partially attributable faults
  20. 20. Mechanism Design Key Question How do you design systems, that have strategic participants, so that the end result is something you want. ● Reverse Game Theory ● Auction theory is an application of mechanism design
  21. 21. Examples of Mechanism Design Auction Design - Objective is to give the item to players who has highest valuation for the item on sale. Sealed bidding What should be the auction rule? 1. The highest bidder wins. The price they win is equal to the amount they bid. 2. The highest bidder wins. The price they pay is equal to the 2nd highest bid.
  22. 22. Ethereum - Casper Casper is a PoS consensus algorithm designed for Ethereum blockchain Proof of Stake (PoS) is a category of consensus algorithms for public blockchains that depend on a validator's economic stake in the network Slashing conditions - Penalising violators
  23. 23. Build on both chain - Nothing at Stake https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ
  24. 24. Proof of Work https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ
  25. 25. Penalizing violators - Slasher https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ
  26. 26. Token Design A token is nothing but a term denoting a unit of value issued by a project or company. ● This unit of value can be used to reward users who participate in the project and perform particular actions ● It can be used as transaction fees for getting a specific service on the network How to design a token mechanism which serves the objective of the platform?
  27. 27. Token Design Example Content Portal - CP token Objective - To create good content on different topics People who are interested in different topics can back them. 3 Topics e.g CRYPTOCURRENCY, POLITICS, INDIA - Curators assigned to each topic - Other people back these curators - You get reward in CP token if more people like your topic. The reward is proportional to number of tokens you back a post with
  28. 28. Truth is not necessarily the schelling point. So people will stake money which people will find more attractive So, the platform becomes useless as a good source of content and only acts as a way for people to increase sensationalization. https://steemit.com/trending/cryptocurrency Topic 1 Post 1 Post 2 Post 3 5 1 2 Topic 2 Post 1 Post 2 Post 3 4 1 3
  29. 29. How can we fix this?
  30. 30. Summary ● Incentives are a powerful tool ● Following the protocol should be an equilibrium ● The protocol should be robust to external incentives ● Following the protocol should achieve the intended objective
  31. 31. Further Readings 1. Course on Mechanism design - https://theory.stanford.edu/~tim/f13/f13.html 2. Proof of Stake FAQ - https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ 3. Cryptoeconomics reading list - https://github.com/ethereummadrid/cryptoeconomics-reading-list
  32. 32. Thanks! @pranay01 pranay01.com

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