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A crash course in mechanism design for cryptoeconomic applications

by
BlockChannel
Medium
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What is Cryptoeconomics?

  • It pertains to the combination of cryptography and economic incentives to design decentralized protocols and applications.

Mechanism Design

  • It is a sub-discipline of economics dedicated to studying mechanisms that incentivize players to behave in socially desirable ways towards a specific objective.

Basic Concepts

  • Mechanism design includes a finite set of players and a set of potential social decisions.
  • Players possess private information, known as signals or types, that can represent their preferences.
  • A common prior refers to a probability distribution over types, while decision rule maps types to social decisions.
  • In transfer functions, tokens are used to incentivize players.
  • Designers get to control the choice of mechanism, but not the players or their types.

Types of Implementation

  • Dominant strategies result in a higher payoff regardless of the strategies chosen by other players.
  • Bayes-Nash equilibrium – no player has an incentive to change their strategy based on their beliefs about the other players' type/strategy.

Results

  • The Revelation Principle – states that there is a payoff-equivalent direct-revelation mechanism where players truthfully declare their types.
  • Vickrey-Clarke-Groves Mechanisms – it is a generalization of VCG auction, where each player has an incentive to bid their exact valuation for the token.

Types of Incentives

  • Payments – for instance, mining rewards.
  • Privileges – these allow their players to extract rents, such as transaction fees. Although mechanism design is prevalent in computer science research, it is only beginning to be implemented in designing blockchain protocols.
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