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Making sense of cryptoeconomics

Josh Stark
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What is cryptoeconomics?

  • Cryptoeconomics is the use of incentives and cryptography to design systems, applications, and networks. 

Cryptoeconomics: Bitcoin as a case study

  • It allows entities who do not know one another to reliably reach consensus about the state of the bitcoin blockchain.
  • Design relies on economic incentives and penalties. 
  • Protocol intentionally makes mining difficult, meaning that gaining control of a majority of the network is extremely expensive .
  • Public-private key cryptography is used to give individuals safe, exclusive control of their bitcoin. Hash functions are used to link each block in the bitcoin blockchain, proving an order of events and the integrity of data.
  • Meaningless phrases like “blockchains are trestles," "bitcoin is backed only by math,” or “blockchains are immutable" are all wrong, but have the effect of obfuscating the essential role of a large network of people whose participation in the network is maintained through economic incentives.

How does it relate to economics?

  • Cryptoeconomics focuses on designing and creating systems. Economic theory designs rules or mechanisms that produce a certain equilibrium outcome.
  • Cryptoeconomics, the mechanisms used to create economic incentives, are built using cryptography and software, and the systems are almost always distributed or decentralized.
  • There is a limit to how much we can rely on incentives to predictably shape future behavior.

Three examples of cryptoeconomics

  • Consensus protocols
    • Bitcoin’s solution, called “proof-of-work," means miners must commit work   in the form of hardware and electricity  in order to participate and receive mining rewards.
  • Cryptoeconomic application design
    • The underlying blockchain gives us a unit of value to create incentives and penalties, and a toolkit to design “smart contract code”
  • State channels
    • Cryptoeconomics also includes designing much smaller sets of interactions between individuals.
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