Slides from my talk on cryptoeconomics at @hasgeek. I primarily talk about design and analysis of blockchain based systems and how to design the protocol to achieve the system goal.

1. Fundamentals of Cryptoeconomics
Pranay Prateek

2. Why?

3. Why do Bitcoin miners follow the protocol rather
than include transactions benefiting them?
Afterall, no one directly controls them - No governance

4. Incentives

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. What is Cryptoeconomics?
Crypto Economics is the application of incentive
mechanism design to information security problems

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. Bitcoin Mining
https://www.slideshare.net/wenyingng/bitcoin-20-47421199

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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. 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. Build on both chain - Nothing at Stake
https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ

24. Proof of Work
https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ

25. Penalizing violators - Slasher
https://github.com/ethereum/wiki/wiki/Proof-of-Stake-FAQ

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. 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. 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. How can we fix this?

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. 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. Thanks!
@pranay01 pranay01.com