A Be inner's Introduction to Cryptoeconomics

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A Be inner's Introduction to
Cryptoeconomics
Be inner 3mo o 6m

Wh t is cryptoeconomics?
In simple terms, cryptoeconomics provides w y to coordin te the
beh vior of network p rticip nts by combinin crypto r phy with
economics.

More specific lly, cryptoeconomics is n re of computer science

th t ttempts to solve p rticip nt coordin tion problems in di it l
ecosystems throu h crypto r phy nd economic incentives. 

It is essenti l to consider cryptoeconomics when buildin

decentr lized networks bec use it is the mech nism th t provides
w y to li n p rticip nts’ incentives without the need for trusted
third p rties.
majmou3a far3iya

R ther th n bein subset of tr dition l economics,

cryptoeconomics is mix of me theory, mech nism desi n,
m them tics, nd other methodolo ies from the field of economics.
The m in o l is to underst nd how to fund, desi n, develop, nd
f cilit te the oper tions of decentr lized networks.

This rticle will dive into the ori ins of cryptoeconomics nd its role
in the desi n of Bitcoin nd other decentr lized networks.

Wh t problem does cryptoeconomics

solve?
Before the emer ence of Bitcoin, it w s commonly believed to be
impossible to cre te peer-to-peer network where consensus is
chieved without si nific nt vulner bilities to tt cks nd f ults.

This problem is often referred to s the Byz ntine Gener l’s Problem.
It is lo ic l dilemm th t demonstr tes how, in distributed
systems, it is critic l for the different ctors to re ch reements.
The problem ssumes th t since some of the ctors mi ht be
unreli ble, reements c n never be m de, nd the network c nnot
function s intended. 

With the cre tion of Bitcoin, S toshi N k moto introduced economic

incentives to peer-to-peer network nd solved this problem.

Since then, decentr lized networks h ve continued to rely on

crypto r phy to chieve consensus re rdin the st te of the
network nd its history. Also, most networks h ve been incorpor tin
economic incentives th t encour e network p rticip nts to beh ve
in cert in w ys.

This syner y of crypto r phic protocols with economic incentives

en bles n entirely new ecosystem of decentr lized networks th t
re resilient nd secure. A business ecosystem is the network of organizations—including suppliers, distributors, customers, competitors,
government agencies, and so on—involved in the delivery of a specific product or service through both competition
and cooperation. The idea is that each entity in the ecosystem affects and is affected by the others, creating a
constantly evolving relationship in which each entity must be flexible and adaptable in order to survive as in a
biological ecosystem.

The role of cryptoeconomics in Bitcoin

minin
The o l of Bitcoin is to cre te v lue tr nsfer network th t
ccur tely verifies tr nsfers of v lue, nd th t is immut ble nd
8er kabel lel taghyir
censorship-resist nt. 
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This is chieved throu h the process of minin , in which miners who

successfully v lid te block of tr ns ctions re rew rded in bitcoin.
Such economic incentive encour es miners to ct honestly, m kin
the network more reli ble nd secure.

The process of minin involves solvin difficult m them tic l

problem b sed on crypto r phic h sh l orithm. In this context,
h shes re used to tie e ch block to the next block, essenti lly
cre tin timest mped record of pproved tr ns ctions c lled the
blockch in. 

H shes re lso utilized in the comput tion l puzzles th t miners re

competin to solve. Addition lly, one of the consensus rules th t
tr ns ctions h ve to follow is th t bitcoin c n only be spent if
v lid di it l si n ture is ener ted from priv te key. 

These technolo ic l rules rel tin to minin re li ned with the

security requirements of the Bitcoin network, includin preventin
m licious ctors from t kin control.

How does cryptoeconomics enh nce

Bitcoin’s security?
Bitcoin’s security model is built round the principle of m jority rule.
This me ns th t m licious ctors could potenti lly t ke control of the
blockch in by seizin control of the m jority of the network’s
computin power in n tt ck commonly referred to s the 51%
tt ck. 

In such scen rio, the tt ckers would be ble to prevent new

tr ns ctions from inin confirm tions or even reverse tr ns ctions
entirely. However, inin control of this mount of h shin power
would be hu ely expensive, requirin subst nti l h rdw re nd
consider ble mounts of electricity.

Cryptoeconomics is one of the re sons Bitcoin h s been successful.

S toshi N k moto implemented ssumptions to encour e cert in
incentives for the different p rticip nt cl sses of the network. The
system’s security u r ntees depend lot on the effectiveness of
these ssumptions bout how network p rticip nts re ct to cert in
economic incentives. 

Without the h rdness of its crypto r phic protocol, there would be no

secure unit of ccount with which to rew rd miners. Without the
miners, there would be no confidence in the v lidity of the
tr ns ction history of the distributed led er, unless if it w s verified
by trusted third p rty, which would ne te one of the m in
dv nt es of Bitcoin.  yal8i

B sed on cryptoeconomic ssumptions, the symbiotic rel tionship

between miners nd the Bitcoin network provides confidence.
However, this is not u r ntee th t the system will persist in the
future.

The cryptoeconomic circle

The cryptoeconomic circle is holistic model of cryptoeconomics. It

w s published by Joel Mone ro nd illustr tes bstr ct flows of
v lue throu h different p rticip nt cl sses in such peer-to-peer
economy. 

The model represents three-sided m rket between miners (the

supply side), users (the dem nd side), nd investors (the c pit l
side). E ch roup exch n es v lue between one nother usin
sc rce cryptoeconomic resource ( token).

In the miner-user rel tionship in the circle, miners re compens ted

for their work throu h tokens used by the users. The network’s
consensus protocol st nd rdizes this process, while the
cryptoeconomic model controls when nd how miners et p id. 

Cre tin network rchitecture th t is sust ined by distributed

supply side (miners) is desir ble s lon s the benefits outwei h the
dis dv nt es. The benefits often include censorship resist nce,
benefits of
borderless tr ns ctions, nd hi her reli bility. But, decentr lized decentralized system
systems tend to h ve lower perform nce when comp red to
centr lized models.

The role of the investor in this model is twofold: providin liquidity for
the miners to sell their tokens, nd c pit lizin the network by
supportin token prices th t re bove the minin costs. 

The model exemplifies these two roles by dividin investors into two
tokens must have a price above the
roups: tr ders (short-term investors) nd hodlers (lon -term mining cost, otherwise no one would
mine the currency.
investors). 

Tr ders cre te liquidity for the token so miners c n sell their mined
tokens nd cover oper tion l costs, while holders c pit lize the
network for rowth by supportin token prices. The miner-tr der
rel tionship works with direct flow of v lue, while the miner-holder
rel tionship works with n indirect flow of v lue. 

This simply me ns th t ll the p rticip nts in such n economy

depend on e ch other to re ch their economic o ls. Such desi n
cre tes robust nd secure network. Compli nce with the
incentivized ruleset is more benefici l to the individu l p rticip nt
th n m licious ctivity - which in turn m kes the network more
resilient.  

Closin thou hts

Even thou h rel tively new concept th t emer ed with the birth of
Bitcoin, cryptoeconomics is si nific nt buildin block to consider
when desi nin decentr lized networks. 

Isol tin the different roles in cryptoeconomic models helps to

n lyze costs, incentives, nd v lue flows for e ch p rticip nt roup.
It c n lso help to think bout rel tive power nd identify potenti l
points of centr liz tion, which is import nt to desi n more b l nced
overn nce nd token distribution models.

The field of cryptoeconomics nd the us e of cryptoeconomic

models c n be hi hly benefici l durin the development of future
networks. By studyin cryptoeconomic models th t were lre dy
tried nd tested in live environments, future networks c n be
desi ned to be more efficient nd sust in ble, resultin in more
robust ecosystem of decentr lized economies.

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