Game theory is fundamental to the development of cryptocurrencies and is one of the reasons why Bitcoin has managed to thrive for more than a decade, despite numerous attempts to disrupt the network.
So what is game theory?
Essentially, game theory is an applied mathematical method that studies human behavior based on rational decisions. A "game" is designed as an interactive environment in which players try to act rationally in response to the rules of the game or to influence the decisions of other players.
The concept was originally developed in economics to study the behavior of businesses, markets, and consumers, but is now widely used in a wide variety of research fields. Game theory models can therefore be used as a way to test potential behaviors about potential interactions and the possible outcomes of their actions in experimental situations, in terms of predictive reporting definitions. These models can also be applied to a wide range of studies in politics, sociology, psychology, and philosophy.
Prisoner's Dilemma
The prisoner's dilemma is one of the most popular examples of game theory models. It describes a situation when two criminals (A and B) are taken to separate rooms for interrogation after being arrested. Both criminals are interrogated without being able to communicate with each other.
The prosecutor will try to convince the criminals to testify against each other in order to reduce their charges. If A testifies against B, he is released and B is arrested and sentenced to 3 years in prison (and vice versa). However, if both of them betray each other and testify against each other, the result is that they will both be arrested and sentenced to 2 years in prison. Finally, if both A and B decide not to betray each other and keep quiet, they will only be sentenced to 1 year in prison due to lack of sufficient evidence.
In this scenario, we would have the following possible outcomes (based on their individual decisions):
Obviously, the best case for A (or B) is not to betray each other and be released, but this requires the other party to remain silent, and we cannot predict what decision they will make. Faced with a better reward, many rational prisoners may choose to act in their own interests and betray the other party. But if both A and B betray, they will be imprisoned for 2 years, which is not the best outcome. Therefore, for this pair, their best choice is to remain silent and get only 1 year in prison instead of 2 years.
There are many variations on the Prisoner's Dilemma, but this simple scenario illustrates how we can use game theory models to study human behavior and the idea of how humans make decisions based on rationality and their possible outcomes.
Game Theory and Cryptocurrency
When applied to cryptocurrencies, game theory models play an important role in designing secure and trustless economic systems such as Bitcoin. The creation of Bitcoin as a Byzantine Fault Tolerant (BFT) system is a harmonious fusion of cryptography and game theory.
Game theory, used in the context of cryptocurrencies, is an important foundational concept for cryptoeconomics, which is basically the study of the economics of blockchain protocols and the potential consequences of their design - based on the behavior of those involved. It also takes into account the behavior of "external agents", those that are not really part of the ecosystem, but that eventually join the network and try to undermine it from the inside.
In other words, the cryptoeconomic system is activated by the rewards provided by the protocol to examine the behavior of the network nodes and consider the most reasonable and possible decisions in the end.
Since the Bitcoin blockchain is designed as a distributed system - consisting of many nodes in different locations - it relies on these nodes to reach consensus on transactions and block verification. However, these nodes cannot actually trust each other. So how can malicious activities be avoided in such a system? How can the blockchain be protected from being corrupted by dishonest nodes?
One of the key features that protects the Bitcoin network from malicious activity is the proof-of-work consensus algorithm, which uses cryptographic techniques to make the mining process expensive and demanding, creating a highly competitive mining environment.
Therefore, the structure of cryptocurrencies built on the PoW system has a high incentive for mining nodes to work honestly (so they don't risk losing any invested resources). On the contrary, any malicious activity will be quickly unleashed and punished accordingly. All mining nodes that show dishonest behavior may lose a lot of funds and be kicked out of the network. Therefore, the most rational decision for miners is of course to act honestly and ensure the security of the blockchain.
in conclusion
In summary, the general application of game theory is to simulate and verify human behavior and the choices made based on rational thinking. Therefore, game theory models are often considered for application in the design of distributed systems, such as cryptocurrency.
Based on a balanced combination of cryptography and game theory, the Proof of Work consensus algorithm enables the Bitcoin blockchain to establish a decentralized economic system that is highly resistant to attacks. The same is true for other cryptocurrencies, and the concepts of game theory also apply to PoS blockchains. The main difference between them is the way Proof of Stake blockchains process transactions and verify blocks.
But please note that the security and resilience of a blockchain is very dependent on its protocol and is directly related to the number of total participants in the network. Larger distributed networks are more reliable than smaller ones.
