When delving into the definition of the term “Cryptoeconomics” there is a lot of confusion among crypto enthusiasts as well as the general public as to what it means exactly. You might ask, why does the crypto industry require it’s own parrallel for economics as a whole, cryptoeconomics is not to be confused with the word “economics” in the general sense.
Ethereum Developer Vlad Zamfir said this of Cryptoeconomics:
A formal discipline that studies protocols that govern the production, distribution, and consumption of goods and services in a decentralized digital economy. Cryptoeconomics is a practical science that focuses on the design and characterization of these protocols.
In simple terms, cryptoeconomics is using cryptography to create incentives in a decentralized application. These incentives form a part of the design of a system to create mechanics around economic theory. Cryptoeconomics in this sense is not a field within economics but rather an area within applied cryptography.
Cryptocurrencies are a product of this, it is this mix of cryptography, computer science, networking and economics which made public blockchains like Bitcoin possible. Using a combination of these technologies Satoshi built a system of economic incentive which makes cryptocurrency possible, it would not be possible with each of these on their own.
Case Study: The Cryptoeconomic Aspects of Bitcoin
Bitcoin was the first cryptocurrency, we will go through it’s aspects which are a result of cryptoeconomics.
1. Block rewards and transaction fees
The blockchain is a ledger which keeps track of the movement of Bitcoin within the system. It relies on cryptography to manage this in a decentralized system. In order for there to be an incentive for miners to confirm the transactions which are taking place, they are rewarded by completing a block of transactions. They will be rewarded a set value of Bitcoin which halves every four years and they have also rewarded the transaction fees from that set of transactions.
This provides an incentive for miners to secure the network, it is said this is one of the reasons that P2P file sharing was not such a huge success. There was no incentive for users to continue seeding a file once they completed downloading it as this uses bandwidth and takes up space on their device.
2. Denial of Service from Transactors
In the same way that actors require an incentive to secure the network, there are also economic penalties for trying to attack the system. Bad actors could, for instance, send many spam transactions and fill up the block space leaving no space for genuine transactions to take place.
In order for transactors to utilize the network, they need to compensate the miners in the form of transaction fees. This reduces the incentive to stall or flood the network with spammy transactions by making it expensive to execute an attack of this nature.
3. Denial of Service from Miners
There could also be the possibility of a denial of service from miners where miners could mine an infinite number empty blocks and reap the block reward and transaction fees without incurring much cost. To stop this, miner’s can only include a certain number of transactions in each block. The transactions which are included are those with sufficient fees. The higher the fee paid by the transactor the higher the likelihood it will be included in the next block.
This creates a free market for determining fees and the idea is that the network will find the optimal fee for paying for the security and computing power of the network and a low enough transaction cost.
2. 51% Attack
The 51% attack is when an actor controls over 51% of the mining hashrate, by doing so they are able to decide which transactions are valid or invalid can potentially double spend transactions by sending the same bitcoin to two or more addresses.
In order to do so the bad actor would have to incur potentially billions of dollars in hardware and electricity in the hopes to gain control of the network, but to what outcome? Once the security of the network is compromised it has now lost all of it’s value.
This article covers the basics of cryptoeconomics, there is a lot of in-depth information out there to do further research. Below we list a few good resources for you to study: