Economic Incentives and Use Of Cryptography In Blockchain | Decentralized P2P Torrents To Satoshi’s Bitcoin Network Features Explained

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Economic Incentives & Use Of Cryptography In Blockchain | Decentralized P2P Torrents To Satoshi’s Bitcoin Network Features Explained

The Crypto Economy uses incentives and cryptography to design new kinds of systems, applications and networks. Specifically, the crypto economy involves the creation of things and is more similar to the design of mathematical and economic mechanisms.

Cryptoeconomics is not a subsector of economy, but an area of applied cryptography that addresses economic incentives and economic theory. Bitcoin, Ethereum, Zcash and all blockchains are crypto economy products.

Cryptoeconomics is what makes blockchains interesting and sets them apart from other technologies. Satoshi’s white paper has taught us we can create new types of technologies through an intelligent combination of cryptography, computer networks, and economic incentives. The new economic crypto systems have the ability to accomplish things that these disciplines could not do alone. The blockchain is just one of the practical examples of this new science.

Cryptoeconomy is derived from two words: cryptography and economics. Many people tend to overlook the “economic” aspect of this equation, and this is the part that gives the blockchain its unique characteristics. The blockchain is not the first system to use decentralized peer-to-peer technology. Torrent sites have used it for years to share files.

The torrent system gives everyone the ability to share files with a decentralized network. The idea was that people would download files and would continue to sow them i.e. share the file with the network so that other people could download too. There was just one problem: it worked on honor. If you were downloading a file, then you should have sown it too. Humans aren’t the most honorable of creatures and without any incentive to continue sowing a file which occupied unnecessary disk space, there was no reason for people to do so.

Satoshi Nakamoto : Theories Of Anonymous Bitcoin Founder

In October 2008, a self-described Satoshi Nakomoto published a document explaining the principles behind bitcoin. As a result, it rocked the online community to its foundations, because for the first time we had a working model for something based on the crypto economy. In contrast to past decentralized peer-to-peer systems, the new model had an economic incentive for people to “follow the rules”. However, the true genius of blockchain technology lies in how to circumvent the underlying problems in order to create a perfect consensus system.

Characteristic Features of Bitcoin

It is based on blockchain technology where each block contains the hash of the previous block and it forms a continuous chain. Each block will include transactions.

Blocks will have a special status that is changes subject based on transactions. For example: if A has got 50 bitcoins and he wants to send 20 bitcoins to B then the new state should show that A has got 30 bitcoins left and B has got 20 new bitcoins. The blockchain must be immutable. It should be possible to add new blocks, but the old blocks can not be tampered with. Only valid transactions should be allowed. The blockchain should be downloadable and anyone can easily access and control a given transaction. Transactions can be added quickly to the blockchain if a sufficiently high transaction fee is paid.

As we mentioned at the beginning, the place where blockchain differs from other decentralized peer-to-peer systems is that it offers users financial and economic incentives to do some work. As in any solid economic system, there should be incentives and rewards for people to do the job, in the same way there should be a system of punishment for miners who don’t act ethically or don’t make a good job. We will see how the blockchain incorporates all these basic economies.

Bitcoin Incentive Structure : Block Rewards For Blockchain Miners and Users

Incentive 1

Token: users who actively participate and contribute to the blockchain receive cryptocurrencies for their efforts.

Privileges: users obtain the decision rights that give them the right to charge the rent. For example: Miners who extract a new block become the temporary owner of the block and decide which transactions they can come in. They can charge transaction fees to include transactions within the same block.

Incentive 2

Awards: good participants receive a monetary reward or a decision-making responsibility to improve the blockchain network.

Punishment: bad participants have to pay a fine or have their privileges abolished for creating inconvenience to the blockchain network.

How do cryptocurrencies have value?

Cryptocurrencies have value for the same reason that money, in general, has value, trust. When people trust a commodity and give it value, it becomes a currency, it is the same reason that fiat coins have value and because gold has had value in the first place. Therefore, when a value is given to a given product, the value changes according to one of the oldest rules in economics, called Supply and Demand.

The demand of the goods is inversely proportional with its offer. The balance point created is the weak point in which one wishes to be. So, let’s use this logic for cryptocurrency and, in general, bitcoins.

The bitcoin supply is set at 21 million. This is the market cap on all bitcoins. Since the total number is fixed, there are several things that need to be considered about the bitcoin supply. For this reason, it is necessary to make some rules to make sure that bitcoins become progressively more difficult to extract. If these measures are not taken, the miners will indiscriminately mite, extracting the remaining bitcoins and placing them on the market, decreasing the overall value.

In order to ensure that miners don’t blow out all bitcoins at once, the following precautions have been taken

A new block is added to the chain only in the 10 minutes range that leads to get a 12.5 bitcoin reward. Time must be set to ensure miners that they not continue to add blocks to the chain without rules.

The second thing that the bitcoin protocol does is that it constantly increases the difficulty level of the mining process. The hash of the block along with the nonce must be less than a particular number. This number is called “difficulty level” and usually starts with a number of zeros. As the difficulty increases, the number of zeros also increases.

With these two factors and the fact that the Mining sector has become a much more specialized process that includes huge investments, the whole process means that the supply of bitcoins on the market is kept under control. And this is true of all cryptocurrencies, also using Proof-of-Work.

How does a decentralized and unregulated peer to peer system remain credible?

Miners have a lot of power and can easily commit crimes and get away with it. This is where all previous attempts at a decentralized system have failed, users are human and humans are prone to “bad” behavior. So, how to maintain a decentralized system of honest human beings? The answer lies in one of the most fundamental economic ideas: Game theory.

Game theory is basically the study of strategic decision making. Making decisions that make more sense to you, keeping in mind the decision of the competitors is basically what the game theory is. One of the most fundamental concepts of game theory is the “Nash Equilibrium”.

Nash Equilibrium is a state in which a part takes the optimal strategy keeping in mind the actions of the other party and can not achieve anything by changing one’s strategy

Financial Model In Crypto Economy

The new financial model to get new investments for start-up projects is to launch the sale of Tokens to the public through the ICO.

The question should be: is the Token necessary in the cryptographic economic mechanism? Understanding the design of an ICO is an essential tool for determining the usefulness and probable value of this token.

So, as you can see, cryptography and economics have combined in a very interesting and intricate way to create blockchain technology. The growth that has lived in recent years is staggering and can only be improved and widely used.

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