What is Crypto Economy?

The most common mistake in the field of Bitcoin is to misunderstand the blockchain as just a technology based on computer science or cryptography. However, Bitcoin leverages the crypto economy to achieve innovation beyond technology. This article will explore how Bitcoin uses the crypto economy to create innovation beyond simple technology.

Misconceptions about the Crypto Economy

The term cryptoeconomics can be misleading as it suggests a connection to the traditional economy. However, the invention of cryptocurrency and blockchain technology does not require a new theory of human choice. Cryptoeconomics differs from applying the theories of macroeconomics and microeconomics to cryptocurrency or token markets.

Utilization of the Crypto Economy

Cryptoeconomics is often used in mechanism design and is closely related to the field of game theory. In game theory, we analyze a given strategic interaction to understand the best strategy for each player and the likely outcome if both players follow these strategies. For example, game theory can be used in negotiations between two firms or countries.

Mechanism Design

Mechanism design is referred to as 'inverse' game theory because we first identify an ideal outcome and then design the game to achieve it. Players pursue their own interests in a way that ultimately produces the desired outcome. For example, when designing an auction, the rules are designed using economic theory to ensure that bidding is done at the actual value placed on the item. One solution is the Vickrey Auction, where the winning bid is the second-highest bid, and economic theory is used to design mechanisms that produce specific outcomes. Cryptoeconomics, like mechanism design, assumes rational behavior and designs the system accordingly.

Cryptoeconomics vs. Mechanism Design

Cryptoeconomics and mechanism design share similarities in the design and construction of systems. Like an auction, economic theory is used to design 'rules' or mechanisms that result in a particular equilibrium. However, in a cryptoeconomy, cryptography and software are used to create economic incentives, and the systems designed are usually distributed or decentralized.

Crypto Economy Case Study

Bitcoin is an example of leveraging mechanisms from a cryptoeconomic perspective. Satoshi Nakamoto, the founder of Bitcoin, wanted certain property rights for Bitcoin, such as the ability to reach consensus on the intrinsic state of the currency to resist censorship. Satoshi Nakamoto designed a system that could achieve these properties by assuming that people respond rationally to economic incentives. As a result, Bitcoin was created based on a crypto economy, which provides security guarantees for decentralized systems. For example, the cryptoeconomic security guarantee ensures the safety of the Bitcoin blockchain from 51% attacks unless someone is willing to risk billions of dollars to cheat. The off-chain process is the result of an on-chain transaction, demonstrating its safety.

Conclusion

Mechanism design is not a panacea for everything, and relying solely on it to predict and adjust future behavior with blockchain incentives is not enough. However, as Nick Szabo points out, leveraging mechanism design allows us to estimate people's future psychological states and infer how they will respond to specific incentives.