If you’ve spent any amount of time in the cryptocurrency world in 2017, you’ve probably come across the term “cryptoeconomics.” If not, you can perhaps be excused for missing it among some of the more entertaining linguistic creations in the cryptocurrency space. This post by Nick Tomaino and this video by Vitalik Buterin should get you up to speed.
In short, cryptoeconomics describes the combination of cryptography and economic incentives to design robust decentralized protocols and applications. According to this strain of thinking, Bitcoin succeeded where other decentralized protocols failed, not because of Proof-of-Work, the idea of decentralized cash, or even fault-tolerant consensus, but because it incorporated cryptoeconomics at the core of its consensus protocol. The grand vision of cryptoeconomics is therefore to extrapolate this success to embed cryptoeconomic incentives into everything — transactions, computation, storage, prediction, power.
Blockchains enable us to enforce scarcity and facilitate value transfer in areas where that would otherwise be impossible and, therefore, radically expand the range of problems to which economic incentives can successfully be applied. Viewed through this prism, cryptoeconomic systems are fundamentally new ways of incentivizing human behavior. And their potential is massive.
While this may be easy to see in theory, actually designing economic incentives is hard. In fact, there is an entire sub-discipline of economics dedicated to studying how to design protocols that incentivize rational actors to behave in socially desirable ways. This is called mechanism design. Though much ink has been spilt on the topic of cryptoeconomics in the last few months, we have little evidence that formal methods from mechanism design are being incorporated in the development of most new blockchain protocols (with some notable exceptions that will be discussed).
To put it mildly, this represents a missed opportunity. Others have stated it more assertively:
The purpose of this post is to introduce the basic concepts of mechanism design, and give a taste for their usefulness in the cryptocurrency world. If you’re working on a blockchain protocol or application, this will ideally provide you with some introductory resources for accessing the literature of mechanism design. My hope is that you walk away from this post, 1) convinced that mechanism design is extremely important to building robust decentralized systems and 2) equipped with the basic resources to start learning how to use tools from mechanism design in your own work. Please note that I am not expert on either crypto or mechanism design and would love feedback on this post from those of you who are.
To start, I provide a brief description of the key concepts and definitions from mechanism design. The goal is to introduce the basic vernacular of mechanism design in the most accessible way possible, in order to make the subsequent discussion of cryptocurrency applications comprehensible. This is not meant to provide a formal introduction to mechanism design. That is better accomplished by reviewing one or more of the following:
This chapter by Vincent Conitzer; This article by Matthew Jackson and his two-part course with collaborators; Chapter 7 from this introductory text on Game Theory by Fundenberg and Tirole
Note that these are just a few resources that I found useful to getting introduced to the subject. Since mechanism design is an established area of economics research, I’m sure there are many others. If you know of any additional materials that you would recommend, please list these in the comment section.