Jaya Klara Brekke, Durham University
Wassim Zuhair Alsindi, Massachusetts Institute of Technology

1. Definition

Cryptoeconomics describes an interdisciplinary, emergent and experimental field that draws on ideas and concepts from economics, game theory and related disciplines in the design of peer-to-peer, cryptographic systems.

Origin

The term cryptoeconomics entered casual usage in the formative years of the Ethereum developer community in 2014-5. The coining of the phrase is typically attributed to Vitalik Buterin with the earliest public usage being in a 2015 talk by Vlad Zamfir entitled “What is Cryptoeconomics” (Zamfir, 2015). For Buterin, the aim of cryptoeconomics is “as a methodology for building systems that try to guarantee certain kinds of information security properties" (Buterin, 2017, pp. 46-56). While for Zamfir, the focus is more broadly on the distribution of efforts, goods and services in new digital economies: "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" (Zamfir, 2015). The term is uncommon amongst Bitcoin developers, but is used to discuss adversarial scenarios such as state-sponsored defensive mining and transaction censorship (Voskuill, 2018).

Cryptoeconomics was coined by the Ethereum community but was initially inspired by the use of economic incentives in the Bitcoin protocol (Nakamoto, 2008). Bitcoin mining is designed with the intention that it would be more profitable and attractive to contribute to the network than to attack it. With the development of Ethereum as the first general-purpose blockchain protocol, the idea of using economic incentives was also generalised as an approach to achieve a broad variety of behavioural and information security outcomes for decentralised systems. This has led to experimentation with the use of cryptographic techniques and incentives in organisational, financial, market and monetary experiments (Davidson et al., 2016; Halaburda et al., 2018; Voshmgir, 2019).

The motivation for the development of cryptoeconomics came about in order to solve specific information security, organisational and economic problems that manifest in decentralised systems. This affinity to decentralisation as an axiomatic aim and primary concept originates from a longer history of the development of peer-to-peer systems as a means to establish autonomous networks (Brekke, 2020). With the invention of Bitcoin, economic ideas were added to the toolbox of computer engineers developing peer-to-peer systems. For some, the motivation was to enable economic autonomy and fair distribution of efforts and rewards within such decentralised networks, what scholar of money and the internet Swartz calls infrastructural mutualism, while for others the promise of provably scarce and unforgeable virtual commodities - digital metallism - was the main attraction (Swartz, 2018), the latter often drawing on economic and monetary ideas of the US far right (Golumbia, 2016).

Evolution

Over time there has been a broadening in the scope of what can be considered cryptoeconomics as the variety of consensus systems and token types has proliferated. The different approaches to cryptoeconomics are beginning to settle into distinct layers of a cryptoeconomic 'stack': 'layer 1' referring to the information security of a network protocol such as proof-of-work and proof-of-stake; and 'layer 2' referring to the token, market or mechanism capacities offered by emerging cryptoeconomic platforms (Alsindi, 2019).

In recent years a number of networks affording general-purpose computation with facile smart contracting and token creation capabilities have emerged. This layer 2 cryptoeconomics entails the creation of notionally valuable economic assets without being connected to the underlying security properties of the network substrate - for example ERC20-type Ethereum tokens, Non-Fungible Tokens (NFTs) and more recently Decentralised Finance (DeFi) synthetic tokens. Whilst having notional economic value, these assets provide negligible security benefits to the base layer of the network: the abstracted non-native assets of 'layer 2' may increase the incentive to attack 'layer 1', as has been discussed in relation to ledger forks (Alsindi, 2019), Initial Coin Offering launches and sudden market-moving events are seen regularly in the hyperfinancialised DeFi sector (Daian et al., 2019).

The scope and definition of cryptoeconomics is still undergoing epistemic formation (0xSalon, 2020) and thus entails specific areas of focus:

Information security engineering

Where the primary focus of the cryptoeconomic endeavour is on the security properties for peer-to-peer 'layer 1' protocols.

Mechanism design

Where the focus is specifically on the use of incentives for behavioural engineering of rational agents in a game theoretical setting (Brown-Cohen et al., 2018).

Token engineering

Where the primary focus is on the functionality and properties exhibited by tokens used in a system. Tokens might for example grant token holders specific rights (such as service access or voting privileges as commonly encountered with the ERC-20 pseudo-standard), be fungible or non-fungible such as NFTs, be generated and distributed through mining, or through airdrops. Different token designs are understood to encourage different types of behaviours and organisational properties (Voshmgir, 2019).

Market design

Where the focus is on employing blockchain protocols and tokens in order to experiment with new kinds of markets that generate specific types of outcomes. For example, bonding curves determine the price of tokens depending on the supply or other factors, with an aim to influence the behaviour of investors (Titcomb, 2019).

2. Issues currently associated with the term

Cryptoeconomics is generally understood to combine cryptographic techniques and economics. However, much of the field of cryptoeconomics “shows an interesting but also alarming characteristic: its underlying economics is remarkably conventional and conservative” (Virtanen et al., 2018). Out of the long-standing and broad fields of economics and associated fields of political economy, monetary theory, finance and social study of finance, most literature on cryptoeconomics takes an overly formalist approach to the contested field of game theory (Green and Viljoen, 2020). Virtanen et al. quote a revealing tweet from the influential Nick Szabo: “An economist or programmer who hasn’t studied much computer science, including cryptography, but guesses about it, cannot design or build a long-term successful cryptocurrency. A computer scientist and programmer who hasn’t studied much economics, but applies common sense, can.” This, adds Lotti, means that the disruptive potential of cryptoeconomic approaches, “in spite of their noble intentions, these projects do not in fact break with the current financial paradigm” (Lotti, 2016, p. 105).

Alternative approaches to cryptoeconomics take a broader societal outlook, for example focusing on the economics of new organisational forms (Davidson et al., 2016), the design of economic space (Virtanen et al., 2018), or on economic and monetary design that draws on mutual credit systems (Brock et al., 2018) and commons approaches (de Filippi and Hassan, 2015; Catlow, 2019). There is, in other words, much broader economic experimentation taking place with and through peer-to-peer cryptographic systems, however, those explicitly labelled cryptoeconomic often imply narrow and formalist approaches limited to Austrian school economics, right wing monetary ideas and game theory, especially apparent in the usage of the term in reference to Bitcoin (Golumbia, 2016; Voskuill, 2018).

One of the ongoing challenges encountered in cryptoeconomics is inherent to mechanism design and market design economics more generally (Ossandón, 2019). Namely the contradiction between the promise of deterministic outcomes in theory and the complex, emergent behaviours and effects of the systems in real deployments. On the one hand, the market design approach in cryptoeconomics promises to deliver specific properties (information security or behavioural outcomes). But on the other hand, the simple rules of the systems designs produce complexity and unintended outcomes (Voshmgir and Zargham, 2019). A contradiction off-handedly commented on by Ethereum developer Floersch when discussing the Casper proof-of-stake approach: "[W]e have this complex behavior emerging from really simple economic rules, and this actually not specific to Casper by any means, this is any protocol that are messing around with economics" (Floersch, 2017, pp. 12-18).

This contradiction is nevertheless “productive” for those seeking to promote economic approaches to social problems: the promise of deterministic outcomes makes the models convincing and attractive from a formalist perspective (Green and Viljoen, 2020), while the complexity obscures any “failures” of the design (Nik-Khah and Mirowski, 2019). These shortcomings are instead relegated to being a problem “of the social” or “with humans” or that the implementation was not sufficiently faithful to the protocol, or even that the protocol implementation was not being expansive or radical enough. This contradiction is extensively covered in political economic and economic history and comprises one of the main critiques of the Austrian school of economics in particular (Mirowski and Nik-Khah, 2018; Heilbroner, 1998), what is also called the performative aspects of economics. From an information security perspective, the incorporation of economic incentives into protocol design in this sense radically increases the complexity of peer-to-peer systems, and correspondingly also increases the attack surfaces and variety of vulnerabilities (Alsindi, 2019).

3. Conclusion

In summary, cryptoeconomics refers to an emerging field that employs economic concepts, primarily from game theory, in the design of peer-to-peer cryptographic systems. The origins of the field lie in specific information security problems arising out of such systems. Competing approaches draw from a much wider field of economic and political economic thinking, including mutual credit systems and commons frameworks, in order to address questions of organisation and societal outcomes more broadly.

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