Cryptoeconomics
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.
References
0xSalon (2020). Epistemic Trespassing Salon Report - Aside on Cryptoeconomic Systems - a case study in attempted epistemic formation. https://0xsalon.pubpub.org/pub/it4vigwo/release/8#aside-on-cryptoeconomi...
Alsindi, W. Z. (2019). TokenSpace: A Conceptual Framework for Cryptographic Asset Taxonomies, Parallel Industries. https://tokenspace.pubpub.org/pub/z0gjv399/release/6#regulating-securiti....
Brekke, J. K. (2020). Hacker-engineers and Their Economies: The Political Economy of Decentralised Networks and ‘Cryptoeconomics’. New Political Economy. https://doi.org/10.1080/13563467.2020.1806223
Brock, A., Atkinson, D., Friedman, E., Harris-Braun, E., Mcguire, E., Russell, J. M., Perrin, N., Luck, N., and Harris-Braun, W. (2017). Holo Green Paper. https://files.holo.host/2017/12/Holo-Green-Paper.pdf.
Brown-Cohen, J., Narayanan, A., Psomas, C., Weinberg, S. M. (2018). Formal Barriers to Longest-Chain Proof-of-Stake Protocols. https://arxiv.org/abs/1809.06528
Buterin, V. (2017). Introduction to Cryptoeconomics, Ethereum Foundation. https://youtu.be/pKqdjaH1dRo.
Catlow, R. (2019). Decentralization and Commoning the Arts. In Free/Libre, Technologies, Arts and the Commons. Nicosia, Cyprus: University of Nicosia Research Foundation.
Daian, P., Goldfeder, S., Kell, T., Li, Y., Zhao, X., Bentov, I., Breidenbach, L., and Juels, A. (2019). Flash Boys 2.0: Frontrunning, Transaction Reordering, and Consensus Instability in Decentralized Exchanges. https://arxiv.org/abs/1904.05234
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Floersch, K. (2017). Casper Proof of Stake, Cryptoeconomics and Security Conference, Berkeley. https://youtu.be/ycF0WFHY5kc.
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Jana
PUBLISHED ON: 27 November, 2020 - 04:08
Hello guys
an interesting read.
I'd have a few points to raise (brief intro: I've been full time in the space, as consultant&event organizer and freelance token economist since early 2017)
* I'd identify the relationship between cryptoeconomics and token economics/engineering right at the beginning
* I am not certain if mining (PoW, PoS etc) is still a part of cryptoeconomics. From computer science perspective, that is an architecture of distributed systems. Some folks can argue that cryptoeconomics can then date as far as to times of Scott Stornetta's work in 1991.
* I appreciate mentioning DeFi - for non-cryptonative people it would be nice to explain in a few sentences what is precisely the difference between DeFi and ICOs (is ICO a DeFi product? Is BTC DeFi?) That's a difficult one.
* I am happy to read this paragraph: "One of the ongoing challenges encountered in cryptoeconomics is inherent to mechanism design and market design economics more generally (Ossandón, 2019)..." but I miss there what is mentioned in the next paragraph - that this is not a problem of cryptoeconomics but rather a social problem. Just swapping those 2 would be welcome.
I am not strongly opinionated in none of the abovementioned points, I think you did a great job.
Thank you
Jana
Ingolf Gunnar Anton Pernice
PUBLISHED ON: 27 November, 2020 - 18:37
Hey Jaya, Hello Wassim!
Thanks for that great contribution. I reviewed the article and will paste my notes below. I hope they are helpful. You did a very good job!
Best,
Ingolf
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# General comments
Strengths:
* Origin of the term is researched very well.
* Current issues in the field are including important discussions that are highly informative. Especially the link to Austrian Economics in the light of complex economic designs to solve social problems is an exciting feature.
* The general structure is clear and benefits understanding.
* Different perspectives and focal points of "cryptoeconomics" were opened up. They might guide the interested reader to the relevant fields of discussion.
Weaknesses:
* The first section fails to offer a clear-cut understanding on "who thinks what" about the term. Also it should, if possible, provide a clear link to the final definition in the conclusion. This issue might easily be resolved by rewording some phrases. F.e. the general idea that "Cryptoeconomics is generally understood to combine cryptographic techniques and economics." should be presented already in the beginning.
* Some phrases are complex and hard to understand.
* There are some minor inaccuracies. Most can be resolved by sharpening up the wording.
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# Notes from review:
* 1. Definition / Origin:
* The authors found the original source and meaning of the term. That is quite nice.
* It is not expressed clearly though, why it is viable to taint academic literature on the intersection of "crypto" and "economics" with the term when not actually used in those papers. Is this just the author's view (as this view deviates from the quoted definitions above)? And - is this what the term ought to be used for - or what is used for de-facto? What sub-concepts exactly are included by “crypto" and "economics" in this context? I can see what the authors are going for, but a more preciseness might add depth and credibility.
* Improve wording of: "solve specific information security, organisational and economic problems".
* "For some, the ... of the US far right (Golumbia, 2016).": Phrase much to long and complicated.
* "With the invention of Bitcoin, economic ideas were added to the toolbox of computer engineers developing peer-to-peer systems.": This is not precisely right. In relation to P2P systems, there have been economic ideas included before Bitcoin (f.e. "Gupta et al. 2003, A reputation system for peer-to-peer networks" or Yang et al. 2003 - PPay: micropayments for peer-to-peer systems").
* 1. Definition / Evolution:
* It is a little hard to follow here, as the original meaning of the term differs between the ideas of the Ethereum- and Bitcoin community and the authors view on its perception in academia. In general, this is a good idea, but wording might be a little sharper.
* In general, the categories provide a nice overview over "hot topics" in the field. Suggestions of important academic literature for each of the categories might provide additional utility for the interested reader.
* As a side note: In general, splitting up the ideas around "cryptoeconomics" into categories seem like a good idea. The category "mechanism design", however, might be seen as part of the other three categories. Incentive mechanisms are part of market design, token- and information security engineering. Not a real issue, though.
* 2. Issues currently associated with the term
* The raised point of "conventional and conservative" approaches from economics is important and interesting. The argumentation and quotations might be sharpened though (f.e. Why only game theory?). The Szabo-quote fits perfectly, the Lotti-quote not so much (or the other way around). Is this section about conventional paradigms or outdated concepts that are applied? Both are interesting but might better be discussed separately.
* "Alternative approaches to cryptoeconomics": Please sharpen up wording.
* "There is, in other words... Bitcoin (Golumbia, 2016; Voskuill, 2018).": Might be simplified.
* The challenge inherent to "mechanism design" in DeFi is outlined nicely.
* "This contradiction": Which? Please, improve the link to prior section.
* The link to the Austrian school of economics is awesome. A little more elaboration might be very welcome.
* 3. Conclusion:
* In my view, the final definition should be rooted a little clearer in the first section to give it more credibility. It is not clear, for example, why it can be stated that concepts applied are primarily stemming from game theory (even though that might very well be true).