During the past few years, digital currencies have been on the rise the central player has been Bitcoin. At first, there were people who felt like the idea of Bitcoin was only that: an idea. This was something that was going to fade into the rearview mirror like so many other fads throughout society. The reality is that blockchain technology, which forms the underpinnings of Bitcoin itself, has now been hailed as a breakthrough. In order to figure out how Bitcoin and other digital currencies work, it is important to understand something called game theory.
Taking a Closer Look at Market Structures
Before getting into game theory, it is important to cover a few basics. The first has to do with something called the market structures. There are four broad market structures that exist on somewhat of a spectrum. The factors that set these market structures apart include the number of producers, how much control there is when it comes to prices, and what barriers exist to entry into these markets. When it comes to these factors, there are several different types of structures. They include perfect competition, monopoly, monopolistic competition, and perfect competition.
First, when it comes to perfect competition, this is a marketplace where it is relatively easy for anyone to get into the market and the sellers don’t have much control over the price of the product. This is the case with common goods, such as bananas. The quality is relatively the same and there isn’t much wiggle room when it comes to prices. Now, let us turn to the other side. A monopoly is one where there is no competition. There is one corporation that holds all of the inventory and there isn’t any room for someone else to enter the market. This is because the barriers to entry are high, nobody else can get involved, and there is one controlling entity that sets the price. This is the opposite of perfect competition. The other two examples fall somewhere in between these two examples.
Taking a Look at Game Theory
Now, we can take a closer look at game theory. For those who might not know, this is a study that focuses on the idea of making decisions. In many respects, this is how corporations make their decision. They think about the actions of their competitors and they make their decisions in response to these strategies. The idea of game theory was first posed back in the 1940s. Since that time, game theory has been a popular focus of study when it comes to markets. Now, game theory has a life of its own. In order for game theory to play a role, there are three separate components that have to exist. These include the players (who are the decision-makers), strategies, and the ultimate payoff at the end of the game.
In game theory, there are two outcomes that can be obtained. The first is called a zero-sum game. This means that if someone wins, the other person has to lose. Then, the opposite of this is a non-zero-sum game. This means that if one player wins, it doesn’t have to come at the expense of someone else. Now, how is this game theory applied? It is time to take a closer look at advertising strategies.
The whole point of the advertising example is to take a look at what happens to two separate firms deciding whether they do or don’t advertise. Is this a zero-sum game? In this case, one firm advertising would not only help that firm but also harm the other firm. Or, is this a non-zero-sum game? In this case, one firm advertising might help one firm but wouldn’t necessarily harm the other firm. This is how game theory is applied to the world of business. In today’s world, game theory serves as the underpinning for a lot of decisions that are made in the economic world.
Looking for Nash Equilibrium
One of the major philosophies that serve as an underpinning for game theory is called Nash equilibrium. This is a solution to the game where each player chooses their optimal strategy, given the strategy that was chosen by the other player. This theory was posed by the character at the center of the popular movie called A Beautiful Mind. This led to the development of a large computer system that basically functioned as a blockchain. Does this term sound familiar? It should. This is the foundation of the world of Bitcoin. This the connection between Bitcoin and game theory, with Nash equilibrium serving as the focal point of the development of blockchain technology.
In this manner, Bitcoin has been formed on the basis of game theory. Because game theory plays a major role in the functions of numerous economic decisions today, Bitcoin is not that different from the rest of the economic landscape. With this in mind, it is time to take a closer look at Bitcoin and game theory.
Blockchain Technology and Game Theory
Let us take a closer look at game theory as it applies to the world of blockchain technology. First, a blockchain is a series of blocks that are all joined together, connected to blocks that have come both before and after it. Each block contains the hash of the block that came before it. In this manner, each block is linked to others, making a chain, giving rise to the term that people use today.
When it comes to the world of Bitcoin, there are two separate players when we look at this in the eyes of game theory. There are users, who use coins, and there are miners, who create them. For those who might not know, Bitcoin miners are responsible for using hardware to make new blocks by solving math problems. It is important to take a closer look at Bitcoin mining when it comes to game theory because this is an important function. When miners complete a series of calculations, they have the option to make a new block. When miners make blocks, the block has to be verified by the rest of the nodes. This is how the game is played fairly.
If miners make a new block without completing the work to make it, then the chain is going to reject the block because the proof of work is not going to be present. On the other hand, if the miners do go through the proper channels to make a new block, then the chain is going to accept it. This is how game theory with respect to Bitcoin keeps the game honest.
In order to really show that game theory works with Bitcoin, it is important to take a look at the way that people could possibly cheat. The first option is to include an invalid transaction and give themselves extra coins. The second way is to add blocks without any work. The third way is to mine on top of blocks that are invalid to get more coins. The final option is to mine on top of a block that might not be scoring optimally.
Why, exactly, don’t these methods work? The answer goes back to Nash equilibrium, which was mentioned above. The game has been designed to incentivize people to play the game fairly. For example, to find ways to mine incorrectly (or suboptimally) would require a tremendous amount of resources that miners simply do not want to spend. The reality is that something like this would be very hard to pull off. They would have to coordinate with everyone else. Furthermore, if a miner is caught, they are likely to be ostracized in the future. Bitcoin mining is almost always done using a pool of people because of the resources required to make a new block. As a result, there is little incentive to try to cheat in the world of Bitcoin mining. In order for Bitcoin to have value, people need to give it value. It people are able to cheat the system, then Bitcoin loses value because people no longer trust it. This means that they will lose faith in it.
Addressing the Idea of a Takeover via Proof of Work
One problem that merits further discussion is called the proof of work problem. Suppose there is someone who tries to make a smart contract to execute this strategy. The idea is that anyone can join the activity using a large deposit. Miners need to send shares of partially completed blocks that they have mined. There is a way to verify this along with verifying the hash system used to make these blocks. People who enter the contract are required to stay until 60 percent of the miners in the system join. Then, people have to stay until a certain number of blocks have been completed.
Now, the chain is going to grow bigger and longer because a majority of the miners have joined this system. They want to join because there is a major reward at the end in the form of blocks and there is no risk to them. Because there is the possibility of double-spending, the value of the currency is going to fall quickly. This is a diabolical problem that could take down the entire system.
Why doesn’t this happen? Because anyone who runs this system knows that if they can do it, someone else. This means that if they succeed using this proof of work takeover strategy, they could be deposed by someone else doing the same thing. As a result, it is better, once again, to play by the rules.
In Conclusion: The Game Theory of Bitcoin
This is a very brief overview of how game theory works and is applied to Bitcoin. In summary, Bitcoin works because the game theory of cryptocurrency has been set up in such a way that people have been incentivized to play by the rules. While the creator of Bitcoin is somewhat of an enigma, the system has worked well to this point. There are people who have tried to cheat the system and have failed because the system itself finds a way to hold people accountable. It will be interesting to see how much Bitcoin continues to grow in the future. Without a doubt, the future of this world of digital currency is still bright.