The Blockchain – The Principle of Cryptoeconomics

Cryptoeconomics enables parties who do not know each other to reach consensus about the state of a blockchain. Without the application of cryptoeconomic principles, decentralized blockchain networks like Bitcoin and Ethereum simply cannot work. And so, it allows the creation of decentralized networks and the ability of these networks to reach consensus, without the need to rely on a trusted central authority.

Many of us are using the file distribution system “BitTorrent”, which is Peer-to-Peer distribution system. BitTorrent idea was that each node in the network downloads the shared file and keeps it shared for other nodes to download but there weren’t any economic incentives for the nodes to keep the files on their computers.

Vlad Zamfir defined Cryptoeconomics as:

“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.”

The Cryptocurrency like Bitcon uses the blockchain technology, which is a distribution Peer-to-Peer system with high incentives and this is the results of Cryptoeconomics. The pillars of Cryptoeconomics come from two words: Cryptography and Economic:

Cryptography is what allows communications and interactions between peers in the network to be proved and secured.

Economic incentives defined inside the system encourages all minors to behave in a way that holds desired properties and enables the network to operate smoothly and thrive over time.

Let’s discover each on of these pillars

Cryptography

Blockchain technology uses cryptographical functions for its operations as follows:

Hashing

In simple terms, hashing means taking an input string of any length and giving out an output of a fixed length. In the context of cryptocurrencies like Bitcoin, the transactions are taken as an input and run through a hashing algorithm (Bitcoin uses SHA-256), which gives an output of a fixed length.

Signatures

In real life, the signature on a document must provide the following characteristics:

• Verification: it makes sure that you who signed that document.
• Non-forgeable: no one else should be able to forge and copy your signature
• Non-repudiation: you shouldn’t take your signature back or claim that someone else had signed instead of you

Cryptography uses the concept of public and private keys as a solution for the signatures, public key is a public and anyone can have it, however private key is private with the sender and shouldn’t be shared with anyone. So if node “A” sends a message to node “B” that is encrypted with node “A” private key, node “B” can decrypt the message by using node “A” public key.

The cryptography signature must also provide similar characteristics as real life signature:

• Verification: If the encrypted message decrypted by using node “A” public key then it verifies 100% that node “A” was the sender.
• Non-forgeable: If someone intercepts the encrypted message by node “A” and sends his own message with his private key, node “A” public key will not be able to decrypt the message with different private key
• Non-repudiation: If node “B” decrypted the message by using node “A” public key, then node “A” cannot claim that he didn’t send the message or someone else sent it.

Proof of Work

It is a mathematical puzzle solution that requires an expensive computer calculation, also called mining. All the network miners compete to be the first to find a solution for the mathematical puzzle that concerns the new block. Each puzzle essentially requires a huge number of attempts. Without going to deep technical, mining process is an operation of inverse hashing: it determines a number (nonce), so the cryptographic hash algorithm of block data results in less than a given threshold.

Zero Knowledge Proofs (ZKP)

It means that node “A” can prove to node “B” that he has knowledge of a certain piece of information without telling them what that knowledge specifically is, in other words ZKF proves a computational fact about the data without revealing the data itself. It can be used to generate a proof of statement to verify each and every transaction by just taking a simple snapshot of each transaction, which is enough to prove to the receiving side that a transaction was done without revealing the transaction itself.

Economic

Economic is the social science that studies economic activity to gain an understanding of the processes that govern the production, distribution, and consumption of goods and services in an economy.

The economic for the cryptography is the part that gives the blockchain its unique capabilities, an economic system where it incentives and rewards the minors to get work done, similarly, it is a punishment system for miners who do not act ethically or do not do a good job.

There are two sets of incentives that participants in the blockchain have: 

Incentive Set #1

• Tokens: The minors who actively participate and contribute to the blockchain get assigned cryptocurrencies for their efforts.
• Privileges: minors get the decision-making rights, which give them the right to charge transaction fees to include transactions within the block itself.

Incentive Set #2

• Rewards: Good participants get a monetary reward or decision-making responsibility for doing well.
• Punishments: Bad participants have to pay a monetary fine or they have their rights taken away for behaving badly

Conclusion

Cryptoeconomics refers to the use of economics (through incentives) and cryptography (through encryption) to design a secure system or network with predefined desired properties.

Sources

What Is Cryptoeconomics?

What is Cryptoeconomics? An Introduction for Beginners

What is Cryptoeconomics? The Ultimate Beginners Guide

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About: Khaled Samy Hall

Khaled is the Co-founder and CEO at HYNO World company, and ST-United General Manager. Khaled has a long history of successful career growth in a variety of industries. He is currently the Book Author of "The ROI analysis: Project Management Office Development" and active Blogger.