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What is Cryptoeconomics?

Last Updated : 24 May, 2022
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Crypto-economics is a combination of two words – cryptography and economics. Cryptoeconomics is the use of incentives and encryption to create systems, applications, and networks. It is the use of cryptography that takes into account economic motivations and economic theory.

  • In blockchains, cryptography is used in both digital signatures and hash functions
  • Cryptoeconomics refers to the application of cryptography, computer networks, and game theory to produce secure and decentralized systems that rely on a set of economic incentives to sustain themselves.

Relation Between Economics and Cryptoeconomics

The relationship between economics and crypto-economics can be described as follows:

  1. Cryptoeconomics combines economics and computer science to investigate the decentralized marketplaces and applications that may be created by coupling cryptography with economic incentives.
  2. Countries that encourage crypto networks profit economically through innovation, investment, job creation, and taxation. 
  3. Access to new demography and technological efficiencies in treasury management are among the business benefits of embracing cryptocurrency as a digital asset.

How Does Crypto-Economics Tackle BGP?

The Byzantine Generals Problem is a game theory problem that describes the difficulties that dispersed parties have in reaching consensus without the assistance of a trustworthy central party. The term “Byzantine generals problem” was coined to characterize a situation in which, in order to avoid catastrophic system failure, the system’s actors must agree on a coordinated approach, but some of these individuals are untrustworthy.

Byzantine fault tolerance which is another name for the Byzantine Generals Problem is only concerned with broadcast consistency, which is the property that when one component broadcasts a single consistent value to other components (i.e., sends the same value to the other components), the other components all receive the same value, or if the broadcaster is inconsistent, the other components agree on a common value. This type of fault tolerance does not include the value’s correctness; for example, an adversarial component that transmits an inaccurate value on purpose but delivers the same value consistently to all components will not be noticed by the Byzantine fault tolerance method.

  • With the introduction of Bitcoin, Satoshi Nakamoto addressed The Byzantine General’s Problem by injecting economic incentives into a peer-to-peer network. Since then, decentralized networks have relied on cryptography to gain consensus on the network’s current and historical status.
  • Furthermore, most networks have introduced financial incentives to encourage network participants to behave in certain ways.
  • This fusion of cryptographic protocols and economic incentives generates an entirely new ecosystem of long-lasting and safe decentralized networks.
  • It can be said that the problem can be solved by implementing a protocol that employs fault-tolerant mechanisms. When faced with ambiguity, adopting a procedure among the generals is the best method to make choices. As a result, because there is no certainty of what will happen, it becomes probabilistic rather than deterministic. 
  • To overcome the Byzantine Generals Problem, Bitcoin employs a Proof-of-Work method and a blockchain. Because Bitcoin’s ruleset is objective, there is no debate about which blocks or transactions are valid, allowing all members to agree on a single fact.

Role Of Cryptoeconomics in Bitcoin Mining

The Ethereum community developed the term “cryptoeconomics,” but it was inspired by the usage of economic incentives in the Bitcoin protocol. Bitcoin mining is intended to make it more profitable and appealing to contribute to the network rather than attack it. 

  • With the introduction of Ethereum as the first successful general-purpose blockchain protocol, the concept of employing economic incentives became more generalized as a means of achieving a wide range of behavioral and information security outcomes for decentralized systems.
  • This is accomplished via the mining process, in which miners that successfully validate a block of transactions are paid with bitcoin. Such a monetary incentive encourages miners to perform honestly, making the network more dependable and secure.
  • Without the cryptographic technology’s difficulty, there would be no safe unit of account to recompense miners. Without miners, there would be no way to verify the authenticity of the distributed ledger’s transaction history unless it was certified by a trusted third party, which would negate one of Bitcoin’s primary advantages.
  • According to crypto-economic theories, the symbiotic interaction between miners and the Bitcoin network fosters trust. However, this does not ensure that the system will continue to exist in the future.

How Does Cryptoeconomics Enhance Bitcoin Security?

  • Bitcoin’s security mechanism is built on the concept of majority rule. This means that a 51 percent attack, in which bad actors grab control of the majority of the network’s computing capacity, has the potential to dominate the blockchain.
  • Cryptoeconomics is one of the reasons Bitcoin has been so successful. Satoshi Nakamoto made assumptions in order to support certain incentives for the network’s various participant groups. The accuracy of these assumptions about how network participants respond to different economic incentives is important to the system’s security assurances.
  • Bitcoin’s Proof-of-Work (PoW) method and transaction verification both employ SHA-256 encryption. One of the bitcoin protocol’s core properties, the transaction blockchain, is responsible for its security.
  • Blockchain relies on a large number of volunteers to sign hashes that employ cryptography to authenticate transactions on the Bitcoin network. This method ensures that transactions are typically irreversible, and Bitcoin’s data security is high.

Cryptoeconomics Model

Let’s discuss how cryptoeconomics model works:


1. Transaction Request: Someone requests a transaction. In the case of Blockchain, a transaction is requested using a device known as a wallet. A cryptoeconomics wallet is a type of digital wallet that allows users to store and manage the cryptocurrencies like bitcoin and ether.

2. Transaction Broadcast: The requested transaction is then broadcasted in a Peer to Peer network consisting of computers, which are also known as nodes. Peer-to-peer (P2P) networking connects a group of computers with equal data processing rights and responsibilities. Unlike traditional client-server networking, no devices in a P2P network are completely dedicated to serving or receiving data.

3. Transaction Validation: After the transaction has been broadcasted to all the nodes in the network, the network of nodes validates the transaction and the user’s status. In other words, once a transaction is delivered to any node connected to the network, the transaction will be verified by that node. If the transaction is found to be legitimate, then that node will disseminate it to the other nodes to whom it is linked, and a success message will be delivered synchronously to the originator.

4. Verification Process: Bitcoin uses digital signatures established using keypairs to authenticate transactions and senders. The sender wants to guarantee that the proper bitcoin amount is transmitted to the correct individual (wallet), and the receiver wants to check that the data is valid and from the sender. The data to be delivered was gathered by the sender. A verified transaction can involve cryptocurrency contracts, records, or other information.

5. Block Formation: After the verification is done, the transaction is combined with other transactions. To create a new block of data for the ledger. A bitcoin public ledger is a mechanism for keeping track of transactions. The ledger anonymously stores individuals’ names, cryptocurrency balances, and a record of all authentic transactions completed between network participants.

6. Adding the block to the blockchain: The new block is then added to the existing blockchain in a way that is permanent and unalterable. The ledger is spread among numerous nodes, which means that data is copied and saved in real-time on each node in the system. When a transaction is registered in the blockchain, data like as the transaction’s price, asset, and ownership are recorded, validated, and settled across all nodes in seconds.

7. Transaction Complete: Then, the transaction is finally complete. 

Rules of Consensus

  1. Proof of labor (PoW): Proof of Labor also called Proof of Work (PoW) refers to a system that necessitates a considerable but manageable amount of effort in order to discourage frivolous or malicious uses of computing power, such as sending spam emails or launching denial-of-service attacks.
  2. Proof of Stake (PoS): Proof-of-stake is a cryptocurrency consensus mechanism that is used to process transactions and add new blocks to a blockchain. A consensus mechanism is a way of validating and securing entries in a distributed database.
  3. Delegated Proof of Stake: Delegated Proof of Stake (DPoS) is a popular variation on the PoS idea in which network users vote for and elect delegates to validate the next block. Delegates may alternatively be referred to as witnesses or block producers.
  4. Proof of Burn: Proof-of-burn (PoB) is a blockchain consensus mechanism that uses less energy than proof-of-work (PoW). Decentralized platforms that use the PoB approach burn coins to guarantee miners reach a consensus. The process of permanently removing cryptos from circulation is known as burning.
  5. Proof of Authority (PoA): Proof of Authority (PoA) is a consensus method based on the reputation that presents a realistic and efficient solution for blockchain networks (especially the private ones). Ethereum co-founder and former CTO Gavin Wood coined the phrase in 2017.

Advantages Of Cryptoeconomics

  1. In the consensus protocol: The consensus protocol uses cryptoeconomics as the basis. The blockchain consensus protocol establishes the foundation for a dependable agreement without the need for a centralized trust party. In the case of bitcoin, this is known as proof of work consensus, because miners must first commit the work in terms of electricity and hardware before participating in the mining process and collecting rewards.
  2. Upgradation to Proof of stake: Cryptoeconomic research is also being used to present Proof of stake as a better alternative to proof-of-work consensus in order to provide a variety of upgrades and modifications.
  3. Overcoming high cost in the blockchain: Cryptoeconomics is also used in state channels, which provides a limited set of interactions between users. This contributes to overcoming one of blockchain’s most significant drawbacks, which is, the cost. Smaller interaction sets ensure that the blockchain is made more efficient by off-chaining some of the processes while retaining confidence with the help of cryptoeconomic design. State channels can be used for any updating process, not simply payment transactions.
  4. Peer-to-peer cryptographic systems: Cryptoeconomics is a new discipline that uses economic considerations to construct peer-to-peer cryptographic systems. The field’s origins can be traced back to specific information security issues that arose as a result of such systems. 
  5. Development of future networks: Cryptoeconomics and the use of crypto-economic models can be immensely beneficial in the development of future networks. Future networks can be made more efficient and sustainable by analyzing crypto-economic models that have previously been tried and tested in real-world contexts, resulting in a more resilient ecosystem of decentralized economies.
  6. Fund transfer between two parties: The major advantage of using cryptocurrencies is that they make it easier to move monies between two parties in a transaction, made possible through the use of public and private keys for security purposes.

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