The basis of much of cryptoeconomic thought is that there is no such thing as a trusted 3rd party. Instead cryptoeconomic approaches rely on implementing incentives and punishments to build a system that is maintained by its users and for which system attacks are very difficult, or very expensive, for an attacker to carry out.
Incentives can be categorised under two broad types:
- Payments
- Privileges
Much of conventional economic thinking believes that rational actors will always respond in a predictable way to incentives. However, some believe that in designing a system to be robust and resilient to attack incentives should only be used as a last resort. This is because whilst incentives can be powerful mechanisms for promoting beneficial behaviour they also often lack a moderation mechanism which can result in unintended negative consequences.
Another argument against incentives is that you cannot always presume rational actors. This can become even more problematic as incentive structures become more complex when even rational actors may find it difficult to ascertain the appropriate decision.
However, one of the advantages of Distributed Ledger Technologies (DLT) is that it can help align incentives amongst a group of token holders.
Incentive design for DLT requires a multidisciplinary approach that considers:
- Mechanism design
- Cryptography
- Systems engineering
- Behavioural economics
- Psychology
We can consider incentive design of a network through two dimensions:
- Automatability – how much work must a human actor do in order to follow the incentives. The less automatability an incentive system has, the more it will be exposed to potentially irrational actors.
- Size of action space – how many possible actions must be explored in order to maximise the incentive. The larger the action space, the harder it is to make the right choices and optimise the results.