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The game theory of Bitcoin and cryptocurrencies

The game theory of Bitcoin and cryptocurrencies

The unique characteristics of cryptocurrencies make them an interesting subject for game theory analysis, as they can help explain the incentives and behaviors involved in trading and investing. This article discusses the concept of the prisoner’s dilemma, mining cryptocurrencies and blockchain forks that are relevant to the game theory of Bitcoin and cryptocurrencies.

Introduction to game theory and cryptocurrencies

Game theory is a mathematical framework that helps explain decision-making in strategic situations. Cryptocurrencies, like Bitcoin (BTC), have become a popular subject for game theorists due to their decentralized nature and potential to disrupt traditional financial systems. 

The prisoner’s dilemma and cryptocurrency mining

In the classic game theory scenario known as the prisoner’s dilemma, two parties must make a choice without knowing what the other will do. In the context of cryptocurrency mining, the prisoner’s dilemma can help explain why miners may act in their own self-interest, even if it is not in the best interest of the network as a whole.

The first miner to successfully solve a challenging mathematical equation receives fresh BTC units. Both computer power and energy usage are essential requirements for the mining operation. The tragedy of the commons, which happens when individuals prioritize their own interests over the needs of the whole, is one of the biggest obstacles in cryptocurrency mining. By mining cryptocurrencies, miners may put their individual financial gain ahead of the network’s overall security and stability.

A helpful foundation for comprehending this behavior is provided by the prisoner’s dilemma. In the scenario, two people are arrested for a crime, and they are offered the option to work together or turn on one another. If they both cooperate, their sentences are both lowered. When one betrays the other, the betrayer is given a lighter punishment, while the other is given a lengthier one. Both receive a moderate penalty if they betray one another.

Related: How does blockchain solve the Byzantine generals problem?

Miners confront a similar decision-making process while mining cryptocurrencies. The network is safe and secure if all miners collaborate by mining honestly and making a contribution. Yet one miner may benefit more from mining maliciously or not contributing to the network if they choose to behave in their own self-interest.

Let’s look at the below diagram illustrating an example of two…

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