Game Theory Meaning

What Is Game Theory?

Game theory is a mathematical method that studies logical decision-making and strategic interactions. It assumes that all participants are rational actors and that the outcome relies on every actor’s choice. Simply put, it is a way of examining the behavior of rational actors and the potential outcome of their actions based on their given circumstances.

In his 1928 On the Theory of Games of Strategy publication, John von Neumann introduced the game theory concept. While it was originally developed in economics to explore how organizations, markets, and consumers behave, game theory is applicable in everyday life, such as in politics, sociology, business, philosophy, and technology, including cryptocurrencies and blockchain. 

For example, game theory concepts can be seen in games like chess, where a player’s every move is influenced by their opponent’s move or the belief that they will make a certain move. They can also be seen in price negotiations, where the seller pitches a starting offer that is high yet reasonable enough to attract buyers; and the buyer can either take the offer or negotiate for a lower price.

Popular examples of game theory concepts include the Byzantine General’s Problem, the prisoner’s dilemma, and the zero-sum game.

Game Theory and Cryptocurrencies

Cryptocurrency networks typically rely on a decentralized and distributed network of node operators to validate transactions and blocks. Although the nodes do not trust each other, they are required to reach a consensus regarding the validity of these transactions. Therefore, blockchain protocols incorporate game theory concepts in their consensus algorithms to prevent dishonest nodes (or external malicious actors) from colluding to steal cryptocurrencies or disrupt the functioning of the network.

For example, proof-of-work (PoW) networks demand expensive hardware and high computing power. Its architecture is designed to incentivize miners to act in the best interest of the network and disincentivize dishonest actions. On the other hand, proof-of-stake (PoS) networks require the validators to have a minimum economic stake, and they risk losing this economic stake if they act dishonestly.

In short, cryptocurrency networks are designed in a way that the most rational and probable decisions a network participant can make are those that serve the network.