Global Bitcoin Game Theory Is Now Playing Out

“Bitcoin’s pawn to e4 move is pressuring other nations to adopt bitcoin.” Joker. Global Bitcoin Game Theory Is Now Playing Out

Updated: 7-5-2019

Bitcoin As A Master Piece of Game Theory And Incentives

The role of incentives and game theory in the most famous blockchain.

In the past decade, thanks to the ever-increasing popularity of Bitcoin, blockchain technology has attracted a significant degree of attention from both academia and industry.

Generally speaking, blockchain is identified as the technology behind Bitcoin.

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However, the Bitcoin blockchain is much more than tech.

All the three main technologies that are leveraged by Bitcoin (a peer-to-peer network, asymmetric cryptography and digital timestamping) had been around for many years. They are not the reason that made Bitcoin special.

Defining Bitcoin as a mere technology would be a mistake. It is, in fact, a masterpiece of technology, economics, mathematics, game theory and, last but not least, philosophy. For the first article of this series, I want to focus on Bitcoin as a masterpiece of Game Theory.

But First… What Is Game Theory?

Game theory studies the process of strategic interactions between two or more players in a situation where the outcome for each participant depends on the action of all.

Global Bitcoin Game Theory Is Now Playing Out

In practice, if you are a player in such a game you must take into account the choices of others when contemplating your strategy. Thinking about their choices, you should also be aware that they are thinking about yours.

Game theory is based on the assumption that all participants are rational actors and are trying to maximize their gains from the game.

The study of game theory is characterized by the following elements:

* Game: Any set of circumstances that has a result dependent on the actions of two or more decision-makers (players).

* Players: A strategic decision-maker within the context of the game.

* Strategy: A complete plan of action a player will take given the set of circumstances that might arise within the game.

* Payoff: The payout a player receives from arriving at a particular outcome. The payout can be in any quantifiable form.

* Information Set: The information available at a given point in the game. The term information set is most usually applied when the game has a sequential component.

Equilibrium: The point in a game where both players have made their decisions and an outcome is reached.

Game theory is especially applied in social situations, where there is no black or white. That is because, when interacting with each other, human beings are highly complex.

Predicting one behavior might be as complex as predicting the future, as it is the result of the interaction of their strategies, payoffs and information sets.

Let Us Have An Example:

* You are in a bar with your best friend and you see 2 girls at the bar counter. One of them is your type and the other one is not. This game has two players and two payoffs, and can have four different outcomes.

The first outcome is as follows, both you and your friend go for the one who’s your type, you hinder each other and none of you get the girl. In plain words: the payoff is 0.

Same goes for the second outcome, where you both go for the one who is not your type. Once again you block each other and none of manages to get the girl. Also in this outcome, the payoff is 0.

The Other Two Outcomes Are:

1. You get your type and your friend gets the one who is not or;

2. Your friend gets his type and you get the one who is not.

With these two outcomes, your payoffs will be maximised and you would have reached the so-called Nash Equilibrium. That is, a situation when the strategies of all players are consistent and where each one chooses the best response to the choices of others.

As a result, the players of the game should follow either one of the latter strategies.

How Is Game Theory Applied To Bitcoin?

What Satoshi Nakamoto, the creator of Bitcoin, did was to find the missing piece of the puzzle: how to ensure that all the actors of a decentralized network behave correctly without trusting each other, an issue that is commonly known as the Byzantine Generals problem.

In simple terms, it is a problem of coordination.

The Byzantines are trying to conquer a city, but the attack will only be successful if all generals coordinate and attack together.

The problem is how to ensure that all generals will follow the plan, even if they are located in different places and do not trust each other.

How Does Bitcoin Solve The Problem?

The players in the Bitcoin blockchain are the users of the network and the miners that maintain it. Since Bitcoin is a distributed network, the miners are essential for the network to work correctly as they confirm the validity of transactions.

In simple words, Bitcoin uses game theory and a system of material incentives to make sure that rational actors behave in a certain manner by aligning their interests.

In particular, they have been used to influence the interactions and the behavior of the miners of the network.

First of all, it is important to lay forward that an agreement on the correct version of the ledger within the Bitcoin network is reached using a Proof-of-Work algorithm: miners have to run computationally expensive operations to mine Bitcoins, incurring in significant electric costs.

This makes computation expensive, to ensure that miners do not deviate from the rules of the network.

To encourage miners to behave in an honest manner, Bitcoin provides an incentive mechanism, to make sure their self-interest is linked to the network functioning well.

What Are The Incentives Provided To Miners?

The first transaction in every new block is a so-called “coinbase” transaction that mints new Bitcoins
(12,5 every block), going to the creator of the block.

That is, to the lucky miner that managed to find the correct block before the others.

It is comparable to a high five by the Bitcoin network: “thanks a lot for maintaining the network with your mining power, here you have 12,5 BTC as a reward!!”.

This might seem a lot but, as mentioned before, miners have to deal with high electricity, hardware and maintenance costs.

Furthermore, the chances of finding the right block before other miners are directly proportional to the % of hashing power controlled and thus — unless you are part of the biggest mining pools — is quite low.

Such material incentives in the form of monetary rewards motivate the nodes to behave uprightly and to support the network, as well as ensuring a fixed and constant emission of new coins in circulation — as there is no central bank to do so in the Bitcoin blockchain!

As an additional incentive, the miners powering up the Bitcoin network also receive a cut on the transactions included in a block. All of these incentives discourage actors from being malicious or trying to attack the Bitcoin network.

The only way an attacker can compromise or tamper the Bitcoin blockchain is by gathering at least 51% of the hashing power. Let us say that a malicious actor is trying to assemble enough power to do so.

He will first have to find expensive hardware — as all of it is currently owned by other miners. If he eventually succeeded he would then have to compromise the network, however, since he is already deeply invested in Bitcoin mining hardware he would not be incentivized to do so.

In case he managed to attack the Bitcoin network, the cryptocurrency would immediately lose significant value — as one of its premises is that its blockchain cannot tamper.

The hacker loot would then become worthless!

As a result, hackers might find it more profitable to stick to the rules rather than trying to undermine the system and their wealth.

Each actor is better off by playing by the rules. Not because they are forced to do so, but because this ensures that everyone benefits from the network.

It is, in fact, a win-win situation, and that is why I believe Bitcoin is a masterpiece of game theory.

The design of efficient economic incentives and cryptography to build blockchain systems has become known as Cryptoeconomics.

Its role is to provide the framework to ensure the development of strong and balanced peer-to-peer networks and to encourage desired behaviors.

It is very much important to mention that these incentives work on Bitcoin due to the size and security of the blockchain, the protocol rules as well as the inherent characteristics of the network.

The same logic applied to smaller networks might not provide the same results in terms of encouragement or balance between the actors of the network.

Bitcoin As A Masterpiece of Game Theory

Global Bitcoin Game Theory Is Now Playing Out

To Sum It Up:

* Bitcoin did not become as relevant as it is nowadays only thanks to the technologies behind it.

* Rather, its value and beauty come from the fact that it encompasses several fields and subjects.

* The introduction of Game Theory in the equation makes it possible for the network to function correctly and to direct the behavior of actors towards the desired outcome. By making use of a system of incentives, Bitcoin manages to align the interests of distrustful actors in a distributed network.

* This creates an equilibrium between the different strategies of the actors. That is: everyone gets the biggest payouts if their strategies are coordinated. This guarantees the correct functioning of the network and the reduction of eventual vectors of attacks as well as possible incentives that actors might have to attack the network.

Updated: 11-19-2020

Game Theory and Bitcoin: The Miners’ Perspective

Competition drives markets. In traditional financial markets, however, competition is limited to the production of goods and the buying and selling process.

With Bitcoin, competition plays a far-deeper role. The minting of new bitcoin, as well as the processing and verification of transactions, are all made more efficient, accurate, and secure, thanks to competition. It’s no surprise, then, that game theory plays a pivotal role in the inner workings of the Bitcoin ecosystem.

A Brief Explanation Of Game Theory

Game theory models the strategic interaction between players in a scenario with set rules and outcomes where the players are rational and looking to maximize their payoffs. In effect, it’s a more detailed, nuanced way of looking at how incentives affect how things get done.

For example, if your job is to shovel 100 pounds of stone into a hole and you’re all alone and have all the time you want, there’s no game theory involved. On the other hand, if someone else is given the same task and you’re each working with the same pile of stones, the dynamics of the situation change.

They change further if only the person who shovels the most gets paid. And, naturally, if you get paid according to how much you shovel, the outcome of your actions would change in yet another way. Each of these situations will be impacted by game theory and its many models.

Although Bitcoin seeks to espouse concepts like “fairness,” “transparency,” and others that are often incongruent with competition, game theory still plays a primary role in the Bitcoin universe.

How Does Game Theory Apply To Bitcoin Mining?

Bitcoin mining involves solving math problems that are used to create new bitcoin and verify transactions. To continue with the stone shoveling example, if you have as long as you want to move the pile of stones, you may choose to take your time.

Your shovel may move slower than if someone else were involved in the task because then the speed at which you shovel would determine whether you get paid more, less, or at all.

The fact that multiple miners compete to verify transactions and generate coins gives Bitcoin an inherent efficiency: The job gets done faster.

To dig a little deeper, three types of game theory driving this process include zero-sum theory, congestion theory, and the Nash equilibrium. Let’s take a closer look at how these concepts work.

Bitcoin Mining And Zero-Sum Theory

Zero-sum theory dictates that the “winner” gets the spoils and everyone else walks away with nothing. In the mining of bitcoin, the first person to solve a problem gets the value associated with completing the task.

Everyone else gets nothing. If you could take a snapshot of the nanosecond a particular hash is found, you would see one user getting rewarded for their work and the others getting nothing.

However, because the Bitcoin system requires so many problems to be solved all the time, in reality, many miners can earn a relatively steady income. The strategies they use are governed by two other game theory concepts — the congestion theory and the Nash equilibrium.

Bitcoin Mining And Congestion Theory

Congestion theory stipulates that the amount each player gets depends on the resources they choose and how many other players choose the same resources.

For example, imagine there are two stations with trains heading to the same destination, and each train can hold only 10 people. One train station is five miles closer to the destination.

If there are 100 people, and everyone goes to the closer station, one train will have to go back and forth 10 times.

On the other hand, if some of the passengers go to the closest station and others go to the station farther away, there will be less congestion, and everyone will arrive at the destination sooner.

In Bitcoin mining, many of the decisions of the miners depend on congestion theory. If there was only one miner, all the spoils would go to her or him. On the other hand, Bitcoin is open to all, so each miner has to decide whether they will get in the game — and add to the congestion — knowing that more people are bound to get in the game, decreasing their chance of winning.

Once a miner decides to get involved, they then have other decisions to make regarding the equipment they choose. Faster equipment provides an advantage, similar to getting on the closer train. However, the quicker the equipment, the more electricity it takes to run, which increases the cost of mining.

If a miner’s earnings won’t sufficiently offset the cost of electricity, they may choose not to get involved. They may also choose to forego setting up a mining system and join a mining pool instead, where the electricity costs are absorbed by multiple participants.

Congestion theory dictates which “train” each miner takes, as well as when and how they get involved.

In addition, the way the decisions of each miner affects the others is governed largely by another game theory concept: the Nash Equilibrium.

Bitcoin Mining And The Nash Equilibrium

In the Nash equilibrium, named after mathematician John Nash from the movie A Beautiful Mind, each “player” recognizes that while they have similar goals, not everyone can get exactly what they want.

Therefore, some will choose to settle for a less-desirable outcome, satisfied with the fact that they are at least getting something. All players agree to proceed, happy to share the spoils.

For example, continuing with the stone shoveling scenario, you may be stronger and faster than the other shoveler. Both of you agree to shovel for the same amount of time, but you get 70% of the money while the other shoveler only gets 30%.

The other person could protest, but realizing that something is better than nothing, they agree to the terms. At this point, an equilibrium is established. At the end of the day, you both earn money and walk away satisfied.

The worldwide community of miners also follows Nash equilibrium principles. Some miners have more money than others and can afford to purchase the latest mining computers, capable of solving specific hashes faster than older models.

Other miners may not have as much money, but they live in areas where electricity is less expensive.

They can, therefore, spend less than wealthier miners who live in areas where electricity is more costly. Some live in places where it will never be profitable to mine, so they join a mining pool instead.

Each miner recognizes that their limitations dictate how much they will get. At the same time, all agree to participate, satisfied with their portion at the end of the day — even if it’s just a small fraction of a bitcoin.

How Miners Are Incentivized

Zero-sum theory, congestion theory, and the Nash equilibrium only work because of the ways miners are incentivized and dissuaded from cheating the system.

Before mining rewards are approved, the technical infrastructure enforces the “trustless” nature of the Bitcoin network.

If miners do not adhere to protocol rules, their block submission will be rejected by other nodes in the blockchain.

All network nodes including other miners verify the ledger entries packaged into a new block. If entries are considered invalid, or the block hash doesn’t meet network requirements, the miner’s result will be rejected and the 6.25 BTC will be awarded to another miner.

While the block rewards are enticing at current BTC valuations, there are other financial implications that compel miners to either continue or suspend network operations.

No miner will win the worldwide competition each time a new block is added (~every 10 minutes), so they must weigh the probability of profitable successes. There are other factors to consider, too. For example, some miners may decide to bow out when electricity becomes too expensive.

Others however, may have a longer time horizon and decide to accept the risk of energy expenditure, calculating that miner attrition will increase their chances of winning new block rewards.

In other words, fewer miners in the network means more chances for the remaining miners to profit. For those adopting this viewpoint, the potential of solving enough blocks to maintain business profitability outweighs the risk of any short-term loss related to high energy costs.

How Bitcoin Is Distributed

Every block consists of many small transactions. When a block is mined, the winning miner is awarded 6.25 bitcoin plus all transaction fees for each transaction they were able to package within the block.

The more blocks you are able to solve, the higher your reward. In other words, you get a bigger piece of the pie. Hunger for more slices of pie incentivizes miners to purchase more powerful equipment or move to areas with lower electricity costs.

Game Theory And The Surety Of The Bitcoin Network

Global Bitcoin Game Theory Is Now Playing Out

In a Nash equilibrium, although the individual participants would like to either get more rewards or a different type of reward, they agree to settle with getting something of value rather than nothing.

The Bitcoin network compels miners to play by an agreed set of rules to add transactions to the distributed ledger, or their work will be summarily rejected.

At the same time miners add security to the network by expending expensive energy that chains each new block to the preceding block via a well established mathematical algorithm.

Each miner is, therefore, a generator of new bitcoin liquidity as well as an auditor, checking the details of network transactions. Even though each problem solved involves a zero-sum game and congestion theory dictates how each miner approaches the task, everyone works in a happy Nash equilibrium.

In the end, game theory is an underestimated, yet essential, element of the Bitcoin network. As each miner plays their role, historical transactions are kept secure and new transactions unanimously approved, which helps maintain Bitcoin’s position as the number one digital currency in the world.

Updated: 2-27-2021

Game Theory In Bitcoin

The Dominoes Have Begun to Fall

“It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self-fulfilling prophecy” – Satoshi Nakamoto

Markets are evolving multi-dimensional entities where moves made by large enough participants have potentially decision-altering consequences for the rest of the market.

Game theory can be defined as a theoretical framework for conceiving social situations among competing players. One who understands game theory considers not just the direct implications of their initial action, but the potential outcomes of those implications as well.

The common phrase “think one step ahead” is a bi-product of thinking using game theory.

This article will discuss in laymen’s terms how surface-level game theory is embedded into Bitcoin on several levels (Corporate, State, Federal) and recent moves that are likely symbolic first dominoes falling in this dynamic of Bitcoin market game theory.

Global Bitcoin Game Theory Is Now Playing Out

Game Theory In Fiat Currencies

It is first worth mentioning that the game theory embedded into the current fiat system is both unhealthy and unsustainable.

Currently, countries are incentivized to competitively devalue their currencies to make their exports more attractive. Since March of 2020, this effect has only been amplified.

There is a close correlation between a nation’s currency and how much its workers are paid. Any nation that devalues its currency also lowers its cost of labor in comparison to other global competitors.

Global Bitcoin Game Theory Is Now Playing Out

This process can generate some growth in the short term because the respective nation’s goods cost less to buyers than other countries. Through this process, countries trying to compete for the same scarce jobs devalue their currency.

This competitive devaluation inadvertently pushes up all asset prices being measured in those currencies in the process.

Another way the United States specifically is incentivized to devalue their currency, thus forcing others to follow, is because of how easily they can print themselves out of debt.

If the US borrows $100 at a 10% interest rate, they owe back $110. However, they can simply print 10% more money, thus debasing the currency by that factor.

When they finally pay off the loan, they are paying back that nominal $110, but it is worth considerably less in spending power.

Printing of money has also incentivized corporate banks to act recklessly in the recent decade, as these banks know that the Fed can simply step in and print money to bail them out.

The incentive structure built around the current fiat system is not healthy or sustainable and is ultimately hurting the average citizen with a savings account more than anyone.

Game Theory In Corporations

From 2017-2019 a slew of small investment funds such as Galaxy Digital have taken on Bitcoin.

However, 2020 would be the first time a publicly-traded company began to allocate a substantial portion of its balance sheet to Bitcoin.

On August 11th, 2020 MicroStrategy announced that they had purchased 21,454 Bitcoins at an aggregate purchase price of $250 million. On September 14, 2020, MicroStrategy completed another acquisition of 16,796 additional bitcoins at an aggregate purchase price of $175 million.

Global Bitcoin Game Theory Is Now Playing Out

Not only did they allocate their treasury to a Bitcoin standard, but have issued several rounds of convertible debt notes as well.

Each of these raises was oversubscribed, with the most recent offering raising $900 Million in the capital at a 0% interest rate.

This concept popularized by Pierre Rochard years ago titled the “Speculative Attack on the Dollar” will likely seem more attractive to other corporations in the future as it becomes clear Bitcoin will emerge as the dominant global currency.

Essentially what MicroStrategy is doing is leveraging a failing currency to acquire the hardest form of money in the history of mankind.

This process can be visualized by a graphic created by (@Croseus_BTC)

Global Bitcoin Game Theory Is Now Playing Out

The company paved the way for future corporations such as Tesla to acquire Bitcoins not only in terms of public acceptance but because they already had created a playbook for Tesla to simply copy.

In this sense, MicroStrategy was a pioneer amongst other public companies, as they set the precursor for how to buy Bitcoins without significantly moving the price.

CEO Michael Saylor describes this process on a podcast saying, “I bought $1,000 worth of Bitcoin every second in the evenings and the weekends, I bought $2,000 worth of Bitcoin during the day.”

The company also paved the way regarding accounting, tax, and regulatory standpoints. On February 5th, MicroStrategy hosted a conference titled, “Bitcoin for Corporations” where they laid out their thesis and strategy for acquiring BTC.

This information is publicly available as well as their downloadable “Bitcoin Corporate Playbook”.

After MicroStrategy, Mass Mutual acquired $100 Million in Bitcoin. In addition, the most well-known recent acquisition was Tesla acquiring $1.5 Billion of Bitcoin, 10% of their cash reserves, with also plan to accept Bitcoin as a form of payment for their cars.

Square recently released their earning statement revealing a purchase of 3,318 Bitcoins at an aggregate purchase price of $170 Million.

With MicroStrategy arguably being the first domino to fall, the dam has been broken and corporations are beginning to seriously consider allocating some of their treasuries to this protocol.

With the major players mentioned above taking stances on Bitcoin and the dramatic positive effect it has had for shareholders, CFO’s are taking a serious look at getting BTC on their respective balance sheets.

Global Bitcoin Game Theory Is Now Playing Out

The game theory behind this within corporate CFO’s is likely why there has been such a dramatic upswing of liquidity moving into Bitcoin, most recently reaching a $1 Trillion market cap.

It is important to mention that it takes months for many large corporations to approve a move like this, with many hurdles and hoops to jump through. One of the main reasons MicroStrategy was able to complete the acquisition in such a timely manner was because Michael Saylor has the majority of voting rights.

With this being said, not only are companies looking to be early adopters which would translate to spending power appreciation but also because it is impossible to know just how many other corporate treasuries that are yet to come later in Q3/Q4 of this year.

In this sense, it makes sense to take at least a small allocation simply as a hedge against the success of the Bitcoin Monetary Network. If enough companies think this way, there could be unseen amounts of new waves of capital coming into the Bitcoin monetary network from corporate balance sheets.

Finally, it is worth mentioning this simple concept: MicroStrategy has acquired 90,531 BTC for $2,171,000,000 at an average price of $23,985 per coin. Tesla acquired 48,000 BTC for $1,500,000,000 at an average price of $31,250 per coin.

If Tesla wants to match MicroStrategy, to acquire an additional 42,531 Bitcoins they must allocate an additional $2,126,000,000 (at the current market price of $50,000) of their balance sheet.

If a Bitcoin standard comes into fruition, whoever has the most coins will have the most spending power; let the competitive corporate stacking begin.

Game Theory In The United States

Here in the United States, with over 331 million residents, there is a unique dynamic amongst the 50 states of the country. Essentially, each respective state is competing against the other to draw in a portion of the total tax revenue.

The number of users on the Bitcoin Monetary Network has exploded in the US in recent years, with each of those users being a potential addition to tax revenues for all states.

If the state of which a user of the network with significant skin in the game takes an “anti-Bitcoin” regulatory stance, it would make sense to just move to another state that has a friendly regulatory stance towards the network.

There have already been several first movers looking to step out ahead on the adoption curve, with the most well-known being Wyoming.

With these first-movers out ahead, other states must take a serious look at this; not adopting could potentially leave them behind, or worse, lose their tax revenue.

If enough states that currently don’t have BTC-friendly regulations think this way, they will begin to take Bitcoin-friendly stances due to game theory.

Game Theory On The Federal Level

One way game theory is taking place on the federal level is in terms of adopting Bitcoin as a treasury reserve asset.

Early on, it will likely be smaller nation-states that adopt, particularly those that have centralized autocratic governments (have limited “hoops” to jump through).

Large bureaucratic democracies such as the United States will likely be later on the adoption curve in terms of putting Bitcoin on their balance sheet.

This gives smaller nation-states an incentive and opportunity to front-run the larger countries, which would potentially gain them a massive amount of power through the process of hyperbitcoinization.

Global Bitcoin Game Theory Is Now Playing Out

Also, similarly to states, countries themselves are also competing to draw in tax revenue and economic growth within their respective borders.

If one country takes an anti-Bitcoin regulatory stance, they could potentially be losing a portion of their population to a nation that has a friendly regulatory stance.

I would suspect this effect to amplify with the adoption of the Bitcoin Monetary Network around the world.

We have already seen several nations (Malta, Singapore..) turn themselves into Bitcoin “safe havens” of sorts, as embracing this technology early on could give them an advantage over others and make their countries more attractive.

If enough countries think this way, it could become a self-fulfilling prophecy.

To conclude, game theory is embedded into Bitcoin on several levels, each of which penetrates the traditional system as Bitcoin’s price rises and more users adopt the monetary network.

To end the article I’d like to leave you with a classic quote from Satoshi Nakamoto, showing the grasp on game theory they must have had:

“It might make sense just to get some in case it catches on. If enough people think the same way, that becomes a self-fulfilling prophecy.”

Updated: 9-8-2021

Edward Snowden: Global Bitcoin Game Theory To Begin Playing Out

The whistleblower has highlighted how El Salvador’s “pawn to e4” move will pressure other nations to adopt bitcoin.

The game-theoretic facet of Bitcoin adoption might soon start playing out in global geopolitics. Famous whistleblower Edward Snowden tweeted about it yesterday, highlighting that Bitcoin favors those that adopt it early, thereby putting pressure on other nations who might be penalized for being laggards.

“Today Bitcoin was formally recognized as legal tender in its first country,” tweeted Snowden on September 7. “Beyond the headlines, there is now pressure on competing nations to acquire Bitcoin—even if only as a reserve asset—as its design massively incentivizes early adoption.”

Snowden’s tweet quoted another from Bitcoin Magazine’s Aaron van Wirdum, currently in El Salvador, which announced the journalist’s ability to pay for his McDonald’s breakfast with bitcoin through the Lightning Network.

Van Wirdum said he wanted to test whether he could use bitcoin to purchase everyday goods at a mainstream, global chain when Bitcoin officially became legal tender in the Central American country.

“But low and behold, [McDonald’s] printed a ticket with QR [code] that took me to a webpage with Lightning invoice, and now I’m enjoying my desayuno traditional,” tweeted van Wirdum.

Natural to a nascent form of money is its consistent growth in purchasing power, compared to well-established monetary goods, as its adoption increases in society. A new money’s adoption is directly correlated to its ability to assume different and more practical use cases.

A monetary good that isn’t widely accepted has limited power and thus has fewer characteristics of fully-fledged money.

Historically, new money starts as a collectible item. Still, as more people begin accepting it and using it, the new monetary good becomes used as a store of value, then as a medium of exchange, and finally as a unit of account.

The final stage requires, in theory, that the money be largely accepted in the world — such a high level of adoption and monetary preference that its volatility would diminish and make it suitable for that use case.

In its early days, Bitcoin was seen by the mainstream mainly as a gimmicky collectible, but recently the narrative has been shifting towards the store of value and digital gold use cases.

However, El Salvador, by adopting Bitcoin as legal tender, is already helping the infant money climb over the store of value use case into the medium of exchange one.

Although a global usage of Bitcoin as a medium of exchange depends on a much higher adoption rate globally, the grounds are being set.

As the Salvadoran population and the country’s economy start benefitting from Bitcoin’s growing purchasing power as a store of value and begin demonstrating actual usage as a medium of exchange, in the long run, game theory suggests that other countries are set to follow suit.

The fear of being left behind and the evident opportunity cost will put pressure on competing nations to store Bitcoin as a reserve asset or adopt it as legal currency entirely.

It is unclear where Bitcoin is in the adoption cycle currently, however, it is clear that the vast majority of the world still does not understand it or use it.

The Salvadoran move legitimizes Bitcoin’s use as a medium of exchange, and maybe the very geopolitical push the currency needed to be put on the global stage.

A successful implementation by El Salvador prepares the grounds for Bitcoin adoption to skyrocket as other nations start taking similar actions, fearful of being left behind. As Snowden concluded the tweet, “latecomers may regret hesitating.”

Updated: 9-13-2021

A Look At The Game Theory Of Bitcoin

Global Bitcoin Game Theory Is Now Playing Out

In part one of this series, we examine the game theory of bitcoin, an often mentioned but often misunderstood aspect of bitcoin adoption.

What is game theory? Simply put, if you are playing any game of strategy, like chess, any move you make in the game will have to be countered by your opponent. The strategic decisions that you and your opponent make will ultimately determine who wins and who loses the game.

So how does this relate to Bitcoin? Bitcoin is the greatest invention since the Gutenberg press. The Gutenberg press affected the game theory of how the Church and State worked and how information was shared with the world.

When Johannes Gutenberg invented his press, he was essentially moving his chess piece to checkmate the Church. For the most part, up until the invention of the Gutenberg press, the Church and people in positions of power or education could read, write and spread whatever information they wanted.

Before the printing press, there were limited copies of important writings such as the Bible. Any knowledge about the world mostly came from whatever your local town had available for a literate figurehead to read in church or school.

Most people were not able to read or write, so they had to depend on others to gain their knowledge of the world. People were told what to learn, believe and how to live their lives by the Church. As long as the State and the Church controlled what the people were taught they could control the people’s ideologies.

Bitcoin has the same game theoretics as the Gutenberg press, but it is working toward separating the State from Money. Now let’s envision a chessboard where the “world’s most powerful players” (WMPPs) — that is, banks, governments, special interest groups — are playing on one side of the chess board and Bitcoin is on the other side.

This chess game between Bitcoin and the WMPPs has been the longest chess game to have ever been played because it has been going on for 12 years. In the game of chess, there are two possible outcomes, stalemate or checkmate.

There is no chance that Bitcoin will face a stalemate in its game against the WMPPs, because a stalemate means that neither player wins or loses. A stalemate results when neither player can make a move that would result in the game progressing any further.

Alternatively, when Bitcoin checkmates the WMPPs king and wins the game of chess, Bitcoin will have become a store of value and medium of exchange for the whole world.

The WMPPs cannot checkmate Bitcoin because, at most, if it were possible for the entire world to ban Bitcoin, as far-fetched as that sounds, Bitcoin would just go underground and be used like the Tor network, aka dark web.

This year, the WMPPs have made the following chess moves against Bitcoin along with “Bitcoin’s game theoretic countermoves” (BGTC):

WMPPs Move #1: China banned all bitcoin miners from their country. China represented approximately 65% of the computing power that runs the Bitcoin network.

BGTC: Bitcoin miners moved to the U.S. and other bitcoin miner-friendly countries. The resilience of the Bitcoin network was greatly tested by this huge move by the second most powerful country in the world.

The Honey Badger does not care about China or any other powerful country’s decision about it. Bitcoin has the mindset of the “little engine that could” and will soon become a steamroller that all countries will have to get out of the way of or get “steamrolled” by.

WMPPs Move #2: The United States snuck in a cryptocurrency “provision” within its “Infrastructure bill” so as to get $28 billion worth of taxes to fund the $1 trillion “infrastructure bill.” The cryptocurrency “provision” was horribly worded by people in D.C. that did not have any clue as to what bitcoin or cryptocurrencies were.

BGTC: Bitcoiners called all their senators and fought for the cryptocurrency provision to be reworded and less harsh on the Bitcoin industry.

This Bitcoin movement sent shockwaves among the halls of Congress and even though the “provision” did not change in favor of cryptocurrencies, the shockwaves that were caused by Bitcoiners will forever be felt.

Bitcoin, the protocol, did not care about the bill nor the opinions of man and kept running to the tune “tick tock next block.”

WMPPs Move #3: The Environmental, Social and Governance (ESG) movement puppeteered Elon Musk to come to the “realization” of Bitcoin’s “immense” amount of energy usage and the need to make Bitcoin “greener.”

BGTC: The Bitcoin Mining Council was created by Michael Saylor and after compiling an immense amount of energy usage data from 23 miners (62% of the mining industry) that freely joined the council, it was found that Bitcoin currently generates more than 50% of its usage from renewable energy.

Bitcoin crashed to $29,000 after the Musk and China FUD in a span of a few months. Bitcoin’s price is now close to $50,000.

The Honey Badger doesn’t care about Musk or the ESG, but the Bitcoin Mining Council is serving as a great way to educate the masses about Bitcoin’s energy usage.

WMPPs Move #4: The International Monetary Fund (IMF) tried to strong-arm El Salvador into not passing a law that would allow bitcoin to become legal tender in the country, by threatening that they would not support El Salvador.

BGTC: The President of El Salvador took things into his own hands and did what he thought was best for his people in passing a bill over a span of one day to allow bitcoin to become legal tender in El Salvador.

El Salvador started using bitcoin as legal tender on September 7, 2021, which is like Bitcoin moving its pawn to the end of the chessboard and all avid chess players know what happens to a pawn when it reaches the end of a chess board.

Pawns become queens, and the queen is the most powerful piece in the game of chess. This game theoretic move by Bitcoin will start a chain reaction among other countries to adopt bitcoin, help bank the unbanked, and protect the purchasing power of those who adopt it from the rampant printing of fiat by all Nation States.

In conclusion, the Bitcoin network will continue to operate no matter what the WMPPs say, do or think. Some of the greatest, most powerful entities like the IMF, China, United States and ESG movement have tried to attack Bitcoin, but it will continue to move its chess pieces on the world’s chessboard to counter every move because it is a beautifully engineered protocol.

You might even argue that Bitcoin is artificial intelligence considering how it has countered the WMPPs every move for 12 years but that will be for a different article.

Updated: 4-21-2023

The Game Theory Of Bitcoin And Cryptocurrencies

The game theory of Bitcoin and cryptocurrencies analyzes the behavior and strategies of participants in the market using concepts such as the prisoner’s dilemma.

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, 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.

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 miners in a cryptocurrency pool to understand how the prisoner’s dilemma can be applied to the context of cryptocurrency mining.

In the above diagram, Miner A and Miner B are two miners in a cryptocurrency mining pool. They have the choice to cooperate (continue mining together) or defect (leave the pool and mine independently). The rewards and payoffs are based on the classic prisoner’s dilemma scenario:

* If both miners cooperate, they both receive a reward (e.g. a share of the mining profits).

* If Miner A defects while Miner B cooperates, Miner A receives a temptation payoff (e.g. a larger share of the mining profits), while Miner B receives a suckers payoff (e.g. a smaller share of the mining profits).

* If Miner A cooperates while Miner B defects, Miner A receives a suckers payoff, while Miner B receives a temptation payoff.

* If both miners defect, they both receive a punishment (e.g. lower overall mining profits).

This diagram illustrates how the prisoner’s dilemma can be applied to the context of cryptocurrency mining.

Global Bitcoin Game Theory Is Now Playing Out

It shows the potential rewards and payoffs for each combination of cooperation and defection, and can help miners make decisions about whether to stay in a pool or mine independently.

The defector will receive a larger share of the profits because they are not sharing their earnings with the other miner. On the other hand, the cooperator who remained in the pool will receive a smaller share of the rewards because they are now contributing more computing power but still receiving the same share of the rewards as before.

To address this challenge, cryptocurrency networks can implement various incentives and mechanisms to encourage miners to act in the interest of the network as a whole.

For example, networks can reward miners who contribute to the network with lower fees or increased mining rewards. Additionally, networks can implement penalties or defensive mechanisms to discourage malicious behavior.
The game theory of blockchain forks

Blockchain forks are another scenario where game theory can help explain the decision-making process of participants. A fork occurs when a blockchain network splits into two separate paths, often due to disagreements among participants about the direction of the network.

A fork can be thought of as a coordination game from the perspective of game theory. Two or more players must work together to attain a common objective in a coordination game. Participants in a blockchain fork must work together to decide which fork to promote and which to reject.

The Bitcoin network split into two distinct forks in 2017: Bitcoin and Bitcoin Cash. This is one of the most well-known instances of a blockchain fork. Disagreements within the Bitcoin community on how to expand the network to handle an increasing volume of transactions led to the creation of this fork.

In this case, members of the Bitcoin community had to choose between sticking with the old Bitcoin network and switching to the new Bitcoin Cash network. The choice was not easy because each fork has pros and cons of its own.

For instance, while Bitcoin Cash offered quicker transaction times and lower fees, Bitcoin had a larger network and higher acceptance.

Participants in this scenario had to take into account their personal preferences and opinions regarding the potential future worth of each network in the context of game theory.

Participants would be motivated to promote Bitcoin Cash even if it meant leaving the original Bitcoin network if they thought it had a stronger chance of long-term growth.

Let’s look at the below diagram, illustrating two miners facing the choice of whether to adopt a new fork in the blockchain or continue on the old fork to understand how game theory can be applied to the context of blockchain forks.

The above diagram depicts the strategic decision-making of two miners, Miner A and Miner B, on a blockchain, as they face the choice of either adopting a new fork or continuing on the old fork. The rewards and penalties are based on the following assumptions:

If both miners adopt the new fork, they both receive a reward (e.g. increased mining efficiency).

If Miner A adopts the new fork while Miner B continues on the old fork, Miner A receives a penalty (e.g. decreased mining efficiency), while Miner B receives a reward.

If Miner A continues on the old fork while Miner B adopts the new fork, Miner A receives a reward, while Miner B receives a penalty.

If both miners continue on the old fork, they both receive a temptation payoff (e.g. maintaining control over the blockchain).

This diagram illustrates how game theory can be applied to the context of blockchain forks.

Global Bitcoin Game Theory Is Now Playing Out

It shows the potential rewards and penalties for each combination of adopting or not adopting a new fork, and can help miners make decisions about whether to switch to a new fork or stick with the current one.

To address this challenge, cryptocurrency networks can implement various mechanisms to ensure that forks occur as smoothly as possible. For example, networks can implement replay protection, which prevents transactions on one network from being replayed on the other.

Updated: 5-3-2023

The Fed Has Little Ammo Left As $30K Bitcoin Price Becomes Key Focus

BTC options and futures markets show no use of excessive leverage from buyers, a healthy indicator as the $28,000 support gets retested.

The Bitcoin price successfully defended the $28,000 support on May 2, but it has yet to prove the strength needed to reclaim the $29,200 level from April 30.

$30K Becomes Crucial For Bitcoin Bulls

Some analysts will pin the recent downtrend on the expectation of an interest rate increase by the United States Federal Reserve on May 3, but in reality, the market is pricing 92% odds of a modest 25-basis-point increase to its highest level since September 2007.

$DXY up/#Bitcoin down on yesterdays PMI data release.

Market is now pricing in a very high probability of 25bps raise at tomorrows #FOMC.

This is likely mostly priced in for BTC, but the comments afterwards (more rates/pause) will likely bring the volatility. https://t.co/H5qtGpd8gA pic.twitter.com/BmdsNRtb1f

— Decentrader (@decentrader) May 2, 2023

As the market intelligence platform Decentrader pointed out, the comments from Fed chairman Jerome Powell are more likely to bring surprise elements, either pointing to further measures to slow down the economy or signaling higher odds of the terminal interest rate being close to 5%. Powell is set to hold a press conference at 2:30 pm Eastern Time.

From an employment perspective, the central bank has reason to believe that the market continues to be overheated. The U.S. government reported 1.6 job openings for every unemployed worker in March.

Moreover, according to the “ADP National Employment Report” released on May 3, private payrolls increased by 296,000 jobs in April, well above the 148,000 market consensus.

However, raising interest rates has negative consequences for families and small businesses in particular. Financing and mortgages become more costly, while investing in fixed income becomes more attractive.

Such an undesired effect of curbing inflation could further shake the core of the financial system as shown by the latest bank failure, this time of First Republic Bank.

Therefore, an eventual Bitcoin price breakthrough above $30,000 could be a definitive sign of investors’ perception shifting from seeing Bitcoin as a risk asset to a scarce digital asset that directly benefits from a weaker traditional banking system.

But to gauge whether Bitcoin’s resilience above $28,000 is sustainable, an investor must analyze if excessive leverage has been used by buyers and whether professional traders are pricing higher odds of a market downturn using BTC derivatives.

Bitcoin, Ether Decouple From Stocks: What’s Next For Crypto After Fed Rate Hike?

The recent decoupling indicates the assets will trade on their own merits.

A 14-month monetary tightening cycle that included 10 consecutive interest rate increases by the U.S. Federal Reserve has taken the federal funds rate to 5.25%, a level considered its probable stopping point.

While some market observers expect interest rates to increase another 25-50 basis points in future, the Federal Open Market Committee (FOMC) “participants’ assessment of appropriate monetary policy” (aka the “Dot-Plot”), implies that 5.25% is appropriate.

The Question For Crypto Markets Is, “What’s Next”?

Investors are ultimately concerned with the future value of the assets they own, more so than what affected that value in the past. Here are a few points worth considering.

First, volumes for BTC and ETH have been declining and trail their 20-day moving averages. The reduced activity implies that investors are staying on the sideline to a certain extent.

As such, singular economic data points are having a muted impact on digital assets. Reduced activity also implies that BTC and ETH may trade within a range, absent asset specific catalyst. This scenario won’t provide a lot of immediate alpha, but also not a lot of downside misery.

Second, bitcoin and ether have largely decoupled from traditional assets. While bitcoin started 2023 with a daily correlation coefficient near 0.90 with the S&P 500, Nasdaq and Dow Jones Industrial Average (DJIA), those have all since declined to close to zero.

The lack of correlation between BTC and traditional assets implies that investors are viewing the impact of monetary policy differently for digital assets than for stocks, at least for the moment. BTC’s correlation with copper, the U.S. dollar and gold has declined as well.

It’s not abundantly evident what would cause such widespread decoupling, or how long it will remain. The re-emergence of BTC as an alternative to fiat currency debasement and ETH’s continued contracting supply are factors that may explain their separation from traditional assets.

Third, perpetual funding rates for BTC and ETH remain positive, an indication of bullishness. With the exception of sharp decline on the day of Silicon Valley Bank’s collapse, funding rates have been positive for the better part of 2023 for both cryptocurrencies.

Finally, “whales” are accumulating both bitcoin and ether. Their paths are different, but the supply held by addresses with more than 100,000 BTC and 100,000 ETH are moving higher. An interpretation of this trend is that entities with the most capital to deploy in crypto are allocating to both assets.

The trajectory for ETH appears to be a measured one, with a decline that began in September seemingly bottoming out on April 20. Bitcoin whales’ movements have been more dramatic, with sharp moves higher followed by declines.

All told, digital assets appear to have branched out on their own. While today’s economic news will have some impact on prices, the extent to which it does will likely differ from traditional financial assets.

Bitcoin Rises As Latest Teetering U.S. Bank Sends Traders To Crypto Haven

California-based PacWest Bancorp is weighing strategic options, according to Bloomberg.

The banking crisis doesn’t appear to be over yet. Shares of PacWest Bancorp (PACW) fell by more than 50% in after-hours action on Wednesday following a Bloomberg report the U.S.-based lender is mulling a range of strategic options.

Bitcoin (BTC) was up on the news, rising more than 2% to $28,900 at press time.

The news on PacWest comes only days after First Republic Bank (FRC) was taken over by the Federal Deposit Insurance Corp. (FDIC) and then sold at auction to JPMorgan (JPM). In a Monday morning call following the takeover, JPMorgan CEO Jamie Dimon said, “I think the banking system is very stable. … This part of the crisis is over.”

Federal Reserve Chairman Jerome Powell had similar thoughts after the latest Federal Open Market Committee meeting Wednesday. Speaking after the central bank’s 10th consecutive rate hike, Powell declared the banking system to be “sound and resilient.”

Other regional bank stocks have been moving lower on Thursday including Western Alliance Bancorp (WAL), down 28%, and Metropolitan Bank (MCB), down 19%.

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