Most of us believe that Bitcoin is more than just a virtual currency. We believe in its value and how it is determined by the consensus mechanism that participants on the network meet with. We trust in its ability that allows purchasing through it and the financial sovereignty that comes with it.

Bitcoin’s system runs on a distributed algorithm that is obligated to perform righteously for the digital asset to function, as to make new coins [mine] or maintain the consensus of which account owns which coins and to validate transactions. The righteousness of its technology and code is what we trust in, which makes us consider it as a store of value and an asset for global transactions.

But the seamless functioning of this algorithm that runs the system relies on assumptions that the nodes present on the network participate in a particular manner. What actually keeps these players away from malicious intentions and makes them cooperate loyally are the incentives induced in the ecosystem. 

It is necessary to understand the psychology, the game theory, and the equilibrium that keeps Bitcoin’s ecosystem stable; rather than relying on the knowledge that only the network nodes run it.

The Psychology 

The psychology of miners is similar to the psychology of any other validator or agent or salesman. They put in their own resources to validate a particular value for it to sell, and for the sales, they put in an amount of effort which is what they are incentivized for. 

Any unethical behavior causes them to lose the future chances of participating in the network which is why they cooperate and perform according to the pre-determined but not mentioned rules everyone mutually abides by. 

Agreement about the principles is a social procedure. Miners come to a common comprehension of what is permitted, with the same standards that can be encoded into the software that every miner uses. Consensus about the current status is an issue of technical frameworks. Every node on the network only has the capability to store the amount of data that all the other nodes can, which limits the whole network to the capability of one single node. This indicates that the network needs to coordinate under all circumstances irrespective of the conceivably questionable system, to accomplish a reliable comprehension of the worldwide network state. Indicating that scientific applied consensus must be accomplished notwithstanding the probability if a few players that will adrift from the distributed standards of consensus on the chain. Just in case, some players do not abide causing Byzantine failures then it can often still be tolerated as the majority of the network will still be cooperative and loyal participants.

When Bitcoin prices crash, mining farms shut as the computational power put into the production of validating Bitcoin transactions is no more profitable. But if not most, a few rigs still keep their work going for the betterment of the community and for the chances of winning back more when the prices rise.

Basically, mining psychology is built around trust in the loyalty of nodes on the network along with the reliance of traders and whales coming back into the game.

The Game Theory

The incentives in the system be it good or bad works with the terms of the Game Theory. If one breaks the rule within the algorithm system, there isn’t any repercussion that outweighs the benefit. This is an asymmetrical design, it disincentivizes bad players that work against the system.

For example with mining Bitcoin, if a miner decides to attempt to double-spend a transaction, the block will end up becoming “orphaned.” Orphaned blocks occur when a miner tries to reverse a transaction by using enough hash power, and the block ends up not becoming part of the actual chain. This can also happen if multiple miners try to “double-spend” which would create a 51% attack. This means that multiple miners are working together to own 51% of the hash power on the Bitcoin network, not allowing for transactions to be completed. These types of activities can be avoided on the Bitcoin. 

For instance with mining Bitcoin, if a miner chooses to endeavor to twofold spend a particular transaction, the block will end up being stranded and will be stated as an “Orphan” block. Orphaned blocks happen when a miner attempts to reverse a transaction by utilizing enough hash control, and the block is kept from becoming a part of the blockchain. This can likewise occur if more miners attempt to double spend which would result to a 51% attack. This implies that different miners are cooperating to possess 51% of the hash control on the Bitcoin network, are not taking into account the transactions that have to be validated. 

These kinds of malicious activities are avoided on the Bitcoin network because if a miner attempts to do this, they will devalue their mining investment. In effect, they lose their mined Bitcoins and aren’t rewarded for completing transactions. Miners are incentivized to be good actors on the network, which is the very essence of Bitcoin’s Game Theory.

The Equilibrium 

If the price of Bitcoin turned zero, miners would not be able to provide any resource to the network, and its trust would eventually go to zero. Consumers would derive no utility from the system and would not pay a positive price for Bitcoins. The equilibrium represents the demand side – and the hash rate provided by miners, who represent the supply side.

Buraschi and Pagnotta the researchers of the paper “An Equilibrium Valuation of Bitcoin and Decentralized Network Assets” bring up that decentralized money related systems are one of a kind in that tokens and at the same time serve two capacities. In addition to the functioning as an asset, they even incentivize miners to keep the system and the network going. The equilibrium cost of the token, at that point, is the answer for a fixed-point issue that portrays the collaboration between consumers and miners.

Basically, the fundamental value of Bitcoin is determined in equilibrium and depends on user preferences, such as risk aversion and censorship aversion. The usefulness of the network is driven by its size and its trust, and the industrial organised structure of the mining market.

Citations

Kroll, Joshua A., et al. “The Economics of Bitcoin Mining, or Bitcoin in the Presence of Adversaries.” Econinfosec.org, www.econinfosec.org/archive/weis2013/papers/KrollDaveyFeltenWEIS2013.pdf.

Emiliano S. Pagnotta, and Andrea Buraschi. “SSRN-id3142022.” Scribd, Scribd, www.scribd.com/document/376560592/SSRN-id3142022#fullscreen&from_embed.

Leave a comment

My Newsletter

Sign Up For Updates & Newsletters