The Crypto Economy: Three Representative Examples

The Crypto Economy

The crypto economy is based on a lack of trust in the ecosystem, and its role is to create trust where there isn't any. The crypto economy is structured in a way that the participants who act in their own self-interest help to maintain the ecosystem, and incur significant losses if they try to cheat or scam others. The crypto economy is not just theoretical, but is actually implemented in practice. This article will examine three representative examples of the crypto economy in action.

Case 1: Consensus Protocol

Consensus Mechanism in the Crypto Economy

Blockchains can reach a reliable consensus without relying on a central trusted third party, thanks to cryptoeconomic design. The proof-of-work consensus mechanism in Bitcoin, for instance, requires miners to invest in hardware and electricity in order to participate in the network and receive mining rewards. This makes it difficult and expensive for a 51% attack to take place. In Ethereum, the proof-of-work consensus mechanism has undergone many improvements and variations, and the platform is now planning to transition to a proof-of-stake consensus protocol called Casper. This new consensus mechanism, created by Ethereum founder Vitalik Buterin and others, eliminates the need for mining, making it more resistant to centralization and less energy-intensive.

Case 2: Cryptoeconomic Applications

Applications Built on Blockchain Technology

Once the fundamental problem of blockchain consensus is solved, we can build applications that run on top of a blockchain platform like Ethereum. The underlying blockchain provides:

• A unit of value that can be used to pay incentives and penalties.
• Tools to design conditional logic in the form of smart contract code.

Examples: Augur and Gnosis

Two representative applications of the crypto economy are Augur and Gnosis. Prediction markets like Augur, for example, utilize cryptoeconomic instruments to function. Augur uses its native token, REP, to create an incentive system that rewards the app for providing accurate predictions. Gnosis, another prediction market, also uses a similar approach, but allows users to utilize other methods, such as oracles, to determine the true value. The crypto economy is also used to design initial coin offerings (ICOs) like the Gnosis Dutch Auction model, which is based on the theory that a Dutch auction will result in a fairer distribution. Designing applications that utilize the crypto economy requires an understanding of how incentives shape user behavior, as well as the potential and limitations of the underlying blockchain platform.

Case 3: State Channels

Efficiency in Smaller Interactions

Cryptoeconomics also encompasses practices that design much smaller interactions between individuals. One notable example is State Channels. Although State Channels are not applications, they are a crucial technology that increases the efficiency of many blockchain applications.

Overcoming the Limitations of Blockchain Applications

A major limitation of blockchain applications is that they can be costly, as sending transactions requires a fee and using Ethereum to run smart contract code incurs higher costs than other computing. State Channels solve this problem by leveraging the design of cryptoeconomics to move many processes off-chain, making the blockchain more efficient while still maintaining its reliability. For example, A and B can exchange multiple small cryptocurrency payments through a state channel, which eliminates transaction fees and the need to check each new block. The signed transactions are stored off-chain, and the parties can send and receive transactions as fast as they want. After the exchange of microtransactions is complete, the final transaction is submitted to the blockchain and a fee is paid for one transaction to close the channel

Advantages of State Channels

State channels offer several benefits over traditional blockchain applications.

• First, they reduce the cost of transactions. By moving the majority of the transactions off-chain, the cost of conducting these transactions is reduced.
• Second, state channels increase the speed of transactions. Transactions are settled almost instantly between parties, and only the final transaction is recorded on the blockchain, making the process much faster.
• Third, state channels increase the privacy of transactions. Transactions conducted off-chain are not recorded on the blockchain, making them more private.

Conclusion

In conclusion, the crypto economy is a vital component of the blockchain ecosystem. It provides a mechanism for creating trust in a decentralized system and enables the creation of a variety of applications and tools. From consensus protocols to state channels, cryptoeconomics offers a robust toolkit for building and maintaining a decentralized economy. Understanding the crypto economy and how it works is essential for anyone looking to participate in the blockchain space. As the crypto economy continues to evolve, it will provide new and exciting opportunities for innovation and growth.