When a Giant stands on the shoulders of other Giants

The emergence of cryptoeconomics

Although we don’t know where Satoshi Nakamoto has gone, we do have some idea of where he’s been. One of the best resources to explore this is Arvind Narayanan & Jeremy Clark’s (2017) “Bitcoin’s Academic Pedigree”. The authors trace the development of various cryptographic primitives, building blocks, that led to the making of a multi-billion dollar cryptoasset.

It’s fascinating to read about the developments from the 1980’s and 90’s (in some cases earlier) that informed the design of bitcoin including timestamping, digital signatures, proof-of-work, Byzantine fault tolerance, public key cryptography and smart contracts, but even more interesting to understand Nakamoto’s fresh approach to information security problems.

Front Row Tickets to Innovation

In many ways, the article is a deconstruction of Bitcoin, starting with a ledger for recording transaction. Then, with timestamping, hash pointers and Merkle trees, giving the ledger a unique data structure where transactions could be efficiently grouped and verified. Hence, the foundation for a digital currency — a ledger with a unique data structure — was laid. Implementing this ledger without a central authority meant it had to be distributed among many computers (nodes). The challenge was in reconciling cases where blocks are generated near-simultaneously and inevitably (yet innocuously) one node thinks the latest block is Block A, while another node thinks it’s Block B (also known as ‘forks’).

While the field of distributed computing, specifically fault-tolerance research, had studied these cases extensively, Nakamoto did not to draw directly from this line of research, opting instead to use the language of a consensus mechanism to explain how to reconcile such forks.

Whereas distributed computing research requires some level of honest behavior among nodes (e.g., > 50–66%) to assure fault-tolerance, Nakamoto’s consensus mechanism puts in place incentives so as to not have to rely on such honest behavior. This departure is subtle, but in retrospect, important: rather than passively count on honest behavior, Nakamoto consensus actively incentivized it.

Less innocuous than near-simultaneous block generation, some people may seek to overcome the supermajority consensus guarantee by acquiring extra nodes (aka a Sybil attack; Douceur, 2002). Hence, there needed to be a way to impose a cost on acquiring extra nodes. Prior research on e-mail spam deterrence (Dwork & Naor, 1992); hashcash (Back, 1997); and later proof-of-work (Jakobsson & Juels, 1999) all contributed to helping create a way of imposing this cost, making it expensive to mount a Sybil attack.

Further yet, Nakamoto asked what would it take to get people to perform computationally expensive work, once again thinking about incentives. Thus, in Bitcoin, there is both a cost mechanism to prevent attacks (computationally expensive proof-of-work) and an incentive mechanism to motivated people perform proof-of-work (block rewards and transaction fees).

There was one catch: a digital currency is needed for people to do the work of securing a digital currency.

Thus, Nakamoto’s innovation is addressing this paradox to literally bootstrap a working economy with a currency that is valued by its participants.

Nevertheless, I’d like to draw your attention to a particular aspect of Nakamoto’s genius as exemplified in the following passage:

A richer analysis of Nakamoto consensus accounting for the role of incentives doesn’t fit cleanly into past models of fault-tolerant systems (Narayanan & Clark, 2017).

Hello Cryptoeconomics

The role of incentives doesn’t fit cleanly into past models because, unbeknownst at the time that the Bitcoin whitepaper was released, Nakamoto had birth cryptoeconomics.

Cryptoeconomics focuses on designing protocols, through incentives and counterincentives, to govern the production, distribution and consumption of goods and services in a decentralized digital economy. Due to the context of decentralized digital economies, cryptoeconomics allows us to think about information security problems in economic terms. As an interdisciplinary field, it combines cryptography, network theory, computer science and economic incentives.

It’s because Nakamoto was an academic outsider that he was able to freely combine insights from so many different disciplines.

The term cryptoeconomics was coined in retrospect, but it captures Nakamoto’s unique insight of using incentives to drive consensus on the protocol. Since then the tools have been used to formalize potential attacks, security models, application design and other consensus protocols.

Nakamoto stood on the shoulders of giants before him, just like the current generation of cryptoeconomic researchers are standing on his.