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Understanding cryptology

A few months ago the famous Silicon Valley venture capitalist Parker Thompson made a tweet saying "the economics of cryptography is foolish. In the end, economics is still the economics. Creating a new vocabulary is merely an excuse to ignore the existing ones. concept".

The term "crypto economics" does cause confusion. People often do not know what it means. The word itself may be misleading, and it seems to imply that there is a parallel "encrypted" version of economics as a whole. This understanding is indeed wrong, Parker has every reason to laugh at such a generalization.

In simple terms, crypto economics is actually a whole new system, application and web based on incentive strategy and cryptography. Cipher economics focuses on creating things that most closely resemble mechanical design (a field where mathematics and economics are combined).

Cryptography is not a branch of economics, but rather a cryptology application that takes economic incentives and economic theory into account. Bitcoin, Ethereum, Zcash and all other public blockchain projects are the product of cryptology.

Economics of cryptography makes the blockchain more interesting and makes it very different from other technologies. We have learned from Nakamoto's white paper that we can establish a completely new technology through the clever combination of cryptography, cybernetics, computer science and economic incentives. These new crypto-economics systems can do what these disciplines themselves can not do. Blockchain is exactly the product of this new and useful discipline.

This article aims to explain cryptology economics in a clear and concise manner. First, let's take Bitcoin as an example of crypto-economic design. Second, we will ponder how cryptology is linked to economic theory. Finally, let's look at the three most active areas of design and research in cryptology.

1. Using bitcoin as a case study to see what is cryptology?

Bitcoin is a product of crypto economics.

Bitcoin's innovation is that it allows individuals who do not know each other to reliably reach the consensus through the Bitcoin blockchain. All of this is achieved through economic incentives and basic cryptographic tools.

The design of Bitcoin depends on economic incentives and penalties. Those who support the operation of the entire network can get the corresponding remuneration miners who contribute their own hardware and electricity, because if they can produce new blocks, they will get a certain amount of bitcoin in return.

Second, economic costs or penalties are part of the Bitcoin security model. The easiest way to attack a Bitcoin blockchain is to control most of the bitcoin network (which is known as a 51% attack) which will allow an attacker to tamper with the transaction and even alter the past of the blockchain.

But control over what you want to do with hashing is costly and is mostly hardware and power costs. The bitcoin agreement is intended to make mining very difficult, which means it can be very expensive to get control of most networks, making it harder to attack the system. As of November 16, 2017, the cost of forming a 51% Bitcoin attack has reached $ 3.14 billion in hardware costs and about $ 5.6 million in electricity bills per day.

Without these well-calibrated economic incentives, bitcoin will not work effectively. If the mining costs are not high enough, then hackers can easily launch 51% of the attacks. Without mining bonuses, no one is willing to buy hardware and pay for electricity to contribute to the entire network.

Bitcoin also depends on the password protocol. Public-private key cryptography is designed to support individual security and give people complete control over their bitcoin. The Bitcoin blockchain connects each block in the system via a hash function to prove the sequence of events and the integrity of historical data.

These encryption protocols give us a reliable and secure system like bitcoin. Without the public-private key as the basis, it is hard to guarantee that users can fully control their own bitcoin. Without the help of hash function, it will be difficult for the node to guarantee the complete correctness of all transaction history in the Bitcoin blockchain. Without the complexity of cryptographic protocols such as hashing functions or public-private key encryption, we have no way to reliably reward miners because we can not be sure that the records of all accounts in the past were correct and correct; without a well-tuned stimulus Mechanism to reward the miner industry, it is difficult for the entire system to adhere to the future.

The design of bitcoin requires understanding both how cryptography and incentives affect the security and functionality of the cryptography system. The economics of cryptography gives a sense of strangeness and counterintuitiveness. Most people find it hard to think of money as a design or engineering problem and hard to understand that economic incentives are actually an important part of this new technology. Economics of cryptography requires that we reconsider the issue of information security from an economic point of view.

The most common mistake in the industry is simply to look at the blockchain from a computer science or applied cryptographic point of view, and we often tend to think in areas we are familiar with, ignoring those areas of expertise. This issue has also led many to overlook the key role of economic incentives. So there are so many arguments that "the blockchain is not trustworthy", "bitcoin is just math-based" or "the blockchain is immutable." All of them mistakenly confused the importance of economic incentives in a large-scale, participatory network . For those who see bitcoin as a product of computer science, it's almost magic, because bitcoin can do things that computer science can not do at all. But in fact, cryptology is not magic, it is just a product of interdisciplinary fields.

2. How is the blockchain more generally linked to the economy?

The word "cryptology" is somewhat misleading because it seems to imply a comparison with traditional economics. This also led to people like Parker so disgusted with this term. Economics is the study of people's choices: how the group responds to motivation. The invention of cryptocurrency and blockchain technology does not require a completely new theory of economics, because of the fact that people themselves have not changed. Cipher economics does not apply macroeconomics and microeconomic theory to cryptocurrencies and money markets.

Cryptography and mechanism design are the most similar, this is a field of game theory. In game theory, we observe a given "game" and then try to find out the best strategy for each player and the participants can follow the possible outcomes that these strategies can achieve. For example, we can use game theory to look at the negotiations between two companies, the relations among nations, and even the evolution of biology.

Mechanical design is often referred to as reverse game theory because we start from the desired result and push backward to design a complete game. If the player pursues his or her own interests in the game, it will produce what we want result. For example, imagine that we are responsible for designing an auction rule, and our goal is to hope that bidders will win the bid at the actual value of a product. To achieve this goal, we use economic theory to design an auction as a game in which every player's core strategy is to bid on real value. One solution to this problem is called the Vickrey auction, where auctions are not visible to users and the winner of the final auction (defined as the player with the highest bid) only needs to pay the second highest bid Can be.

Like mechanism design, cryptology emphasizes system design and system creation. Just as in our auction example, we use economic theory to design a set of rules or mechanisms that produce a balanced result. In cryptographic economics, we use cryptography and computer software to implement this kind of economic incentives, and the systems we design are often distributed and decentralized.

Bitcoin is the product of this approach. Nakamoto wants Bitcoin to have certain features, like its ability to agree on its internal state and its ability to resist censorship. He then designed a whole bitcoin system to implement these features on the assumption that people respond to economic incentives in a reasonable way.

In most cases, cryptology can guarantee the security of distributed systems. For example, cryptographic economics can ensure that unless someone is willing to spend billions of dollars, the Bitcoin blockchain is absolutely safe against the 51% of the attacks mentioned earlier. As another example, cryptographic economics can be as secure as a chain transaction on a state channel (we'll talk about this later).

Here we should note that the mechanism design is not a panacea. It is limited to predict the reliability of future behavior through incentives. Nick Szabo points out that ultimately, in fact, we are guessing people's possible mental states in the future and how they react to certain incentives. The reliability of a cipher economics system depends in part on its control over the response to economic incentives.

Three cases of crypto economics

There are currently at least three different systems in design, which we can call crypto economics.

Case 1: consensus agreement
Blockchain can reach a credible consensus without having to rely on third-party trust, a product of cryptographic economics. Bitcoin's solution to this is the "proof of workload" consensus that miners must be involved in work in the form of hardware operations and power consumption to participate in the network and receive mining rewards.

The System of Workload Improvement and Design Alternatives are a hot area of ​​research in Cryptography. Ethereum currently offers a series of enhancements and enhancements to the original design of the workload-proof consensus mechanism to enable faster block-out times and to stop the mining-centricity caused by the large number of ASIC mines.

In the near future, Ethereum plans to move to a "proof of equity" agreement called Casper. This is a work-intensive alternative that does not require mining: it does not require specialized mining hardware and a large amount of electricity.

In the proof of workload, the actual role of miners in buying hardware and spending electricity is to increase the cost of miners and fight the 51% attack at the cost of high costs. The idea behind the proof of entitlement system is to use cryptocurrency deposits to achieve the same inhibitory effect, rather than real-world investments like hardware and electricity. In mining a system of proof of entitlement, you need to use a certain amount of ether for smart contracts "bonds." As with the proof of workload, this raises the cost of 51% of the attacks, with attackers having to provide a large amount of ether to attack, but at the same time they will also lose those ones forever.

Casper was designed by Vlad Zamfir, Vitalik Buterin and other members of the Ethereum Foundation. You can learn more about the history of Casper design in Zamfir's series of articles and podcasts. Buterin also wrote a long essay about Casper's philosophy of design, which can be found on the Ethereum Wiki.

Case 2: Applied Design of Encryption Economics
Once we've solved the fundamental issue of blockchain consensus, we can build applications on blockchains like Ethereum. The underlying blockchain offers us (1) a foundation token that can be used to motivate and punish (2) a toolkit for designing application logic in the form of "smart contracts." The created application is also a product of cryptology.

For example, Augur, which focuses on market forecasting, needs a mechanism of cryptology to work. Augur uses its own tokens, REP, to create an incentive system that rewards those who speak the truth and then uses it to solve market forecast problems. The innovation here is that it makes it possible to diversify the forecast market. A similar approach is used by Gnosis, another market-forecasting product, which also uses another mechanism to make users say what they really think.

Cryptography is also used to design token sales or ICOs. For example, Gnosis auctions its tokens for "Dutch auctions," which theoretically results in a fair distribution plan. As we mentioned earlier, one of the application areas of mechanism design is auction, and token sales or ICOs provide us with new opportunities for applying this theory.

This seems like an entirely different question than establishing a basic consensus agreement, but they actually share similarities and both can be considered as applications of cryptology. Building these applications requires understanding how the incentives affect the user's behavior and carefully designing the economic mechanisms that can produce some result reliably. They also need to understand the capabilities and limitations of building the underlying blockchain of the application.

Many blockchain applications are not necessarily the product of cryptology, such as applications such as Status and MetaMask - the two applications are the wallet and platform for Ethereum blockchain. They do not involve any additional cryptographic economics except for part of the underlying blockchain.

Case 3: State channels
Cryptography also includes the realization of small-scale interactions between design individuals, most notably the state channel. Status Channel is not a new application, but it is a very valuable technology that most blockchain applications can use to increase efficiency.

Restrictions on blockchain applications are relatively expensive on the chain, requiring a fee for transactions that are carried out, and running smart contract codes over Ethernet is relatively costly relative to other types of calculations. The idea behind the status channel is that by using cryptographic economics, we can put multiple operations down the chain to improve the efficiency of the blockchain while maintaining the credibility of the blockchain.

Imagine Alice and Bob wanting to exchange a large amount of small cryptocurrencies. The traditional way for them to do this is to send all the transactions to the blockchain, but this operation is not efficient and it not only needs to pay more transaction fees , And each transaction must wait for a new block to confirm.

Instead, imagine that transactions signed by Alice and Bob are not submitted first to the blockchain, but rather to be done quickly between them without any overhead in the process as there is virtually no blockchain hit. The balance of both parties is quickly updated after each transaction is processed.

When Alice and Bob have completed all the small transactions, they close the status channel by submitting the final status to the blockchain (ie, the most recently signed transaction), paying only for an unlimited number of small transactions between them can. They can trust this process because Alice and Bob both know that every update passed between them can be synchronized to the blockchain and there is no way to cheat if the channel is properly designed.

You can put the status channel very much like our behavior in the legal system. When the two parties sign the contract, they usually do not need to submit the contract to the court and ask the judge to interpret and execute the contract. If the contract is properly designed, both parties need not participate in the court at all as long as they promise to do so. In fact, either party can go to court and enforce the contract to make it effective.

This technique is not only valid for payment but useful for any status updates of Ethereum programs, so the term is the more generic "status channel" rather than the narrow "payment channel." Not only is the two-way multiple payment, we can continue to update smart contracts bidirectional. We can even send the entire Ethereum smart contract to the blockchain and execute if needed. These programs do not have to be run, as long as the guarantee can be run when needed.

In the future, most blockchain applications will somehow use statechannels. Fewer chain operations are a very important improvement and many of the things that are done on the chain today can be moved into the status channel while still being sufficiently effective.

The above description skips a lot of important implementation details and how statechannels work. For more detailed information, take a look at a model implementation of Ledger Labs last summer that showed the basic concept of statechannels.

Liam Horne and Jeff Coleman recently announced that they are developing a more general status channel, which is also supported by L4 and Vitalik Buterin.

to sum up

Thinking about the area of ​​blockchain from the point of view of crypto economics is very helpful. Once the idea is thoroughly understood, it helps to clarify many of the arguments in the industry.

A clearer way to distinguish blockchain applications is to determine if it applies cryptographic economics. Blockchain that does not depend on cryptology but simply a distributed ledger may work for some applications, but they are not unlike Bitcoin and Ethereum, which have adopted consensus and incentives for cryptology Application is actually very different. It is clear that these are two very different technologies, and the easiest way to distinguish between them is whether they are the product of cryptology. Second, the consensus on crypto economics should be independent of the literal chain of blocks, which may have something in common with blockchain, but, as we said before, Blockchain application is actually not accurate.

The ICO boom has drawn more attention to this distinction, despite the fact that few people actually make it very clear. Many people think the important thing about tokens is whether it forms an integral part of their application. In fact, the more clear question to ask is: are these tokens part of the design of crypto-economic mechanisms in this application? This is also an important tool for understanding whether an ICO project is worthwhile.

In the past few years, we have been thinking of this completely new field from the point of view of bitcoin to basic technology (blockchain). And now we may need to take a step back and think of the field in a unified way: crypto economics.