Exploring Economic Incentive in Blockchain Use
By Ariel Zetlin-Jones, Associate Professor of Economics
Most people call blockchain a technology, and this is a useful first step. It is a new technology for maintaining public ledgers or databases among a large group of people. But it’s more than that.
Saying blockchain is simply a technology is a bit like saying eBay is a technology. You can write computer code to enable individuals to create and participate in auctions on eBay, but the outcomes will depend on human behavior. In much the same way, the performance, security, and usefulness of blockchain as a technology will depend on a careful analysis of how humans interact with it.
This is what we’re doing at Tepper. We are taking an analytical approach to human behavior with the goal of creating better-designed blockchain technologies. Here are a few questions we’re exploring.
How big should a blockchain block be?
How much data should be encoded in each block of a blockchain? By adding bytes to a block, can a blockchain “scale” and transmit more transactions more quickly? This question—how many bytes a block should contain—sounds like a purely technological question.
But Tepper School researchers show that changing the block size may be futile: The individuals who encode data into blocks may have strong economic incentives to artificially limit the data they encode into each block. Our researchers study these incentives and propose new solutions to improve a blockchain’s scale.
How do we decide which is the “right” version of the blockchain?
In a blockchain network, each new record added to the blockchain refers or points to a record that already exists in the blockchain. The blockchain network is like a tree that is always expanding and branching out. Each path through this tree—from the original “root” to any given record—represents a different version of the blockchain database.
Which version is “correct”? In blockchain, no central authority tells users the answer. For a blockchain to be useful, its users must come to a consensus. To help make this happen, blockchain designers build in a consensus protocol that recommends a correct version to users.
Computer scientists ask: If a large number of machines are programmed to follow this protocol and a few machines make an error, will the rest of the machines still end up at the correctly recommended version of the database? At Tepper we ask: Would individuals have economic incentives to agree on a recommended version of the database?
Unfortunately, the answer for many existing blockchain protocols is no. Tepper faculty are developing consensus protocols based on new economic models of blockchain that take human behavior into account.
How do we create a stable cryptocurrency?
Cryptocurrencies, which represent digital tokens or units of account embedded in blockchain data, have swung widely in price since Bitcoin was introduced. Some entrepreneurs have designed blockchains and associated cryptocurrencies meant to stabilize the U.S. dollar price of their cryptocurrency.
Designing currencies with stable prices relative to other currencies is an old challenge in monetary economics. In our work at Tepper, we have shown that attaining full price stability may not be a desirable goal after all. We’ve also shown how to use economic theory to design cryptocurrencies that are immune to certain kinds of unwanted volatility.
Exploring blockchain and its potential applications is a natural fit at Tepper. Our research shows that the economic incentives that drive human behavior play a critical role in how blockchain technology is and will be used. Its success as a useful tool will depend as much on how humans interact with it as on the technology itself.