Game of Coins: The Behavioral Economics of Crypto

It’s a basic principle of human behavior that people are more cooperative when eyes are watching. I mean this literally and figuratively. Literally because you don’t need a human to watch, just eyes. And figuratively because these eyes don’t even need to be real, they can just be an illustrated pair of eyes. I’m not kidding. A famous social-psychological study[1] showed that people are less likely to free-ride a supposed honor system based coffee stand when a sign asking them to leave money in a cup had a pair of eyes drawn on it. Actually, people left nearly three times more money than they did when the picture was just of flowers. As Daniel Kahneman, one of the founding fathers of behavioral economics puts it, people are “endlessly complicated and interesting.”[2]

Of course, the general principle that humans cooperate more when other people are watching (called “reputation management” by the likes of psychologists and game theorists), is just plain common sense. The hard part isn’t identifying this tendency, the hard part is figuring out how to make people cooperate when no one is looking (and when drawing a pair of eyes on paper just doesn’t cut it). We struggle with this in the physical world. Consider the predicament limited natural resources present. It’s hard to turn your AC down in the summertime if you think that your doing so will cause you to suffer, and your neighbors won’t turn their AC down so it doesn’t make a difference anyway. “Ah, what the heck, I’ll just keep it at 72” is closely followed by nasty, preventable blackouts. Such is the tragedy of the commons.

Many people believe it is the job of the government to regulate and fairly allocate such common resources. Without California’s water conservation laws, people would fare much worse in the drought, the argument goes. We can’t trust people to be selfless, so we need Uncle Sam, and his very foreboding eyes, to come and babysit.

Let’s consider what the commons dilemmas have looked like in the cyber world. Storage, bandwidth, and computation are the three basic infrastructural needs of the electronic universe. And rather than entering into a social contract with Uncle Sam directly, cyber citizens have entered into social contracts (otherwise known as Terms of Service) with the Big Four. It goes something like this: We will provide you with reliable storage, bandwidth, and computation and in return, you’ll let us mine your data and metadata for profit.

Users agree, and voila: Google, Amazon, Facebook, and Apple traffic-direct their limited, albeit large, resources as they please. In exchange the Big Four mine and profit off user-generated data. And all people of the world live happily ever after cyber lives. Until Uncle Sam pulls the plug on net neutrality and they realize that nobody watches the watchmen — except for friends of lobbyists — which isn’t all that reassuring.

“Who watches the watchmen?”: Crypto-economic platforms

This sentiment rings popular with Crypto-Libertarians and Classical Liberals, but it leaves many concerned that the Wild West of Initial Coin Offerings are just dirty scams to make a quick buck. So, what’s with these ICOs anyhow?

Cryptocurrencies now are being crafted and tailored to meet specific cyber resource needs. Filecoin uses coins as cooperation incentives for a Dropbox-like decentralized storage system. Ethereum uses coins for decentralized computational power. AXE* uses coins as cooperation incentives for decentralized bandwidth. Are you seeing the theme? The heart of the crypto crowd is to replace biased, and sometimes downright unethical, governing third-parties with unwavering algorithms and ledgers that every peer gets to watch. Everyone is a watchman. Ancient Greece’s vision for democracy realized in the electronic economic realm.

But what makes this any different than crypto-anarchism? Shortly after Bitcoin started to picking up traction and being used by the infamous Silk Road, much of the general public began to equate cryptocurrencies with shady business deals. Bitcoin isn’t regulated, so obviously the purpose of Bitcoin is to empower pimps and drug-rings, the thought went. But, it’s not entirely true that Bitcoin isn’t regulated. It is — it’s just crowd-sourced regulation. And this might be a primordial goo we social psychologists can work with.

The four “I”s

Social psychologist Mark Van Vugt[3] has outlined the four “I”s that motivate successful resolution of commons dilemmas: Identity, institutions, incentives, and information. So let’s take a look at what these new crypto-era cipher startups will need to pull off.

Identity.

Although many equate cryptocurrencies with privacy, remember that they are all based on public ledgers. It’s more confidential than anonymous per-se. Each action is added to a record associated with a public key. While you might not know that Jane Smith ripped 5 people in a row off, you do know that X public key ripped 5 people in a row off, was nice to two people before that, and free-rode prior to that. Probably best not to take your chances doing business with X public key.

This is more powerful than you might initially imagine. Psychologists have found that people are far from fair in their interactions in totally anonymous so-called “dictator games.” In these games, an individual is put in a seat of total power (the dictator) to split valued resources between themselves and another party. Unsurprisingly, when the dictator has the benefit of anonymity, they tend to hoard the resources. However, if the rules of the game are shifted such that the dictator role swaps between parties in subsequent rounds, and the players of the game can keep a mental record of one another’s dictatorship roles over time, people become much more friendly. This behavioral change is unsurprising, but keep in mind that this happens even though no one’s private identity is revealed. Give me a public ledger, and I’ll show you a (probabilistically) honest man.

But, take the mask off and the effects are all the more powerful. If you can connect actions with a person’s true face and name, behaviors become increasingly prosocial.[4] Twitter’s blue check mark is aimed at reliably verifying identities to prevent bad actors from impersonating. But on second glance, it also keeps the real Slim Shady from being, well, shady. Martti ‘Sirius’ Malmi, the first developer of Bitcoin after Satoshi, is working to create one such decentralized identity system, called Identifi. Potential gossip is a powerful motivator. Show me a face and a name, and I’ll show you either an honest person, or a non-rational masochist.

Institutions.

Here’s where I abstractly disagree Van Vugt. He says that institutions are needed to build trust between individuals in commons exchanges. Cryptoeconomic exchanges operate orthongonally to this principle. Rather than attempting to create trust, they simply do-away with it. They create “trust-less” systems. Trust is automated in this frontier. It’s not something you pay for, it’s something you take for granted.

So, let’s instead take a liberal interpretation of Van Vugt and say that “algorithms” can substitute for “institutions” in the cipher world. Bitcoin makes the trustworthiness of a purchaser irrelevant. The algorithm simply ensures no double-spending will occur, adds the exchange to the blockchain ledger, and all eyes everywhere bear witness to that interaction. The elegance of blockchain-based cryptoeconomic platforms is that they eliminate the need for trusted institutional mediators.

Incentives.

Humans seek pleasure and avoid pain. This is a no-brainer, and it hasn’t escaped the likes of Bitcoin, AXE, Filecoin, and Ethereum. These platforms have built incentives into the software’s infrastructure, and done so craftily to get around the chicken-and-egg problems that plague new currencies. Bitcoin’s mining system, for instance, releases fewer coins with each new block. This incentivizes early adoption by eliminating long-term inflation, and makes coins mined early on more valuable when considering the proof-of-work required to mine them.

AXE has innovated upon this idea with its two-dimensional blockchain. As coins are exchanged for decentralized bandwidth, the coins collect a sort of wear-and-tear. Thus the earliest adopters who “hodl” genesis coins will have the most valuable coins in the entire system. But mining restores some of the life into a used coin, akin to a used laptop regaining some of it’s value by becoming refurbished. This wear-and-tear function prevents Sybil attacks, because artificial exchanges aimed at inflating one’s reputation would result in wear-and-tear on the transfer coins, which ultimately punishes the schemer. This is an example of how cryptoeconomic platforms can add punishments over and above poor reputations.

Information.

Humans crave information. We just don’t like being the dark. We need to feel competent that our cooperative actions (or inactions) in a common system will actually make a difference. These crypto-coin companies will need to educate their users in how bad-acting will affect the overall ecosystem, and how good-acting will make a measurable difference as well. This goes for personal rewards and punishments and reputation management too. In case anyone offering coins is listening: this crypto-decentralized stuff isn’t intuitive, make sure users know the basic cause-and-effects of your systems.

Psychologists are cynical about human nature. It’s why we put people into dictator games and document their dark sides emerging. I earned my doctorate specializing in the study of human morality. Based on my experience, cryptoeconomic platforms should aim to disseminate information which elicits “elevation” (a sense of awe and wonder at the moral beauty) of cryptographic decentralized platforms.

People also need information about why they ought to care about cryptoeconomic platforms. If these big ICO projects wish to cut down on free-riders, they need to make their philanthropic message clearer. By being honest in these cryptoeconomic platforms, users are empowering marginalized individuals to access private data storage, computation, and information transfer. The point of crypto-this, crypto-that decentralized everything isn’t to buy drugs, and it’s not really to avoid international transfer fees or even so much to retain privacy. These are side-effects.

It’s to say “down with the tyrants.” It’s to drive the marginal costs of information to near-zero, so that any one in the world can become educated. It’s to prevent censorship. It’s to allow women to have bank accounts. It’s to keep corrupt governments from making lifetime-savings transactions mysteriously disappear. It’s to break telecommunications monopolies. It’s to level the playing field. It’s to disrupt racism, sexism, classism. It’s to jump out of the gunky matrix that lobbyists and politicians have plugged us into. Do you want to cheat and free-ride that system? Do you want to destroy that vision? I’m guessing you don’t.

*The author is an employee of AXE’s parent company.

[1]Bateson, M., Nettle, D., & Roberts, G. (2006). Cues of being watched enhance cooperation in a real-world setting. Biology Letters, 2(3), 412–414.

[2]Nobel Prize Autobiographical Information; https://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2002/kahneman-bio.html

[3]Van Vugt, M. (2009). Averting the tragedy of the commons: Using social psychological science to protect the environment. Current Directions in Psychological Science, 18(3), 169–173.

[4]Piazza, J., & Bering, J. M. (2008). Concerns about reputation via gossip promote generous allocations in an economic game. Evolution and Human Behavior, 29(3), 172–178.