The Free Market and Game Theory in the Proof of Stake Consensus

you feel comfortable in a system that concentrates power in a few players?

In Cardano, a discussion is currently taking place in the community, like a war between the “centralist” multi-pool operators and the “decentralist” single-pool operators.

The concentration of delegation in some pools, mainly multi-pool operators, has been encouraged by the ISO (Initial Stakepool Offering) model to raise funds for projects.

Opinions have polarized in the community.

Free Market, Game Theory and Proof of Stake

Monopoly is a system in which an economic agent (monopolist) holds great power because it is the only one in an industry that owns a specific and differentiated product, good, resource or service.

A similar situation of concentration occurs with Oligopoly, but instead of a single actor, there are only a few.

Monopoly does not only occur in capitalist economic systems, but also in communism, which, unlike the free market, power is concentrated in the State.

Thus, monopoly is centralization, the opposite of decentralization.

Then, you must understand Game Theory, which is an area of applied mathematics that uses models to study interactions in formalized incentive structures, the so-called “games”.

Von Neumann, Morgenstern and John Nash outlined the basic postulates of this theory during the 1940s and 1950s, and several applications have been granted to this tool in the field of economic decisions.

Nash equilibrium assumes that each player has adopted his best strategy, and everyone knows the strategies of the others. It is a situation in which all players have put their strategy into practice, and know the strategy of their competitors, and thus will seek to maximize their profits. Consequently, no player has any incentive to individually modify his strategy.

One of the problems with Nash equilibrium is that it does not necessarily lead to efficient situations in the Pareto sense (1).

(1) Vilfredo Pareto (July 15, 1848-August 19, 1923), Italian engineer, sociologist, economist, and philosopher who postulated “Pareto efficiency,” where given an initial allocation of goods among a set of individuals, a shift to a new allocation that at least improves the situation of one individual without making the situation of others worse is called a Pareto improvement.

In Game Theory, “Prisoner’s Dilemma” is the best known problem, which shows that two people may not cooperate with each other, even if it is against the interest of both.

Finally, the third element you should know to understand my article is the Proof of Stake (PoS), a blockchain consensus method to validate block production, being one of the most used, together with Proof of Work.

PoS is used by Cardano, among several blockchains, and PoW by Bitcoin, among others. The particular case of Ethereum, which currently uses PoW, and is making the transition to PoS.

In PoW, the validation power is concentrated in the hardware of the validators, called miners, where computational power makes the difference to discover a mathematical algorithm, and thus be chosen validator.

In PoS the election of validator (stakepool operator) is done by drawing lots among the nodes, but with better weighted “luck” for those who have greater delegation, i.e. greater amount of funds in staking of the protocol’s cryptocurrency, either from the operator himself or from the delegators who have elected him.

The Road to Decentralization

Consensus in blockchain is the primary basis for decentralization, and therefore it is important to understand its dynamics.

According to the design of the Cardano protocol, as in most PoS networks, competition is generated among stakepool operators to attract delegators, so that they allocate their ADAs funds to their node.

The proposed competition is consistent with the free market, and being a permissionless blockchain, it is open for anyone to take part in the creation of the blockchain blocks, either as a participating node or as a delegating fund holder.

Understanding this is key to taking action. Choosing a node to delegate is a vote in the PoS consensus.

Would you want Cardano to elect by protocol (Ouroboros) the validating nodes equally regardless of staking? Would you want all nodes to sign blocks having been elected in order one by one?

If so, there would be no competition, since no operator should strive to attract delegation, and should only work to keep its node in an operable condition.

The tendency to concentration is natural for human societies, both in free trade systems, and even more so in totalitarianisms. The Pareto principle (known as the 80–20 Law) speaks about it in all human spheres, and in economics it shows how most of the global wealth is concentrated in a few hands.

Free action between supply and demand has its conditioning in Game Theory. With the right incentives, the equilibrium between the two is more likely to remain healthy, without concentrating power in a few players, i.e., an equilibrium towards decentralization.

Final Words

It all boils down to the pursuit of decentralization, since the majority agreement in the ecosystem is that centralization is undesirable.

If all participating players know each other’s strategies, and assuming that free competition is accepted under the rules of the protocol, i.e. knowing the incentives, Nash equilibrium is the consequence, at least in theory, seeking Pareto efficiency.

Freedom of choice is also part of decentralization, and it is not coherent to “force” delegators to choose only single pool operators, but it is necessary to show the benefits of doing so, to maintain the sustainability of the network in the long term, avoiding concentration in a few hands.

The choice is yours, and making an informed decision is advisable.

Always DYOR (Do Your Own Research).

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Li₿εʁLiøη

Li₿εʁLiøη

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Researcher — ϚʁyptøWriter — Content Creator | Twitter @liberlion17 website: liberlion.com