Game theory is one of the most important concepts to grasp to understand blockchains/crypto, strategy, and decision making.
Game theory is the study of how and why people make decisions within a competitive situation, while keeping in mind what actions their competitors will take. You can think of it as the study of strategic decision making.
But, game theory isn’t just about games. It’s used for any situation where two people have to make decisions with rewards and consequences. The ultimate goal is find whether a “best” strategy for a given game exists.
Poker is a great example because the other players choices influences your strategy. For example, should you play tight while your opponent is playing loose? Or, should you bluff or not? Or, raise/fold?
So, how does this apply to crypto? The Bitcoin blockchain was designed in a way that it is a self-enforcing Nash Equilibrium. Incentives come into play to encourage participants to maintain the protocol and avoid the Byzantine Generals Problem.
Miners are incentivized to be good actors on the network. If miners want to earn rewards, they have to abide by the rules. Otherwise, miners lose time, electricity, and processing power (costs). This is because mining has a recursive punishment system.
For example, a node controlled by a miner is free to go rogue and create an invalid block. The miner is deterred from doing this because other nodes that follow the same strategy will be punished and excluded from the system.
If a miner creates an invalid block, the other miners will simply ignore the invalid block and keep mining on the main chain. As a result, miners will choose the most stable state (Nash Equilibrium).
The system is Byzantine Fault Tolerant due to the majority of miners working in coordination to achieve and maintain the most stable state of the network at all times.
To further understand game theory, here are some of the more important concepts: