Programmable Incentives: Intro to Cryptoeconomics

[Music] all right amazing to be here so many people that I love in the audience it's amazing DEFCON 3 very special time so this talk is going to be on crypto economics programmable incentives it should give you a nice little overview of what it is to you know what is crypto economics anyway so hopefully the next button will work eventually all right it worked so programmable incentives we have a new spell aetherium gives us a new spell and that is the smart contracts and that allow us to program with incentives and so this will you know hopefully give you an idea of where to go so first public blockchains have a secret sauce there are two components to the secret sauce the first one is open access that means that anyone is able to deploy a smart contract or send a transaction this is critical to the guarantees that we want to have so this durable can send a transaction this durable can sent a transaction even a robot can send a transaction and there's no distinction everyone can do it the second key piece is trusted execution so that means that all these smart contracts and transactions are going to execute exactly as defined that is critical and that gives us programmable money so programmable money we've got our main character this durable Sam is sending a deploying a smart contract and you know great coder here and this is a hat token contract so what does that mean that means you can mine tokens by wearing a hat pretty simple pretty simple stuff that is the programmable money now these other terrible's they see the smart contract they're like oh that looks pretty cool I should I should you know maybe maybe all mind some of these tokens now that's the programmable incentives we're like incentivizing these gerbils to do whatever so they see the smart contract boom they start wearing hats right this is a pretty magical thing this this gerbil right here Sam didn't know these two other gerbils just uploaded some code that code was able to be verified and caused the wearin hats amazing so when we have programmable money from public blog chains that gives us programmable incentives and when you have programmable incentives you can program people it's pretty crazy pretty crazy stuff and it's a little bit scary like program people not necessarily the thing that it's a little bit too much power almost so what we want to do is we want to program good outcomes this is critical if we're going to be using our newfound crypto economic powers we need to program good outcomes so how are we going to do this well we can use crypto economics so crypto economics can give us the ability to say okay these are our incentives this is going to be the outcome that they will produce or at least give us some certainty around the this outcome and the the kind of technical definition is the application of economics and cryptography to achieve security information goals but I'll give hopefully some insight around what that really means mmm so first quote from Vitalik you can't reason about blockchain consensus protocols without thinking about economics this is fundamentally a core component of what makes the blockchain special and what makes these systems work it's people we're talking about people working together and cooperating we have two nice things in our tool belt cryptography I'm going to spoil it economics is the second one but first we'll start out with cryptography so we've got hash functions we've got digital signatures we've got merkel DAGs we've got zk snarks right so like these are just a few of our of the many tools that we have to work with incentives and this is the next part you know economics the incentive stuff so we've got tokens voting rights etc and what we can do is we can combine all of these things in our like utility belts to create crypto economic mechanisms so I personally work on caspere this is what I spend most of my time on because it's you know the first most interesting application of crypto economics in my opinion but you know there are many actually ok not most interesting the one the most interesting one is out here somewhere and I don't even know about it so this is crypto economics right so in Casper I use we use hash functions digital signatures tokens voting rights to create a cool protocol so this is a overview of you're not gonna learn Casper here unfortunately there's a few other talks which let you do that and there's all sorts of stuff online it's there's a there's a whole bunch of literature but you can see here that we're creating new blocks and each block has a pre patch right so okay there's the hash we've also got tokens that the blockchain is giving out the validators tokens okay there's our token incentive and we've also got these validators see at the bottom they are voting on the next block so there we got we have voting so all of these all of these protocols kind of use a combination of these core tools and if you squint hard enough just quit a little bit right now you can see they're actually those gerbils from you know the first first few slides great we they're all just these people we don't know them we're coming up with economic rules they're playing the game and it's causing a good outcome it's gerbils all the way down folks gerbils all the way down called the TEC so so here's some good outcomes and there's some bad outcomes right so we want to promote the good outcomes and we want to discourage the bad outcomes that means we want trusted execution the first two things that we had in in the you know first few slides the blockchain secret sauce there's also open access which allows us you know everyone concentran actions and we have fast finality and a number of other things and you know I'll give a there's some other talk so you can learn really about this stuff so that is just one of a huge number of crypto economic mechanisms and to be honest it's relatively boring compared to what is possible so the potential for these mechanisms is humongous I I'm like very excited to see what comes out so I'm gonna give an overview of any automated market maker contract and so this is something that Vitalik came up with and I think it's a really nice simple mechanism which can give a little bit of a foundational intuition for what these systems can do and how maybe to to build them so first if I were sitting down and like wanting to create a project on aetherium I would say okay first I need to design a mechanism easier said than done but let's assume we did it analyze some incentives so okay my mechanism has these people playing in it I'm going to see ok this will happen and that person will you know react accordingly and then make a website and logo publish analysis observe the behavior and record findings so this is honestly very similar to the like scientific method we have a hypothesis that we come up with we test our hypothesis and we iterate and this is like how we can actually further the like science of these protocols super exciting so here's the the market maker example we are first we have our main character a rich gerbil has a hundred even a thousand Unni the rich gerbil will deploy a market maker contract to the blockchain send it to the miner the miner will mind that transaction and create an market maker contract so this market maker has a hundred even a thousand unit in it and allows us to send and receive uni that's the whole point so so it's really just like a decentralized exchange kind of so the way that this works is you see those numbers on the right-hand side that is the invariant 100,000 is the environment so this is what calculates the exchange rate from eath to uni or you need to either so we've got these durables once again they don't know anything they're just watching the blockchain they see it and they're like well I want to I want to trade my eath for a uni so one of them sends a need to the contract and now we have 101 eath in our contract but we don't know how much uni we should have so that we equal 100 thousand right we always want to keep that 100,000 constant so we recalculate we do 100,000 divided by 101 and we get nine hundred and ninety point zero nine so this is how much a uni we will have after that transaction is sent and what we'll do is we'll send the excess uni to the person sending the eath so this is like a super easy exchange right I sent one either I got back nine point zero one uni cool and I also give a little fee to the market maker so they have a reason to actually put up this money so we've got an exchange rate before and an exchange rate after and we can actually see you know the more eath you send the more expensive uni will be the more uni you send the more expensive eath will be so this is a really simple mechanism it doesn't require a token it just you know execute exactly as defined great so now let's analyze incentives this is a critical part right this is where the actual crypto economic learning is going to come in so this is a participation incentive overview so you can analyze tons of incentives for you know all day but this is you know one example so the exchange Creator is a key player where they're going to be the they're gonna front to the the tokens and they have this passive fee income which will which they'll receive for for creating the market but they'll also have this capital lock-up cost they'll also have to maintain a 50/50 hedge of those tokens so when you create one of these markets what's going to happen is it's going to always equal out you're always going to have this 55 50 hedge you also have the token buyers they're pretty simple they're just you know sending transactions they the only downside for participating is you know the exchange fee and then we have the token arbitrage errs so these guys play a important role in keeping our exchange rate correct so what they'll do is if they see the price is you know out of whack versus another exchange they'll buy some tokens here and sell them over there and call it a day right make some easy profit so here are some open questions that may or may not have good solutions that but we can get closer and closer to you know better and better justifications so first fees is it a race to the bottom well it'll probably you know hit some equilibrium based on the like cost of capital etc but you know we can we can kind of like model this out and play around with it we can also say oh is it worth it in the first place like what tokens is it worth it for so if you think that one token is going to just go plummet then you probably don't want to create a automated market maker for that token we can do some analysis there so what what kind of market depth do buyers need right so we depending on how much how many tokens are fronted in the first place the exchange rate will change more or less so if you have more tokens and in the beginning from the exchange creator the more tokens the people can buy before the exchange rate gets out of whack and how closely will these arbitrage how closely will the token price match other exchanges basically like what's the cost of this arbitrage and you can come up with like models for this and you know there's a million things that I haven't even thought of but what we can say is we can say okay if these incentives hold true or these assumptions hold true then our market maker will act within you know as we expect within these bounds and that is going a long way because that gives us a real hypothesis something that we can test something that we can iterate on also will it promote good outcomes then we cannot forget that we're trying to build a better future some good outcomes right we've got easier exchange and trustless trades but there also some bad outcomes may be no kyc right so maybe you want a kyc your token holders who knows another thing is now we just deploy to production right we actually see if this thing works so to go live super simple code it up in Viper shout out to Viper open source it put it on either scan verify your smart contract and publish it you know this is this is something that everyone has access to every single developer can make a website code up a smart contract post on reddit not hard anyone can deploy a smart contract which can hold millions of dollars this is something that just wasn't possible before we are entering a new space where we have the capability to just recreate financial systems and anyone can do it it's pretty crazy so in our you know our little gerbils they're using the site going live this is a loading screen because they're like using it anyway and my friend even like in a weekend we coated this up and made a little website it's super simple anyone can do it so learning from mistakes this is a key point right we created this thing but now let's learn from it oh wait what's happening oh my god oh geez minor front-running what happened so that guy looks a little scared I'll give him bunny ears so our incentives from the previous thing turns out it was incorrect we didn't really reason about it properly we forgot about the minor frontrunners right these it's super low risk profit so essentially what happens is a miner receives a transaction it's a huge buy order they say oh well actually let me slip in my own transaction before that play the buy order on top of it and then sell for you know a quick profit right so they can make just like print a little bit of money right and that's crazy and that's something that we didn't necessarily account for and so people would not know about this if we weren't sharing our findings so maybe we can disincentivize this somehow right well let's think about it okay well maybe we can have a flat rate per block I mean not really it kind of mitigates the problem but it's not great maybe trust a transaction or during an Oracle hmm or just accept it as a minor tax like a minor tax so now we want to adjust our previous models right now another thing that we may not have expected okay so we thought these token arbitrage errs we're going to our bar our system well it turns out they automated themselves away now they're just BOTS and hats and this is something that can that is actually very normal what we're going to see is we're going to see these crypto economic mechanisms deployed people are going to start out playing the game themselves and then they're going to be like oh wait I can just automate what I'm doing away and it'll run on its own and so this is both really cool because like Oh awesome a shoe a fishin see but also really scary because it's like Oh BOTS own all the money kind of scary so once again good outcomes bad outcomes we need to think about these things so maybe BOTS get richer it's not rich get richer BOTS are getting richer and we have miner front-running that we didn't consider previously so important step we have to share our findings right we've got all this information and all the people need to know so gives people ideas helps everyone out spreads the love really good so we have the opportunity to create a brighter future with these incentives programming really exciting more equitable world superpowers for makers right the the magic spell that we have the smart contracts these programmable incentives we can use them to really reshape what the world looks like financially and we've got these tools to do it right we have aetherium we've got ipfs warm you know torrenting etc and way more of course and not just our superhero but like our main character everyone can do this every single person in this room so incentives drive behavior and open access to programmable incentives sets the stage for radical change right this is a really unique moment in history so this change can be good or this change can be bad right we can program incentives which promote cooperation and you know equitability and you know general happiness everyone's goal uh key or we can create incentives which prop up a few people and give them way more power than they already have right this is like kind of terrifying and we've got BOTS that could you know not only could it be people that are propped up it could be bots that are just running our lives and because I have you know a little extra time I'll give my theory so I'm really into this idea of like ai ai ethics being built out of robust crypto economic mechanisms so essentially if we do have like super powerful AI maybe we can actually defend against that by creating economic systems that they play in that promote good behavior right so if we have kind of bad incentives then our AI just playing the games just as defined are going to call us even more havoc than than previously so anyway we've got these big problems you know energy markets that we can you know mitigate with carbon credits or any other cool incentive structures we've got financial tools that currently people don't have access to but we can you know create decentralized exchanges so that they do we can also reward content creators with you know more interesting incentives than you know just like maybe patronage or even cooler stuff like curated lists that you know you want to get on or whatever there's so many options when you unlock this ability to program incentives and you've got you know tons of people who may or may not have identification can give them some decentralized identity or network neutrality like let's make some mesh networks be awesome so we need to design mechanisms test them in the real world and share our findings and do that over and over on a large scale every single one of us and we have to make sure that we are promoting positive outcomes all along the way right this this could go really well or it could go really badly probably not in between but maybe in between let's be real it'll be a mixed bag so it's up to you to you know make this a reality this is a nice photos they have the crew and we can all be you know superheroes but with great power comes great responsibility we have to be able to like do this in a sensible way we need crypto economics so we know what the actual outcomes of our incentive mechanisms are going to be we also need you know good ethics so we know that there are crypto economic mechanisms are actually going to achieve good outcomes but we can also be super villains right we can also program some evil Green Goblin people to take over the universe and on our souls more than they're already owned right like this is this is very real and very possible and you know super exciting but god I got to consider it so I'm Karl tech and that was an introduction to crypto economics programmable incentives thank you so much [Music]