(1/24) Blockchain Basics: Crypto-Economic Security
Distributed computing requires trust; next-gen is decentralized computing, built with systems designed for the anonymous internet. Systems that replace a trust with a economic rationality.
Unpacking the core of crypto.
(2/24) Trust is the confidence or belief in the reliability, truth, or capability of a person or system to act as expected, even in the absence of complete information or oversight.
We all inherently understand trust - we've been swimming in it since the day we were born.
(3/24) In the real world, trust comes from long-term interpersonal relationships and/or through the threat of consequences, and is built on a foundation accountability.
Accountability is the mechanism that sustains and strengthens trust; without it, trust is impossible.
(4/24) So here's the big question: how can you develop trust between people that are completely anonymous and can effectively disappear at any time, for any reason?
Throughout human history, this question is basically irrelevant... but the Internet changed everything.
(5/24) The internet connects people and servers across the globe, but by its very nature the internet does not enforce identity or provide any mechanism for accountability.
And so, the inevitable question: how can we create trust on the internet?
(6/24) The first answer was simple: we simply bootstrap off of the trust we have in the real world. Instead of trusting individuals across the internet, we rely on centralized actors that exist (and can be held accountable) in the real world.
Let's quickly look at an example.
(7/24) Say I want to sell something that you want to buy. Instead of figuring out how I can trust you to send me the money after I sent you the object (or vise versa), we both agree to trust a company like @eBay.
The reason we trust eBay: if things get bad, we can sue.
(8/24) The problem: what if the centralized actor isn't really trustworthy? Or what happens if the system used to hold them to account isn't able to hold them to account?
We can point to countless examples, but let's just skip to the big one: the Global Financial Crisis (GFC).
x.com/LogarithmicRex/status/1560502871329648641
(9/24) The GFC taught us a harsh but important lesson: sometimes trust just does not cut it. We need systems built on something stronger than trust.
Fortunately, in the very moments when the GFC was unfolding, we were given a path forward. Satoshi Nakamoto gave us @Bitcoin.
(10/24) The conversation around Bitcoin has always been about digital money, going back to the original conversations even before the genesis block.
But the underlying innovation that made Bitcoin so important had nothing to do with money... it had to do with trust.
(11/24) Bitcoin is made up of a network of anonymous, completely untrusted computers which coordinate to share the same internal state.
The system that keeps these computers in sync is called a consensus mechanism. Bitcoin uses Proof of Work (PoW) for its consensus mechanism.
(12/24) PoW relies on a verifiable and computationally expensive process to keep these computers in sync.
Importantly, PoW guarantees that cheating the system requires significantly more compute power than the entire Bitcoin network and is incredibly expensive.
(13/24) This is the idea behind crypto-economic security: a system is crypto-economically secure if cheating the system costs significantly more than the potential gain from cheating.
PoW achieves this via difficult, power intensive computation, but we have other solutions.
(14/24) The most prominent consensus mechanism is Proof of Stake (PoS). Developed after PoW, PoS is actually easier to understand and therefore is the best way to illustrate crypto-economic security.
So let's quickly walk through the specifics of how PoS works.
(15/24) To participate, every party must first put something of economic value into escrow. Once they've "staked" this capital, they are given permission to affect the system.
If a participant cheats, their capital is forfeited, usually destroyed (a process called slashing).
(16/24) In order for a PoS system to be effective, the amount of staked capital (or, more specifically, the amount of capital forfeited) must significantly exceed the total possible proceeds from cheating.
Put another way, it must be economically irrational to cheat.
(17/24) This dynamic is how crypto-economic security changes what trust means for a system secured by a consensus mechanism.
You never have to trust the other parties to be good actors, you just need to trust them to be rational actors.
(18/24) Let's return to our example from tweet 7 - I want to sell something that you want to buy, over the internet. Before Satoshi, this required a centralized facilitator.
But let's design a system that enables this transaction from peer-to-peer without trust... trustlessly.
(19/24) Our decentralized eBay will implement PoS, meaning we both have to put capital at stake in order to participate.
The item I'm selling costs $100 - decentralized eBay will require both you and I to deposit a greater amount into escrow. Let's say $250.
(20/24) Once our capital is escrowed, I can first send you the item. I don't need to trust you're a good person and going to send me money - I know with certainty that if you don't, you'll lose even more money than you owe me.
Or you can send me the money first - same dynamic.
(21/24) I have no idea who/where you are, but because of the capital we've put at stake, we're able to transact trustlessly over the internet.
Pulling this all together, crypto-economic security is a concept that helps us build systems that "don't" require trust.
(22/24) Before we go... you may be asking yourself, "why is it called crypto-economic trust? What's the crypto part?"
The answer: accountability. In order for crypto-economic systems to work, we need to apply punishments (and rewards) to individuals.
(23/24) Cryptography allow us to represent a digital identity that is completely independent from our real-world identity.
Thus, crypto-economic systems can still do the work needed to replace a trust with a rationality assumption (eg slashing) over the anonymous internet.
(24/24) In summary: crypto-economic security is a tool deployed to replace trust in an anonymous system. PoW achieves this by maximizing the compute cost, PoS by triggering slashing.
A system is secure when the cost of cheating is higher than the potential profit of cheating.