Mechanism Design

Description

Federico Ast:

1.

"The field of mechanism design can be considered as the “engineering” part of economic theory. The designer starts with a desired goal and then defines how a mechanism (a game) can be designed to attain it. Required is a systematic look at institutions and how they will affect the interactions between agents that are expected to act strategically in order to reach their own goals.

...

The Bitcoin blockchain was a working example of how a clever mechanism design could create an institution that effectively incentivized a distributed network of anonymous computers to reach consensus on a single state of a ledger. This new discipline combining cryptography and economic theory to create secure distributed networks came to be known as cryptoeconomics, which can be considered a branch of mechanism design.

In the wake of Nakamoto's pioneering design, the potential of blockchains for building economic and social institutions has been studied. Cryptoeconomic designers seek to engineer solutions that drive human behavior toward the desired goal. In this way, blockchain is a technology for creating and executing the types of rule-systems (i.e. smart contracts, decentralized autonomous organizations) that enable economic coordination.

Cryptoeconomic design can be applied to produce a wide variety of systems to reach desired outputs through incentivizing adequate behaviors. Cryptoeconomic systems provide an innovative way to coordinate behavior beyond governments or centralized mechanisms. As we shall see in the next section, it also has the potential to produce a legal order than can be defined as decentralized justice."

2.

"Existing decentralized justice systems (e.g., Kleros and Aragon) require users to deposit a cryptographic token to express their interest and availability in resolving disputes in the platform. A pre-defined number of jurors are randomly chosen among all those who deposited the tokens. Once they are drawn, jurors independently analyze the evidence and vote for the party they believe is right. Jurors are rewarded with cryptocurrency tokens if they vote like the majority and penalized with the loss of their deposit if they are incoherent with the majority.

In this way, by looking at their individual self-interest, jurors are incentivized to vote on the consensual truth about the dispute. The truth about the dispute is the focal point on which jurors tend to coordinate in order to collect the reward.

As in any cryptoeconomic protocol, decentralized justice systems have a number of game theoretical defenses against attacks by malicious agents who would try to abuse the system for their own interest. This results in a mechanism design structured in such a way that agents, while seeking their economic interest, produce a fair outcome without any ethical assumption on juror behavior.

Users seeking to attack the system (e.g., accepting bribes or casting a vote without proper consideration of the evidence) are likely to vote incoherently with the consensus majority, resulting on average in an economic loss. On the contrary, users behaving honestly (e.g., not taking bribes, taking proper care in assessing the evidence, etc.) are likely to vote coherently with the majority resulting on average in an economic gain.

In order to assess whether a dispute resolution system qualifies as decentralized justice, one may ask the following question: Does the mechanism design generate the economic incentives for the system to produce fair decisions without having to rely on moral considerations about the agent's behavior?"

(https://stanford-jblp.pubpub.org/pub/birth-of-decentralized-justice/release/1?)

Characteristics

Federico Ast:

"Decentralized justice systems built as decentralized autonomous organizations on blockchains such as Ethereum’s comply with the Weingast and Hadfield (2013) criteria for institutions able to produce rule of law:

The decision-making logic is publicly available. As open source projects, decentralized justice systems have their code deployed on a public blockchain which anyone can examine and replicate.

The institution resolves ambiguity. Decentralized justice systems typically have different courts addressing different types of cases (e.g., e-commerce, insurance, finance). Each court has a clear set of rules defining how evidence should be evaluated and how decisions should be made.

The decision-making logic is stable. Both the general procedural rules of decentralized justice systems, as defined in their mechanism design, and the specific rules of each court tend to be stable and not change often.

The institution gives predictable results to novel inputs. Court guidelines and jurisprudence accumulated in past rulings help predict how the system is likely to rule in a given case.

The institution is impersonal. As users interact with the decentralized justice system under a pseudonym (e.g., an Ethereum public address) the real identity of parties and jurors stays hidden. This contributes to decision-making on impersonal grounds.

The institution can produce new rules by soliciting information from users. Decentralized justice systems have a governance mechanism which enables users to make decisions about the evolution of the protocol, including the creation of new courts, the developing of rules for courts, setting adjudication fees as well as a number of decisions regarding software development.

These features guarantee that decentralized justice systems comply with two key features that we would expect from any justice system.

First, the system is secure in the sense that no agent can unilaterally and arbitrarily influence the decision-making process. The entire procedure (handling evidence, jury selection, jury incentivization and execution of ruling) works in a fully automated and immutable way thanks to blockchain code. This guarantees that the decision-making process will work exactly as written in the code and will not be affected by any agent with “special decision rights.”

Second, the system is managed by the community (typically defined by users holding the protocol cryptographic tokens). Any necessary changes in the procedure will have to be made through some type of voting procedure. Transparent to all participants in the network is the information regarding how rule changes are executed.

The combination of these features gives a decentralized justice organization the key features we expect from rule of law: equality of citizens, predictability and community governance. In order to assess whether a dispute resolution system qualifies as decentralized justice, one may ask the following questions:

Is the dispute resolution procedure encoded as a decentralized autonomous organization on a blockchain?

Does it comply with the features that Hadfield and Weingast require for the rule of law?

Does the system have a governance mechanism that members must use in order to make changes in how the system works?

Does any agent possess some “special rights” to introduce changes in the procedure?"

(https://stanford-jblp.pubpub.org/pub/birth-of-decentralized-justice/release/1?)

Discussion

Mechanism Design, Bitcoin and the Blockchain

Yongseung Kim:

"Building on the principles of game theory, mechanism design is a branch that focuses on how to structure the rules of a system so that individual participants, acting in their own self-interest, achieve outcomes that are desirable for the system as a whole. Rather than analyzing existing games, mechanism design creates systems where the incentives align individual actions with collective goals. This concept is integral to the design of decentralized systems like Bitcoin.

In Bitcoin, mechanism design is applied through the proof-of-work (PoW) consensus mechanism, ensuring that participants (miners) act in ways that secure the network. Miners expend computational resources to solve cryptographic puzzles. The first miner to solve the puzzle adds a new block to the blockchain and is rewarded with newly minted Bitcoin and transaction fees. This reward system ensures that miners are incentivized to follow the protocol because deviating from it, such as attempting to submit fraudulent transactions, would result in wasted resources without reward.

A key aspect of Bitcoin’s design is its defense against a 51% attack, where an attacker would need to control more than 51% of the network’s mining power to manipulate the blockchain. However, the enormous cost of obtaining this level of control, both in terms of hardware and energy, makes the attack impractical. Even if successful, the value of Bitcoin would likely plummet due to the attack, making it economically irrational. This aspect of mechanism design ensures that the best course of action for miners is to cooperate honestly with the network’s rules.

Another critical feature of Bitcoin’s design is its difficulty adjustment mechanism, which regulates how difficult it is to solve the cryptographic puzzles that secure the network. As more miners join the network and add computational power, the difficulty of the puzzles increases, maintaining a stable block time of approximately 10 minutes. This adjustment mechanism ensures that Bitcoin’s supply schedule remains predictable, and it prevents any single miner from dominating the network.

Through this carefully structured system, Bitcoin’s mechanism design aligns the interests of individual participants with the security and stability of the entire network. By making honest participation more profitable than malicious behavior, Bitcoin demonstrates how decentralized systems can achieve consensus and security without central control. This use of game theory and mechanism design principles highlights how well-designed incentives can lead to cooperative behavior even in trustless environments."

(https://medium.com/@deframing/the-meaning-of-monetary-economics-in-the-crypto-world-e7f89e60d3a3)