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Cryptoeconomics focuses on incentive structures that use cryptocurrencies and virtual currencies. This allows for financial outcomes for users of a cryptoeconomic system governed by computer code. Using financial cryptography (such as smart contracts), both the production and distribution of a given digital asset can be determined, allowing for novel systems such as decentralized digital currencies and decentralized autonomous organizations.
Bitcoin's proof-of-work system is widely regarded as the first successful cryptoeconomic mechanism. The incentive structure is programmed into the Bitcoin protocol using the blockchain, the rules of the system are transparent and immutable. In the Bitcoin network, miners use computing power to solve mathematical problems; if successful they are rewarded in Bitcoins, this acts as incentive.[dubious ] To compromise the blockchain a bad actor must control over fifty percent of the total computing power used for mining. Having additional miners therefore disincentivizes attackers; as they in turn would have to increase their compute to reach the fifty percent level. Importantly, utility gained from successful attack would be diminished as the attack would likely decrease the value of Bitcoin and specialized mining hardware. This financial loss for the attacker deters attacks on Bitcoin.
Ethereum started with the same cryptographic protocol design as Bitcoin. It is currently[when?] implementing a proof-of-stake protocol as a lower energy alternative to proof-of-work protocols. The new proof-of-stake protocol was designed in line with cryptoeconomic principles through creating financial penalties for individuals that attempt to perform malicious actions that destabilize the system.
State channels are mechanisms that allow digital transactions and data transfer to happen outside a Bitcoin-like blockchain system while maintaining the same cryptoeconomic guarantees. If disagreement arises on the state channel, these interactions can be brought back onto the blockchain for settlement. State channels are also referred to as a “layer 2 solution” as it has the option of reverting to the original blockchain, or the “layer 1”. With state channels, interactions can happen at zero cost while maintaining the security guarantees of a blockchain.