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The Legitimacy of Game Theory, Network Effect & Lindy Effect in Bitcoin

When asked why they think Bitcoin is the future of money, enthusiasts often mention Game Theory, the Network effect, and the Lindy effect as some of the hypotheses that supposedly back the rise of the flagship cryptocurrency. Bitcoin advocates believe these theories justify why cryptocurrency is touted as the future of money. So what are these theories, and how do they apply to bitcoin?

Game Theory, and why Bitcoin is a Schelling point?

Game theory was essential in the development of bitcoin and is one of the reasons the cryptocurrency has endured for more than a decade, despite repeated attempts to disrupt the network.

It is essentially a way of applied mathematics used to understand human behavior based on rational decision-making. Because the “game” is meant to be an interactive environment, participants are more likely to act logically when responding to game rules or the influence of other players.

Game theory is essentially a method of applied mathematics used to understand human behavior based on rational decision-making. Because the “game” is meant to be an interactive environment, participants are more likely to act logically when responding to game rules or the influence of other players.

The concept was first conceived in economics to analyze business, markets, and consumer behavior but has since been widely applied to various disciplines of study. As a result, game theory models may be used to investigate the probable behavior of interacting agents and the consequences of their actions under specified conditions.

When applied to bitcoin, game theory models are critical for developing a safe and trustless economic system, such as Bitcoin’s. Bitcoin was created as a Byzantine fault-tolerant (BFT) system as a consequence of a successful marriage of encryption and game theory.

The general use of game theory is to model and study how humans act and make logical decisions. As a result, while building a distributed system, such as Bitcoin, game theory models are always considered.

Schelling Point, also known as a Focal Point, is a core concept in Game Theory established by American economist Thomas Schelling in the 1960s.

”People can often concur their intentions or expectations with others,” Schelling wrote, “if each knows that the other is trying to do the same.”

A Schelling Point is a solution or plan of action that individuals agree on without communicating with one other. The more individuals who see a Schelling Point and interact with it or take action due to it, the more powerful the Schelling Point becomes. The strength of a Schelling Point is also determined by how unique it is. If a Schelling Point provides a solution to a problem that cannot be achieved in any other manner or a method of expression that has no genuine alternative, it can act as a magnet, attracting the majority of those who find it.

Bitcoin supporters believe the coin has the potential to become the most powerful Schelling Point in history, as no asset is known apart from gold. It has the potential to attract such a diverse and global myriad of users, all of whom are looking for a solution to the same predicament: how can one safeguard savings from the debilitating effects of inflation and currency devaluation while avoiding the hassles and headaches of physical ownership?

Another feature of a robust Schelling Point is that the more attention it receives, the better it becomes because attention amplifies the signal and increases its distribution. Bitcoin fits perfectly within this paradigm as the value of Bitcoin moves. As it gets more attention and users gravitate toward it, the network becomes even stronger and even more robust and widespread. This growth, in turn, generates more attention, and the cycle repeats.

Gold is also a Schelling Point. Nobody needed to communicate to decide that gold was suitable for the job; instead, all other elements were rejected via reasoning or experimentation. Silver, for example, had a good run, but it wasn’t rare enough to be competitive.

Bitcoin is the first asset to provide a store-of-value equation as a digital equivalent to gold while completely bypassing the periodic table. However, this does not imply that the Bitcoin network is fictional or unreal.

It is incredibly tangible and real in the form of a globally proactive user community, a globally dispersed infrastructure unaffected by any single point of failure, and a global collective consciousness of brilliant programmers continually upgrading the technological framework.

This is why Bitcoin is often touted as the dominating Schelling Point of the Information Age, which would imply that it is the most effective Schelling Point of all time.

The Network effect of Bitcoin

Another factor, which Bitcoin experts believe the cryptocurrency benefits from, is the Network effect. A network effect is an economic impact that defines a product or service that adds value to the network as more people join it. When a network effect exists, each new user that joins the network adds value to the product. This, in turn, encourages more users to join the network, increasing its value, and so on.

Bitcoin offers a number of very desired characteristics, as well as a powerful network effect. Miners help to secure the network and have a lot of liquidity to keep their operations running. But suppose another network is established with the intention of serving a similar use case as Bitcoin. Miners may receive greater payouts, but they will not have the same liquidity to exit their positions. They might take a chance and hope for better liquidity in the future. Alternatively, they may continue mining bitcoin with a high degree of assurance that they would be able to stay afloat. This is how the network effect works. Even if the alternative is technologically superior or offers greater benefits, switching isn’t always a good idea.

Bitcoin can beat the paper money Lindy effect

The Lindy effect is a theoretical phenomenon in which the future life expectancy of some non-perishable items, such as a technology or a concept, is proportional to their current age. Thus, the Lindy effect argues that the longer something has persisted to exist or be utilized in the present, the longer its remaining life expectancy is expected to be. Basically, both the Schelling point and the Lindy effect can be considered a subcategory of the network effect.

So, according to the Lindy Effect hypothesis, if an idea survives for ten years, its predicted future life period is similarly ten years. Bitcoin has been around for ten years and has many detractors. The Lindy Effect hence suggests that Bitcoin will survive another decade.

And longevity has proven to be great for Bitcoin over the years. From bare pennies in 2009, the value of a single Bitcoin has risen to more than $48,000 today. Prices are expected to rise even further over the next ten years.

However, in terms of money, the U.S Dollar is the perfect example of the implications of the Lindy effect. From a broader viewpoint, the present scenario can be dubbed as the Fiat Lindy effect. However, monopolies don’t stay monopolies, and the lindy effect theory suggests the same. Innovation breaks open the Lindy effect, and Bitcoin is currently doing just that.

We have seen this through our monetary history, which has evolved a lot over the past century alone. Now, like in the case of Bitcoin, there is a lot of competition when it comes to fiat, but since the dollar is the world reserve currency, it effectively functions as the global monopoly of money.

The many restrictions of the fiat currency Lindy Cycle are precisely the issue that Bitcoin seeks to address. It enables us to develop non-sovereign money in the digital world, which is a revolutionary achievement in itself. Furthermore, when compared to gold, Bitcoin has an even more limited supply. All of these factors combined demonstrate why Bitcoin enthusiasts back the legitimacy of this hypothesis.

The shift to the next generation money protocol has been ongoing for more than 12 years now, and there will certainly be many more years of adaptation forthcoming. However, it is becoming increasingly obvious that Bitcoin is the indisputable Schelling point, having benefited from the network effect and breaking the existing fiat Lindy effect. 

Disclaimer: Cryptocurrency is not a legal tender and is currently unregulated. Kindly ensure that you undertake sufficient risk assessment when trading cryptocurrencies as they are often subject to high price volatility. The information provided in this section doesn't represent any investment advice or WazirX's official position. WazirX reserves the right in its sole discretion to amend or change this blog post at any time and for any reasons without prior notice.