In these lessons, we're looking at the seven design principles underlying blockchain. Our third principle is value as an incentive. What does this mean? Well, the way blockchain is set up, it aligns the incentives of all stakeholders. It uses a token of value, like a bitcoin, to promote behavior benefiting the blockchain as a whole. The behavior also builds a person's reputation. Satoshi Nakamoto programmed the software to reward people who work on it and use its tokens. When everyone has a stake in the network, people make sure that it stays healthy. The problem it solves is a destructive incentive system. In the first era of the Internet, power was concentrated in large corporations. They could extract enormous value from the system making them more powerful, still. Large banks nearly broke the financial system because their leadership was rewarded for risk-taking and short-term thinking. Remember, in 2008 that's how the incentives were set up. The quarterly report was king. This caused a host of bad behaviors including predatory loans targeting the poor. Likewise, large dot-coms pretended to offer something for nothing. They advertised "free" services in retail, search, and social media, and the real unseen cost was user data, which they exploited to boost revenues. But whenever these firms get hacked, consumers are left to deal with a stolen credit card and their bank account information. The blockchain breakthrough is in using programming to incentivize good behavior. Satoshi recognized that people act in their own self-interests. So, he needed to harness that self-interest to build and protect the blockchain. One of the things he had to defend against was a so-called Sybil Attack. That's when a node forges multiple identities making one person seem like a bunch of different people. This makes the peer-to-peer network less trustworthy. You don't know whether you're dealing with three parties or one party using three identities. On the other side things, it also makes it much harder to prove you are who you say you are. To fight Sybil attacks, Satoshi didn't make it impossible to acquire extra identities. Instead, he made it so that there was no benefit in doing so. He programmed the source code so that no matter how selfishly people acted, their actions benefited the system. The resource requirements of the consensus mechanism, combined with bitcoins as a reward, compelled participants to do the right thing; to act with integrity. Sybil attacks no longer make economic sense. When miners create a block and link it to the previous one, the miner who completes the block first gets a set quantity of bitcoins for their efforts. Satoshi's protocol rewarded early adopters handsomely with bitcoins. For the first four years, miners received 50 bitcoins for each block. Every four years the reward per block is halved, 25 bitcoins, 12.5 bitcoins, and so on. Because they now own bitcoins, the miners are invested in the platform's long-term success. So, they buy the best equipment to run mining operations, spend energy as efficiently as possible, and maintain the ledger. Bitcoins also represent partial ownership of the blockchain itself. It's not just incentive to mine and transact with others, by owning and using bitcoin, participants are financing the blockchain's development. Here's an example of how making a selfish choice benefits the network, and it involves miners. Every so often, different miners find two equally valid blocks of equal height. This means the rest of the miners need to choose which block to build on next. They generally pick whichever they think will win rather than building on both. Otherwise, they'd have to split their processing power and all the electricity they're providing between these forks. Well, that's a losing strategy. The longest chain represents the greatest amount of work. So, participants choose it as canon. This solidifies the blockchain and keeps everybody on the same page, all because every miner wants to back the right horse. By acting in their own self-interests, miners serve the peer-to-peer network, and that affects their reputation. Before blockchain technologies, people couldn't easily leverage the value of their reputation online. Even offline our identities are multifaceted, and our reputations are different among different groups. We keep documents to prove our ID, like passports and our driver's license, but on the blockchain, your identity is inherent and recorded with your actions. The Bitcoin blockchain also preserves value by programming its monetary policy right into the software. This means the currency is more secure. Not only is it immune to counterfeiting and theft, but it also resists inflation. Satoshi kept the supply of bitcoins at 21 million, to be issued over time. The current rate of mining is six blocks per hour. Since the amount of bitcoins awarded for mining a block is halved every four years, those 21 million bitcoins should all be in circulation around the year 2140. This should guard against hyperinflation and currency devaluation. Currencies are not the only asset, we can trade on a blockchain. Sky's the limit, really. New financial instruments are possible, from proof of asset authenticity to proof of property ownership. There might also be blockchain and bitcoin applications for virtual worlds such as the ones described in books like Neal Stephenson's Snow Crash, or Ernest Cline's Ready Player One. Unlike fiat currency, each bitcoin is divisible to eight decimal places, and this lets users combine and split value over time in a single transaction. That means that users can set up smart contracts to measure the use of the service and eke out tiny fractions of payments or micro-payments. That kind of metering is great for the Internet of Things when the physical world becomes smart and starts exchanging information and doing transactions. So, what are the implications of using value as an incentive? With blockchain, people have a financial incentives to collaborate effectively and to create just about anything. If your reputation is valuable and trackable, online discussion groups won't be inundated with trolls. Bad behavior will cost too much. Home owners could receive real-time payments for using solar panels to generate sustainable energy for the network. Software developers on open source projects could pay contributors for acceptable code. Imagine all that and more.
