Game Theory Is The New Business Model

Business models are aplenty — direct sales, subscriptions, advertisements, etc. Although these business models are easily understood today, they were significant innovations in how business could be done in their time. However, I believe that the fundamental idea which dictates these innovations has not changed at all — it is the question: "Why would the customer prefer this?"

This question made entrepreneurs realize that customers would rather pay a monthly subscription for software instead of a one-time payment. It made entrepreneurs realize that customers would tolerate advertisements in exchange for getting the service for free. Any innovation in business models fundamentally boils down to that question.

However, decentralized apps and blockchain protocols are fundamentally driven by a different question. Instead of a business -> customer relationship, blockchain protocols are used by multiple different parties who each have their own incentives. Instead of only having to think what a customer wants, entrepreneurs today need to think about what every party in the system wants, and how to devise a solution which aligns everyone's incentives — this requires a deep understanding of Game Theory.

For decentralized applications and blockchain protocols, we need to ask "Why would every party in the system prefer this over the existing system?". As an entrepreneur, if you cannot answer it, you will need to tweak your system and incentive structures such that the question becomes answerable.

Often times, it is simple to theorize why a blockchain protocol would make sense if everyone is using it — improved efficiency, more trust and transparency, etc. However, it usually difficult to answer why each party will adopt the protocol in the first place. For example, supply chains on the blockchain seem to make sense because there could be autonomous payments as the goods pass hands along the supply chain, drastically reducing friction and improving accountability. However, it is actually the case that parties in the supply chain have an incentive to withhold payments as long as they can. If there is no penalty, a supplier would rather pay later than earlier. So one could theorize that a system which penalizes suppliers who pay late will align every party to pay on time and achieve emergent efficiencies, but in reality there is absolutely no incentive for suppliers to opt-in to such a system in the first place. This is classic Game Theory — the state of supply chains today are at Nash Equilibrium, where suppliers are acting in their own self-interest even though acting in the collective interest of the group would be more beneficial to them.

Another example is medical records on the blockchain. One could theorize that medical records on the blockchain will create great efficiencies, as there is consensus across every hospital and every clinic as to what the patient's medical history is — no more missing medical information or wasted time communicating between clinics. This makes sense as a system, but what are the incentives for each clinic and hospital to upload each of their patient's information to the blockchain? The incentives for each party are not clear, and hence there is stasis.

This is why an understanding of Game Theory is crucial in building and architecting blockchain protocols. Instead of merely having to think about the customer, entrepreneurs now need to imagine the system as a multi-player game and tweak the incentives such that every party is aligned. Over the next few years, we will see a lot of innovation in the Game Theory and the incentive structures across different industries. The blockchain protocols where there is true alignment of incentives will be the ones that succeed.