A Game Theory Perspective on the Impact of Ethereum Merger on Price

Economic incentives are extremely important in our world. Tax incentives, financial incentives, subsidies and tax rebates drive human behavior every day. Incentive behavior also applies to cryptocurrencies. In a world where community engagement is extremely important, protocol incentives play a key role in customer acquisition and retention.

Game theory plays a huge role in DeFi incentives. Game theory is a mathematical model of strategic interactions between rational players in games. Some of the most common games played in DeFi are symmetry vs. asymmetry, perfect vs. imperfect, cooperative vs. non-cooperative, synchronous vs. sequential, and zero-sum vs. non-zero-sum.

The Game of Ethereum 2.0

Game theory in Ethereum can be divided into two parts: player design and mechanism design. Actor design attempts to optimize actors’ decisions for maximum utility. Mechanism design is a bit like inverse game theory, designed for a specific intelligent population. Usually whales.

Participant design is very common in decentralized exchanges. There are three types of participants: exchange creators, token buyers and arbitrageurs. Exchange creators are the developers/leaders of the protocol, token buyers are the people who use the product, and arbitrageurs are the groups who want to profit from price differences in the protocol.

The most common game is between exchange creators and token buyers. Exchange creators want people to use their products, and token buyers want fast, efficient transactions and generate profits. What is the goal of Ethereum? Find the Nash Equilibrium. Nash equilibrium is the best outcome in the game. ETH’s Nash Equilibrium is where users provide liquidity and generate consistently high returns.

Lock the liquidity of ETH

The goal of any incentive program is to promote good outcomes, not bad ones. The positive outcome that Ethereum is trying to facilitate is that participants lock up their liquidity in the protocol. ETH is more liquid when users keep their liquidity locked, maximizing efficiency.

The problem with current liquidity pool models is inconsistency. The current mechanism for obtaining liquidity is through high APY. High APY attracts liquidity providers. However, as more people provide liquidity to the protocol, the APY becomes smaller as transaction fees are spread across more users. As APY decreases, users will pull their liquidity and find the next protocol.

Community participation is very important for all cryptographic protocols. More users = higher protocol value. The most common way for a protocol to acquire new users is through an incentive system with high rewards. It is common for protocols to offer high APY and airborne. It is reasonable to assume that most rational crypto actors are profit maximisers. They will flock to whoever offers the most rewards. However, most of them are only short-term solutions. Many protocols sacrifice long-term stability by capturing high short-term rewards for users. This is not sustainable practice.

Like most areas of life, some strategies work and some don’t. Ethereum is currently in a very primitive stage. Over time, however, we see which incentive structures work, and over the past month Ethereum has successfully merged its testnets Ropsten and Sepolia, which Goerly plans to do within two weeks. These merge tests are running smoothly and the core developers will be ready to deploy the real thing into mainnet.

Merger proceeds quietly

In Sepolia in particular, the merger was quietly taking place. Bear markets are really troublesome. However, with each successful test merge, confidence is slowly brought back to Ethereum without many realizing it. One piece of evidence is the recovered stETH peg. This means that macro elements will quickly become irrelevant as the Ethereum merger looms. If the inflation numbers improve, even more so, it will send the market into a frenzy.

For all of them, the biggest bullish reason is Ethereum developers hinting at a fixed date for the mainnet merger. The merger will take place on September 19. Now let’s talk about the possible hurdles of Ethereum’s pre-merger rally.

First, the market may bring more “surprises”. After all, anything can happen between now and September. However, if the Fed’s rate hikes eventually work, there is still hope for an improvement in the inflation data. A second bearish trigger could come from the ETH developers themselves. The possibility of another delay would put many investors in that position.

All in all, the best way to be bullish is to be cautiously bullish. Regardless, ETH is still very attractive today.

A Game Theory Perspective on the Impact of Ethereum Merger on Price

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/a-game-theory-perspective-on-the-impact-of-ethereum-merger-on-price/
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