The words of Crypto by the Bitsapiens team.

Game Theory

What Is the Game Theory?

Developed by John von Neumann, game theory is one of the most widely-used theories within the study of economics.

To put it simply, game theory is a way of creating a simplified interactive environment (a ‘game’) that allows researchers to model how people and entities will respond to certain actions.

Examples of Game Theory

One of the most famous game theory illustrations in action is the prisoner’s dilemma.

The prisoner’s dilemma is a game in which the participants have a zero-sum incentive to harm each other and a non-zero-sum incentive for not hurting each other.

It was conceived as a thought experiment that is a two-person non-cooperative variable-sum game.

Game theory can also be understood in the context of the digital assets marketplace.

For instance, the Bitcoin market can be described as two types of investors, the holders (i.e. long-term investors) and the opportunists (i.e. short/medium-term investors).

In general, holders will buy during low-volatility periods.

Opportunists will end such periods and trigger volatility when they enter the market.

Thus, each type of investor has two strategies they can use, depending on the behavior of the other type of investor.

All are acting in their interests, competing for asymmetric rewards while cooperating to grow the overall value of BTC.

This is a perfect application for game theory as it observes two separate groups of persons reacting and responding to the behavior of the other group — an ideal application for game theory.

Useful Terms in Game Theory

Any time we have a situation with two or more players that involve known payouts or quantifiable consequences, we can use game theory to help determine the most likely outcomes. Let’s start by defining a few terms commonly used in the study of game theory:

  • Game: Any set of circumstances that has a result dependent on the actions of two or more decision-makers (players)
  • Players: A strategic decision-maker within the context of the game
  • Strategy: A complete plan of action a player will take given the set of circumstances that might arise within the game
  • Payoff: The payout a player receives from arriving at a particular outcome (The payout can be in any quantifiable form, from dollars to utility.)
  • Information set: The information available at a given point in the game (The term information set is most usually applied when the game has a sequential component.)
  • Equilibrium: The point in a game where both players have made their decisions and an outcome is reached