Ever thought of a Token Model as a Game? Token Architects call it Mechanism Design.

In simple words, the theory of mechanism design analyses how institutions and social organizations should be structured in such a way that they produce the desired effects. This theory, which was even worth a Nobel prize, has infinite possibilities of application. One of most obvious and direct applications of mechanism design is token sales.

More in detail, mechanism design is the art of designing the rules of a game to achieve a specific desired outcome. While game theory takes the rules of the game as given and helps us determine outcomes based on them and the strategic interaction of players, mechanism design uses the framework of game theory with incomplete information and asks about the consequences of different rules and chooses the game structure rather than inheriting one. Therefore, in the context of token economics, “tokenomics” in short, mechanism design allows us to look at the overall design of the network and participants’ incentives in order to influence the outcomes of the network game in addition to determining the optimal design of the network itself.

To set the rules of the game, we first need to define the environment we are considering and the actors participating in the game. This involves describing who the participants are, the set of potential decisions, the set of preferences for each participant, and any private information that they may hold to understand information asymmetry. The utility of a well-designed token will create powerful incentives that drive activity in the network; therefore, understanding how a token’s utility actually drives behavior is a critical aspect of any token design process.

Market design involves designing a market structure to achieve a set of desirable properties. Generally speaking, exchange environments need to be designed in such a way to facilitate efficient outcomes. The design of the market needs to allow enough potential transactions to be available at once so that a particular type of agent does not possess the power to influence the market on its own. Additionally, there needs to be enough time for offers to be made, accepted, rejected, and for transactions to be carried out. Finally, it should be safe for participants to reveal their preferences truthfully.

Formally, a mechanism involves a finite number of players and a set of potential social decisions. Players possess private information, also referred to as signals or types. Each individual’s type can represent his/her preferences, but that same type can also be used to encode other types of private information. There may also be a common prior, which is a probability distribution over types. Given that the optimal decision will inevitably depend on individuals’ types, a decision rule is also typically designed, mapping types to social decisions. In such ecosystems, a transferrable good (a token, for instance) may be used to incentivize players, usually by capturing the externalities that their actions impose on others, then leading to a social choice function with monetary and non-monetary components. The mechanism can be deterministic, always outputting the same decision and payouts for a given, or can be probabilistic according to some rule.

The biggest challenge is that mechanism design usually relies on a trusted intermediary to guarantee correctness and privacy, the latter being something that blockchain itself cannot ensure. There are also typically more factors to specify in a crypto decentralized setting than in traditional applications of mechanism design to centralized settings, were a central agent is in charge of running the mechanism. In a decentralized setting, an algorithmic agent may have to be created in order to run the mechanism, with all the implications that this brings for the monetary policy of the blockchain protocol. For example, questions about token burning and minting processes require close attention, as these kinds of decisions can affect a relevant component of the players’ utility.

Even if only a few entrepreneurs and developers are nowadays applying mechanism design theory when engineering new token architectures and even fewer academic economists have started to study its properties in relation to blockchain protocols, I am confident that the enormous opportunities brought by its application to tokenomics will become clearer to all experts in this field.

By Eloisa Marchesoni.

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