Game Theory + Blockchain = Reliable Banking?
Today, the banking sector is by far different from what it once was. In a bid to increasingly facilitate the type of services that customers demand, modern banks now need to gain access to a broader array of technology and methods of interaction as well as transaction. Although this may appear like it could cause more inefficiencies in the banking system, it can streamline the sector. This is owed to the innovations in blockchain technology, and getting inspiration from the game theory.
Banking as a Service (BaaS)
Modern banking is the kind that you can access on your mobile device when you make a deposit with your photo or when you transfer funds using Venmo, traditional functions based on the BaaS (Banking as a Service) model. This gives consumers the chance to carry out regular banking operations without the need to find the ATM closest to their locale or needing to know the exact time their branch opens. This new BaaS model has made banking to get representation from a myriad of features typically facilitated by third-party fintech firms.
These features are integrated into a banking system unified under one brand. This flexibility can operate beyond integrating mobile banking applications. BaaS presents a level of flexibility that enables banks to integrate blockchain initiatives to tackle the problem plaguing the financial sector. According to John Nash, this issue is best represented by the prisoner’s dilemma based his contribution on game theory.
Game Theory, Prisoner’s Dilemma, and the Blockchain
Game theory is an aspect of mathematics that focuses on strategic interaction between rational actors. Prisoner’s dilemma is the most renowned thought experiment in game theory. According to the experiment, there are two prisoners brought for questioning for suspected participation in separate crimes similar in nature. The sentence for both crimes is three years. But, the police suspect both prisoner A, and B, collaborated to commit a more serious crime which carries a four-year sentence.
If a police offer a deal and one prisoner chooses to confess to committing the more serious crime going on to implicate the other prisoner, then the one who confesses will get a lighter two-year sentence. While the other prisoner gets a harsher eight-year sentence. This happens only when one prisoner confesses, while the other denies. If both confess, then they will be given the standard four-year sentence.
As is obvious, the most practical option for both prisoners here is to deny any involvement in the more serious offence and get a three-year prison sentence. But, since neither prisoner can really be sure of the strategy the other is employing, both individuals will opt to confess. Note that this is based on pure logic; if one prisoner confesses while the other does not, the one who doesn’t confess runs the risk of doubling their prison time. Confession is the perfect option they have in their circumstances something that Nash observed as a suboptimal equilibrium.
The illustration above is the exact situation the banking sector is in right now. Trust among the key financial players is nearly non-existent. There is no transparency when it comes to conducting transactions. This leads (based on the thought experiment) to a suboptimal equilibrium reached in the financial sphere. This scenario can cause a systemic inefficiency which in turn can incur costs because regular audits will be required.