DeFi Game Theory

Understanding game theory

Game theory studies interactive decision-making, where the outcome for each participant or "player" depends on the actions of all. If you are a player in such a game, when choosing your course of action or "strategy" you must take into account the choices of others. For a classic example, see the prisoner’s dilemma.

In order to fully understand the game theory of D3 Protocol, let us first take a look at how OHM applied game theory to their protocol. There are three actions that a user can take (stake, mint, or sell) each assigned a different value as per the prisoner’s dilemma.

Game theory in the context of DeFi

Staking provides high yield returns taking OHM out of the market and stabilizing the price. This benefits the protocol and is assigned a value of 3. Minting provides discounted OHM and helps the protocol to accumulate liquidity. This, though still very beneficial to the protocol, is assigned a lower value of 2. Selling has a negative effect as it drives the price of OHM down for all holders, and is therefore assigned the lowest value of 1.

This is where the now famous (3, 3) comes from. When both players act within the green boxes you get a net positive outcome. The yellow boxes offer a net neutral outcome (one action negates the other). And the red box is the only net negative scenario for both player and protocol.

Flaws in the OHM game theory

8 out of 9 outcomes are either positive, or neutral, and only 1 is net negative. The players that take the most positive action receive the biggest rewards. Therefore, the odds are in favor of a positive sum game. However, as we have seen with both OHM and TIME, this game theory falls apart, largely due to unrealistic APYs, out of control inflation, and irrational human emotion.

D3 Protocol builds on the original OHM innovation, adding multiple additional layers designed to take DeFi game theory to never before seen levels, and in doing so, offering realistic, sustainable, and more consistent APYs, and addressing the inflation issue, whilst also delivering an auto-investing and auto-compounding treasury. The next sections cover these innovations in detail.

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