The Psychology of Incentives on Blockchains

Decentralized networks like blockchains have the potential to solve complex problems by incentivizing individuals to contribute their specialized knowledge and skills to achieve a common goal.

For example, the challenge of quickly finding the right employee can be solved by incentivizing individuals to disseminate the job description to the most appropriate people in their circle of professional acquaintances. As more and more people learn of the job description through these network effects, the chances that the right and motivated candidate hears about the job become larger and larger. Ultimately, such a decentralized network of referrals would result in the optimal candidate coming forward in a relatively short period of time compared to what a dedicated HR person could achieve on his or her own.

This mechanism can work in a variety of domains, and relies on the principle that the promise of reward motivates individuals to contribute to the network. However, the psychology of incentives is far from straightforward. In fact, a whole academic field of economics and its rebellious child, behavioral economics, are dedicated to studying how people respond to them.

At nCent Labs we are at the cutting edge of applied incentive research. Over time we will share some of our work in exploring the most important psychological determinants of how people respond to incentives, and how these should change the way we think about creating decentralized networks.

The complex psychology of monetary incentives

The most obvious way of incentivizing people is promising them money in exchange for their contributions. However, academic research and everyday life suggest that people’s response to monetary incentives is nonlinear. In other words, the effort people invest in a task does not always increase in proportion to how much money they make.

First, trivial monetary incentives can backfire by insulting people and reducing the amount of effort they’re willing to put into a task. The reason is that people not only observe the magnitude of the incentive, but also ponder its social meaning: A tiny monetary incentive could be construed as a message that a person’s work is worth very little. As a result, trivial monetary incentives can result less effort than giving no monetary incentive at all.

Next, very large monetary incentives can also backfire by stressing people out and reducing their ability to perform well. For example, the behavioral economists Dan Ariely, George Loewenstein, and their colleagues gave different amounts of money to people in rural towns in India for performing a variety of tasks that involved creativity, motor skills, and memory. In most cases, people who received large incentives (as high as full monthly incomes in that region) performed worse than those who received less money. In general, high payments create more stress to perform well, and at extreme levels this can hurt performance.

Moreover, money can change the psychological meaning of an interaction. Money can be detrimental in situations where people were already doing something out of social obligation or social norms. To illustrate this point, consider the case of daycare centers in Haifa, Israel that were trying to reduce the number of parents who showed up late to pick up their children. Parents’ tardiness was costly to these daycare centers because employees had to stay late with the children. So, the centers instituted a monetary fine for tardy parents with the logical expectation that this fine would deter late pickups. As the figure below shows (reproduced from the academic paper on this study), to the chagrin of the daycare centers the proportion of late pickups increased! The reason this monetary (dis)incentive backfired was because it replaced a social norm. Before the fine, parents tried to get to the daycare center on time to pick up their kids as a way of honoring their commitment to the daycare center owners. The fine suddenly put a price tag on being late, and it wasn’t a very high price. Instead of disincentivizing tardiness, the moderate fine conveyed that being late really wasn’t all that bad.

Parents’ late arrivals in daycare centers increased after introducing a monetary incentive to show up on time (Gneezy & Rustichini, 2000)

The larger point is that people respond to the meaning they impute unto monetary incentives rather than to the monetary incentives themselves. Sometimes people interpret a monetary payment as a signal that the task is not worthwhile or that their effort is not valued, and at other times people interpret the incentive as a signal that the task is beyond their capabilities. In those cases, monetary incentives are likely to backfire.

Finally, getting money in exchange for effort creates a mindset of costs and benefits. To illustrate what this means, consider the psychological difference between the way we act in our social relationships and in our work relationships. We usually don’t nickel-and-dime our friends for every favor we do or every meal we buy for them. But in our work, we closely monitor how much effort we put into every task and we frequently ponder whether we are paid enough for our toil and sweat. At times, we do less because we do not believe that we are being justly compensated.

This point is illustrated in an experiment done by Dan Ariely and his colleague, in which people were given either candy or cash for doing a task that required effort and patience (using a mouse to drag digital gray balls from one side of the computer screen to the other side of the screen). Participants’ effort was sensitive to the amount of cash they received, with more money leading to more effort. But participants worked just as hard for a few pieces of candy as they did for a lot of candy. Participants who received money closely monitored their effort relative to how much money they got whereas participants who received candy did not engage in this cost-benefit monitoring.

What does all this mean for incentivizing decentralized networks?

To be effective, monetary incentives must not be too high or too low, cannot replace an existing social norm or social obligation, and cannot be understood as a signal that the task is not worthwhile. In certain situations, non-monetary incentives may be more effective than money in motivating action within decentralized networks.

In contrast, money can be an effective incentive when people interpret it as a signal that their work is valued. Money can also be effective when the problem requires people to increase their current level of effort because people are sensitive to the magnitude of a monetary incentive (so long as it’s not exceedingly high or low).

Beyond these points, the psychology of incentives highlights the importance of understanding the context of each and every situation in which decentralized networks are employed.

Decentralized networks enable customized applications to be developed to solve a wide variety of problems in business, government, social activism, space exploration, education, and health.

Each of these areas, and each of the specific problems in these areas, will have different social norms, conventions, and idiosyncrasies that would change the psychological meaning that people impute unto monetary incentives, the standards for what is considered “high” and “low” amounts of money for a given level of effort, and the degree to which people closely monitor the effort they put into a task in exchange for money. Designing monetary incentives effectively requires knowing the context well. Experimenting on a small scale with different incentives can also be helpful, if the situation allows.

Below are some interesting reads from the academic world — we made sure that these are accessible and insightful for non-academics. In future articles in this series, we’ll explore non-monetary incentives, the uncertainty inherent in incentives in decentralized networks, and the types of motivations that incentives can tap into.

To learn more about our work, email me directly at [email protected]. To stay in the nCent loop, hear me tweet and join our international telegram channel.

References

Heyman, J., & Ariely, D. (2004). Effort for payment: A tale of two markets. Psychological Science, 15, 787–793.

Gneezy, U., & Rustichini, A. (2000). A fine is a price. Journal of Legal Studies, 29, 1–17.

Ariely, D., Gneezy, U., & Loewenstein, G. Mazar, N. (2009). Large stakes and big mistakes. Reviews of Economic Studies, 76, 451–469.

Liu, P. J., Lamberton, C., & Haws, K. L. (2015) Should Firms Use Small Financial Benefits to Express Appreciation to Consumers? Understanding and Avoiding Trivialization Effects. Journal of Marketing, 79, 74–90.