Using an evolutionary game approach, this paper studies different equilibria in the electronic marketplace, and demonstrates that electronic transaction through a TTP is an evolutionarily stable strategy. According to the evolutionary game analysis, people will gradually adopt this strategy in the electronic marketplace

Ba, Sulin

Stinchcombe, Maxwell

Whinston, Andrew

Zhang, Han

English

AIS Electronic Library (AISeL)

Association for Information SystemsAIS Electronic Library (AISeL)AMCIS 1999 Proceedings Americas Conference on Information Systems(AMCIS)December 1999Trusted Third Parties in the ElectronicMarketplace: An Evolutionary Game ApproachSulin BaUniversity of Southern CaliforniaMaxwell StinchcombeUniversity of Texas at AustinAndrew WhinstonUniversity of Texas at AustinHan ZhangUniversity of Texas at AustinFollow this and additional works at: http://aisel.aisnet.org/amcis1999This material is brought to you by the Americas Conference on Information Systems (AMCIS) at AIS Electronic Library (AISeL). It has been acceptedfor inclusion in AMCIS 1999 Proceedings by an authorized administrator of AIS Electronic Library (AISeL). For more information, please contactelibrary@aisnet.org.Recommended CitationBa, Sulin; Stinchcombe, Maxwell; Whinston, Andrew; and Zhang, Han, "Trusted Third Parties in the Electronic Marketplace: AnEvolutionary Game Approach" (1999). AMCIS 1999 Proceedings. 85.http://aisel.aisnet.org/amcis1999/85238Trusted Third Parties in the Electronic Marketplace:An Evolutionary Game ApproachSulin Ba, University of Southern California, sulin@rcf.usc.eduMaxwell Stinchcombe, University of Texas at Austin, maxwell@mundo.eco.utexas.eduAndrew B. Whinston, University of Texas at Austin, abw@uts.cc.utexas.eduHan Zhang, University of Texas at Austin, hanzhang@mail.utexas.eduAbstractUsing an evolutionary game approach, this paperstudies different equilibria in the electronic marketplace,and demonstrates that electronic transaction through aTTP is an evolutionarily stable strategy.  According to theevolutionary game analysis, people will gradually adoptthis strategy in the electronic marketplace.IntroductionElectronic commerce arguably provides betterefficiency for many types of business.  However, the lackof trust and familiarity with the new digital economymakes many people apprehensive about moving to theelectronic world.  Fear of security breaches, mistrust inthe products and services offered online, and the lack oflegal structures are major obstacles to the growth ofelectronic commerce.  Ba et al. (1998) argue thatinformation asymmetry poses serious challenges to thegrowth and wide adoption of electronic commerce.  Oneaspect of information asymmetry is security, and the otherone, perhaps more significant, is the product qualityuncertainty problem (Akerlof 1970).  Certificationauthorities (CA) such as Verisign have emerged in recentyears attempting to mitigate the security problem byhelping authenticate online traders (Froomkin 1997).However, the current structure of CAs does not addressthe product quality problem. An authenticated onlinevendor (i.e., he holds a valid digital certificate) can stillcheat consumers by selling counterfeit products orproducts that do not match up the promised quality.  Oneconsequence could be that in the electronic marketplacepeople only do business with well-established companies.Small or new online business entities consequently maybe forced out of the market, which obviously impedes theadequate growth of electronic commerce.  Using a gametheoretic approach, Ba et al. propose a new design oftrusted third parties (TTP) that not only issue digitalcertificate, but also protect the interest of online playersby disseminating trading partner reputation. They havedemonstrated that with the help of TTP - an extralegaleconomic incentive mechanism - the most profitablecourse for anyone wishing to do business online is to behonest.The question is, will people use the services of trustedthird parties?  How does the electronic market evolve?Will individuals continue their electronic transactionswithout the extra protection of TTPs, as most of thetransactions are done today, or will the transaction goingthrough a TTP become the dominant strategy in theelectronic market? This paper attempts to study thedynamics of the electronic market by identifying thedifferent equilibria of the market and the characteristics ofdifferent strategies using an evolutionary game theoryapproach.Research Model: Electronic Transactionswith and without TTPsIn the global electronic market, vendors and buyersrandomly match with each other and play a two-persongame.  Since a player can sometimes be a buyer and othertimes a seller, we model the game as a symmetric game.Building on the TTP model proposed by Ba et al (1998),we assume that each player has two strategies availablefor each business transaction in the electronicmarketplace: electronic transaction without going througha TTP, and electronic transaction through a TTP.In the electronic market, many products offered onlineare digital products, which, incorporating the uniqueadvantages of the electronic media, are mostly experiencegoods.  Their quality becomes known only afterconsumption (many information goods are purchased onlyonce).  Therefore quality uncertainty is a critical issuewith respect to digital products.  Conventional goods arealso an important component in the electronic market.For example, it’s more convenient to order books, CDs, orairplane tickets online than go to the physical stores oragencies.  However, all transactions in the electronicmarket, regardless of conventional goods or digital goods,have security and quality uncertainty problems.  TheTTPs help mitigate the problems by tying a player’sreputation to each transaction that he engages in.Business agents need to maintain and protect theirreputation if they want to continue their business in theglobal electronic market.  By obtaining a digital239certificate from a TTP, buyers and sellers get a guaranteeabout the quality of their transactions.  But buyers andsellers that do not use the services of TTPs may becheated.  For example, they may end up with counterfeitproducts or products that do not match up the announcedquality.  Therefore, in our model, the payoff a forelectronic transactions through a TTP is higher than thepayoff a′  for electronic transactions without a TTP:aa ′> .Let ETTP denote electronic transactions through aTTP, E electronic transactions without using the servicesof a TTP, then we have the following table with therespective payoff for each strategy.1Obviously, there are two Nash equilibria in this game:(E, E) and (ETTP, ETTP).  Which equilibrium will thetrading partners play?  We will use an evolutionary gametheory approach to analyze the situation.A fundamental concept in evolutionary game theory isthat of an evolutionarily stable strategy (ESS).  An ESS isa Nash equilibrium satisfying an additional stabilityproperty.  That is, an ESS should be able to withstand thepressures of mutation and selection once it becomesestablished in a population. (Maynard Smith and Price1973, Maynard Smith 1982).Mathematically, the set of pure strategies is denoted},...,2,1{ kK =  and the associated mixed-strategy set,}1:{ =∈=∆ ∑ ∈+ iKik xRx . Suppose that a smallgroup of mutants appears in a large population ofindividuals, all of whom are programmed to play the same(mixed or pure) incumbent strategy ∆∈x .   Suppose                                                          1    		 	   		      	 	   	 	       	 	  	 		   		 	  		also that the mutants all are programmed to play someother (pure or mixed) mutant strategy ∆∈y .  Thepayoff to strategy ∆∈x  is ),( yxu  when playedagainst ∆∈y .  A strategy ∆∈x  is evolutionarilystable if and only if it meets the following two conditions(Maynard Smith 1982, Weibull 1995):),(),( xxuxyu ≤ y∀ ,),(),(),(),( yxuyyuxxuxyu <⇒= xy ≠∀ .The first condition is a Nash equilibrium requirementand the second one is a stability requirement whichensures that the ESS x  can repel mutants such as y .  Ifthe conditions fail, then the strategy y  is said to be ableto invade x .Theorem: In the electronic marketplace, ETTP is anevolutionarily stable strategy.Proof.i) Is ( )0,1=x an ESS?If ( )0,1=x , this means consumer andvendor all will play E, then ( ) axxu ′=, . Nomatter what y is, ),(),( xxuxyu ≤  because( )aaCoa ′′≥′ , (Convex hull of aa ′′, ).Therefore, Condition 1 is satisfied,and ( )0,1=x  is a Nash equilibrium strategy.Suppose ( )1,0=y , then( ) ( ) axxuxyu ′== ,, .  However,ayyu =),( , and ( ) ayxu ′=, , but aa ′ ,so ),(),( yxuyyu > , then Condition 2 is notsatisfied.  Therefore, ( )0,1=x  is a Nashequilibrium strategy but not an ESS.!  a′  a′ a′  a′" a′  a′ a  a  #$ Payoff to a player following the row strategy against a playerfollowing the column strategy$ a > a′ > 0240ii) Is ( )1,0=x an ESS?If ( )1,0=x , this means consumer andvendor all will play ETTP, then axxu =),( .No matter what y is, ),(),( xxuxyu ≤because ( )aaCoa ,′≥ .  Therefore, Condition 1is satisfied.  Obviously, Condition 2 is alsosatisfied, because we cannot find a ∆∈y  sothat ),(),( xxuxyu = .  Therefore ( )1,0=xis an ESS.Our proof shows that with the payoff structure0>′> aa , ETTP is an ESS.  In other words,individuals who try to use ETTP do better than thoseindividuals who stick to the E strategy.  Currently, manyindividuals adopt the E strategy.  They may enjoy all theadvantages associated with electronic transactions,however, they may also experience problems arising fromthe security and/or product quality uncertainty issues.Therefore, trusted third parties come into the picture. Theconversion from E to ETTP basically is a learningprocess. At the beginning, only a small group ofpopulation may try to use ETTP.  They provide a newchannel to conduct electronic transactions, which can beconsidered a mutant strategy (ETTP). The informationabout the experience may be reported in the media, maybe discussed in the news group, or spread through word ofmouth.  If those individuals who try ETTP do less wellthan those individuals who stick to the E strategy, then theindividuals who use E have no incentive to modify theirstrategy and those who try ETTP will return to theincumbent strategy.  However, with the services of TTP,ETTP is a better strategy that leads to a higher payoff.  Sosooner or later, the mutant strategy, ETTP, willsuccessfully invade the electronic market.  Theindividuals who currently use E will eventually changetheir strategy to ETTP.ConclusionUsing an evolutionary game theory approach, weanalyze the electronic marketplace, and demonstrate thatelectronic transaction through a TTP (ETTP) is anevolutionarily stable strategy.  With the services of TTP,people can learn about their trading partners’ reputationbefore they conduct transactions.  Therefore, they do nothave to be restricted to businesses with a household name.They can go for small companies in the market as long asthese small companies have a good reputation.  In a sense,thus, TTPs help small or new companies to compete inthe electronic marketplace.  This research has strong,practical implications for intermediaries in the cyberspacewhich offer services to protect market participants fromopportunistic behaviors.  Currently there are severalintermediaries that disseminate online product or servicequality information.  For example, Bizrate(www.bizrate.com) – a site that rates online merchants indifferent categories – uses information from consumers tokeep track of merchants’ reputations; Carfax(www.carfax.com) provides vehicle history informationto people shopping for a used vehicle.  eBay(www.ebay.com) – an online auction site – provides aFeedback Forum that allows customers to leavecomments about their experiences with their eBay tradingpartners.  Even though these intermediaries deal with aspecific type of quality uncertainty problems, they couldbe treated as the operational business model related to Baet al (1998) and this research paper.ReferencesAkerlof, G. A. “The Market for Lemons: QualityUncertainty and the Market Mechanism,” QuarterlyJournal of Economics (84), 1970, pp.488-500.Ba, S., A. B. Whinston, and H. Zhang, “The Design ofa Trusted Third Party for Electronic CommerceTransactions,” Proceedings of the 4th AmericasConference on Information Systems, Baltimore, 1998, pp.269-271.Froomkin, A. M., “The Essential Role of TrustedThird Parties in Electronic Commerce,” In Kalakota, R.and A. B. Whinston (Eds.), Readings in ElectronicCommerce, Addison-Wesley, Reading, Ma, 1997. pp.119-176.Maynard Smith, J.  Evolution and the theory of games.Cambridge University Press, Cambridge, 1982.Maynard Smith, J. and G. R. Price, “The Logic ofAnimal Conflict,” Nature (246), 1973, pp.15-18.Weibull, J. W, Evolutionary Game Theory, The MITPress, Cambridge, Massachusetts, 1995.

Trusted Third Parties in the Electronic Marketplace: An Evolutionary Game Approach

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Trusted Third Parties in the Electronic Marketplace: An Evolutionary Game Approach

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