What Is Decentralization In Cryptocurrency?
Decentralization is one of the most common “buzzwords” getting tossed around in the cryptocurrency culture. The community uses the term as a way to signal the superiority of the coin they’re rooting for, while the ultimate knock-down is to call a crypto coin “centralized”.
But what makes a system decentralized?
In most cases, people conflate the former with a distributed system or the technology (e.g. blockchain).
Before we try to define it, we need to establish the root philosophy of decentralization.
Away From A Central Authority
Decentralization is a response to the problems of our current system.
That goes beyond technology, information, and currency. We’re living in a society that operates under the parameters of a centralized “protocol”:
- Government – has the power to introduce, maintain, and change the laws that govern us
- Banks – they’re in charge of our economy and the way our monetary system works
- Companies – their structure allows for one person (CEO) to change policies and make the final decision
- Markets – every uptick or drop in value creates a domino effect
In the past, there were many political attempts to take away control and power and redistribute it to the people. But it wasn’t until very recently that decentralization permeated our culture.
Even though crypto blew up in popularity in the last 5 years, the internet is still the biggest thing that happened when it comes to decentralization.
The hardware infrastructure is decentralized (if one PC or server stops working, it won’t bring down the system) but many people claim that the internet consumers use is centralized. The majority of the traffic goes through a few specific websites (nodes) like Google or Facebook. And the server owners can theoretically decline access (see China).
Nonetheless, the internet paved the way for cryptocurrencies.
It created an environment for different coins to foster, without an authoritative entity regulating and limiting them.
But the question remains, what makes a coin decentralized? What are the benefits and potential dangers?
Decentralized Currencies, Decentralize Economies
“A lot of people automatically dismiss e-currency as a lost cause because of all the companies that failed since the 1990s. I hope it’s obvious it was only the centrally controlled nature of those systems that doomed them. I think this is the first time we’re trying a decentralized, non-trust-based system.. “
Satoshi Nakamoto is one of the biggest pioneers of cryptocurrency and the creator of the protocol used in Bitcoin. He proposed a decentralized approach to transactions, through a peer-to-peer network. The creation of the blockchain achieved exactly that.
Still, there have been many attempts for a theoretical definition of decentralized cryptocurrencies:
Perhaps the most accurate one comes from the co-founder of Ethereum: Vitalik Buterin.
He suggested that there are 3 types of software decentralization:
Often, a coin can be centralized in some aspects (e.g architecturally decentralized but politically and logically centralized) and still be regarded as decentralized.
But let’s take a closer look.
1. Architectural Decentralization
How many parts, physical computers, of the system have to break before the network collapses?
When you have 1000s of different nodes handling transaction, there isn’t a central point of failure, meaning if one part collapses the system will remain intact. There’s interdependence within the system.
Here’s an example:
Let’s say you want to fly to a city that has 5 airports.
While you’re flying, it turns out that the airport you were supposed to land at originally, shut down. You still have 4 different airports you can safely use. That means you’ll arrive at your destination through a different airport.
That’s how a transaction works when a node is, for example, attacked.
2. Political Decentralization
How many people, organizations, entities control the hardware or the blockchain?
Political decentralization is a controversial subject among the crypto community.
Many argue (as we’ve already mentioned) that the internet itself isn’t really decentralized, since the majority of traffic is controlled by a couple of centralized entities.
The same argument is made when certain exchanges handle 90% of the transactions and volume of a coin. It comes down to social consensus and whether the people working on a project can be impartial.
Think of it like this:
Let’s say you own a product and you want to sell it all over the country.
But you realize that 90% of the roads are owned by one company and if that company decides to (unfairly) cut you off, you don’t really have any other options. That means you have to obey their rules.
In crypto, it means that if an exchange that handles the majority of coin’s transactions gets attacked, the coin itself is in danger (even if it’s architecturally decentralized).
A prime example is Nano and the Bitgrail double-spending error.
Bitgrail lost $150 millions worth of Nano, effectively tanking the price of the coin and compromising the integrity of the whole project.
3. Logical Decentralization
Perhaps one of the hardest concepts of decentralization.
Vitalik says: “…does the interface and data structures that the system presents and maintains look more like a single monolithic object, or an amorphous swarm? One simple heuristic is: if you cut the system in half, including both providers and users, will both halves continue to fully operate as independent units?”
Even though many people consider blockchains fully decentralized, in reality, they aren’t logically decentralized. They operate using the same data and an identical interface the users and providers have agreed upon.
To understand when a system is logically decentralized, it’s easier to ask when it’s centralized.
The typical structure of a traditional company or corporation goes something like this:
There’s the CEO at the top, the board, the different departments, the managers, the employees. Every decision that affects the company as a whole is been made at the top: CEO and the board of executives. The decision involves the different departments and the people working there, even if they didn’t get a vote.
On the other hand, if 10 people are working on a project and two of them decide to abandon it, unless the majority votes in their favor, the project will continue.
Pros And Cons of Decentralization In Cryptocurrency
The goals of decentralization are to “kill the middle-man” and allow for peer-to-peer transactions without a central bank or authority taking a cut.
Bitcoin, Ethereum, Litecoin, etc. were created as a viable alternative that would provide security, speed, and independence.
Minimal Transfer Fees and Speedy Transactions: Instead of waiting hours and get charged huge fees for every transaction, users receive or transfer their funds in minutes, paying a very small %.
Security: As we’ve already mentioned, architectural decentralization makes systems far more resilient to attacks, since there are no single-points-of-failure.
Transparency: Users can access every single transaction and timestamp in order to verify it. Plus, the transactions cannot be altered by anyone.
Even though decentralization is at the core of cryptocurrencies, there are some disadvantages.
Volatility. It’s not uncommon for BTC to fluctuate 20% or more in a single day. That can deter the average person from investing.
Illegal Practices: Anonymity allows for people to launder money or transfer funds coming from illegal activities. The infamous deep-web site “The Silk Road” would sell guns, drugs, etc. and would only accept BTC, making it very hard to track down the participants.
Mass scale adaptation: Cryptocurrency has the potential to replace traditional currencies. The only problem is that, right now, the majority of people don’t have the technical knowledge to enter the market and use the blockchain.
Of course, these are issues every new technology has to face in the beginning. It’s a matter of time, persistence, and educating the general public.
Is it possible for decentralized cryptocurrencies to stabilize the global economy?
Up until now, the US dollar is the dominant currency of the market. When the dollar suffers, the whole economy suffers. A prime example of that is the crisis of 2008. A decentralized currency system could, in fact, help maintain economic stability, even when there’s a recession.
1 BTC in the US is 1 BTC in Venezuela, 1 BTC in England, 1 BTC in India.
At the same time, a centralized model brings instability and heavily influences every non-economical affair. Instead, a decentralized currency that isn’t bound to the ups and downs of a single country is promising.
For a country, this means internal stability while maintaining the right to participate in the global economy, without being dependent on a centralized authority.
Even if it takes years for cryptocurrencies to take over, one thing is for sure:
Decentralization could impact the lives of millions of people and change the way we view money.
P.S- What qualities do you think a cryptocurrency has to possess to truly be decentralized? Comment below!