If you have been following cryptocurrencies, you will hear that it is underpinned by a technology known as the blockchain. Though a buzzword in itself, part of the excitement about the technology has been about decentralization.
The cryptocurrency revolution has not been free from controversy and regulatory setbacks. For starters, the crypto movement poses a threat to the current financial system, which is controlled by governments using the central banking system as proxies.
The decentralized nature of cryptocurrencies offers a glimpse of a financial future free from government or central bank control. In essence, the issuance & governance of money, as well as the provision of financial services, will not be a role reserved for an elite few. It is much like political freedom, where one country attains its sovereignty and right to rule itself.
The crypto revolution, spearheaded by cypherpunks, is on the brink of rewriting our financial ecosystem. But before then, we have prepared an in-depth article on decentralization.
What is decentralization?
Decentralization is the process by which the decision-making powers of an organization or ecosystem are shifted away from a central authority and distributed equally (or not) to all the members of the organization or ecosystem.
Decentralization concepts have found their way in business, political science, money, technology, public administration, law, economics, and management services.
Decentralization was born out of the need to address challenges that arose as a result of centralized systems. In government systems, decentralization has been called for because it could solve problems such as economic decline among others. The majority of centralized governments have fallen due to pressure from the international community.
For the purpose of this article, we look at decentralization from the perspective of blockchain technology and cryptocurrencies.
We live in a world in which we use money, notably fiat currency, issued by governments via central banks. The currency represents the strength or weakness of a country’s economy. But it does not paint a full picture as the power to make political and economic decisions are left in the hands of an elite few.
Some of these decisions have been bad, to say the least, and they have come back to haunt those at the bottom of the social ladder. Who said that the creation and maintenance of money is a task assigned to a select few? Whoever does the same is charged with a criminal offense.
Blockchain technology, created by the mysterious Satoshi Nakamoto, decentralizes the issuance and governance of digital money, thereby removing the role previously played by governments and banks. This is better understood by understanding blockchain technology and its underlying concepts.
What is blockchain?
Blockchain technology is a chain of blocks. A block represents digital information kept on a public database or the chain and secured through cryptography. Once the data is grouped and stored into a block, it is added onto the chain.
One of the appealing characteristics of the blockchain is decentralization. The blockchain is not managed by a single central authority. The information entered on the blockchain is publicly displayed on thousands of computers that maintain the network by validating transactions and adding data blocks on the chain.
Blockchains are not easy to maintain. In order to encourage people to participate in the maintenance of the protocol, an incentive mechanism is put in place to reward those who maintain the network. Blockchain was popularized by bitcoin, the firstborn of cryptocurrencies. Both bitcoin and blockchain were tipped to revolutionize the financial system.
While bitcoin has come a long way, this is still far from reality. Some claimed that cryptocurrencies would replace banks. As reality sets in and the potential use cases of bitcoin are explored further, blockchain technology is proving that it is more than just the technology that powers cryptocurrencies.
Even governments that have spoken strongly against cryptocurrencies have shown their interest in funding further development and research into blockchains.
Different types of blockchains
When the Bitcoin network first came onto the picture, people had a hard time separating the network from the blockchain. The two were just one. As more people researched deeper about blockchains and created alternatives, it was clear that there were different types of blockchains. Each one has its own use case.
Public blockchains are what blockchains were supposed to be. The public blockchains are fully decentralized and there is no single person that has control over it. The Bitcoin network is a perfect example of this. The transactions on the Bitcoin network are publicly recorded in the order in which they are added.
Unlike other closed networks where one has to ask for permission before joining, a public blockchain is just like the internet. Anyone can join anytime, wherever they are.
Public blockchains are censorship-resistant. This means that authorities have no control over users and cannot shut them down whenever they like. We have seen dictatorial governments blocking residents from accessing blacklisted websites.
Public blockchains have an incentive model to reward those who maintain the network. In the case of Bitcoin, they are called miners. Their role is solving complex equations. Whoever solves the equation is rewarded with freshly minted bitcoins.
This is what keeps the Bitcoin network going despite the huge amount of electricity required to run the mining machines.
Think of a private blockchain as an exclusive invite-only country club in which new members are picked according to a set criterion. A private blockchain, also called a permissioned blockchain, has notable differences from public blockchains.
Unlike public blockchains where joining is open to anyone, private blockchains are closed and only open to those that have been given access to them. You need permission to join. In a way, they are centralized because there is a central system that determines who joins and who doesn’t.
The transactions are private since the blockchain is private. The transactions are only visible to the participants that have been given access to the network.
Though proponents have criticized private blockchains, these private protocols are important for enterprises that want to enjoy the benefits of blockchains without exposing their data to the public eye. As a result, the central entities running these blockchains have complete control of the governance structure and the data shared.
If you come to think of it, maybe it makes some sense. It is similar to the internet and intranet. While the internet is good for the public domain, companies that eternally collect, store, and distribute sensitive information need to keep it away from the public eye.
Under private blockchains, there is also what is called a consortium blockchain. This is more like a private blockchain but governed by a collection of entities rather than a single authority. It is just like a group of companies coming together to form a consortium.
A hybrid blockchain is one that combines the characteristics of public and private blockchains. The true capability of a hybrid blockchain depends on its architecture. For instance, a service can be built on a permissioned blockchain but still use a public blockchain to improve security.
Is the bitcoin network centralized or not? Some say it is while others say otherwise. We can only get to the bottom of this by understanding how bitcoin works.
In the early days, bitcoin was easy to mine and you could do that with your home computer. There was no need for it to be difficult since those were the early days. Making mining difficult at the time could have scared away potential miners and hobbyists.
As the bitcoin fever grew and more people engaged in mining, the stakes were raised a bit and mining turned into a lucrative business. This is even similar to gold mining. Those who arrive when gold has just been discovered in a new area will not incur high expenses in the mining process. They can even get the gold from the surfaces.
As more people scramble for gold, it becomes scarce and the next logical step would be bringing in heavy machinery to drill underground in search of the yellow precious metal.
This is what happened with bitcoin mining. As bitcoins became more scarce, new machines designed to specifically mine bitcoins were created. The expensive equipment meant that only individuals with a lot of money or corporations could afford to set up mining operations.
These expensive machines, coupled with high electricity demand, make mining a very expensive process. In order to stand a better chance of mining bitcoin, some individuals or organizations pulled their resources together to create bitcoin mining pools.
Over the years, a few mining pools have emerged stronger, putting others out of business. An ordinary person with just a computer can no longer compete in the lucrative mining business.
In a way, the Bitcoin network is centralized because mining is mainly controlled by a number of large mining operations. The Block reported that 65% of the bitcoin network was controlled by Chinese miners. The data was taken from CoinShares. However, Bitmain who was the leader in mining for awhile has recently been declining in control over the networks processing power.
At the same time, bitcoin is only worth it if many people use/own it. Currently, a large amount of the circulating supply is held by large “Bitcoin Whales” who have acquired the majority. They can manipulate the market until more of the supply is spread out amongst more people.
Coming back to our question: Is bitcoin centralized? There is no single entity controlling it but the difficulty of mining bitcoins has pushed many people out of the market, leaving behind a group of entities to take control of the network.
Despite this, economic theory still prevails. Every 210,000 blocks (roughly every four years), Bitcoin experiences a halving where the mining reward is cut in half. This is essentially deflationary (the opposite of our current monetary system). In order for large miners to stay active the price must increase to offset the lower mining reward to pay for their expenses. This creates new opportunities for new miners to enter the market.
Regardless, all miners have incentive to keep the network growing to make their investment in time and money worthwhile. With the creator Satoshi Nakamoto still unknown, Bitcoin could be the most decentralized network to ever exist.
Benefits of decentralization in crypto
Do we really need a decentralized concept for the governance of money or anything else for that matter? Let’s list some benefits of decentralization.
- Security – The financial world is built on centralized systems that have one single point of failure. Companies generally have back up data centers located around the world to keep their services running in case something happens. But if they are targeted, these services can be crippled. This is not the case with decentralized blockchains. The data on the blockchains are stored on thousands of computers (nodes) connected to the blockchain network. If a person has to hack the blockchain, he has to hack all the computers on the network. While this is theoretically possible, the end result does not offer any benefits at all to the hacker.
- Decentralization also comes with decentralized services that may benefit the masses. It creates services that offer cheaper and faster services to people who may not have used such services from the current financial system. Think of the DeFi movement. Services such as trading, lending, borrowing, and insurance among others are being automated. The elimination of intermediaries will lead to cheaper and faster services. Think about the struggle people go through when they want to send money from one country to another. The transactions take days to go through, and that’s not even the bad part. People have to pay a lot of money in service fees for these transactions to happen. With cryptocurrencies, two people can directly send each other money without using a bank.
Funding through decentralization
Decentralization matters because it supports a new model for raising capital. Before the initial coin offering (ICO) boom, startups only had to raise money through venture capital or borrowing from banks. Venture capitalists were the gatekeepers to the tech boom. It was entirely up to them to fund a new startup or not. Who knows the number of good projects that never made it due to a lack of funding?
The crypto industry, has made it possible for new projects to raise capital from people spread all over the world. This fundraising model has helped fund projects that could not have made it on the desks of venture capitalists.
Perhaps what is not realized is how the ICO model helped to shape the distribution of wealth. Investing is no longer limited to rich people only. It was possible for someone in developing countries to invest in a novel idea without going through so many hurdles. The traditional financial system is always in favor of the rich, who have access to new projects that can net them big returns in the future. Currently, most developed countries require early investors to be accredited which essentially means their already wealthy. This rule has nothing to do with financial literacy.
There is no doubt that most ICO’s failed and the wild west nature may not have been the solution. However, it opened the eyes of many to the fact that things need to change to allow people the same opportunities regardless of economic class.
Decentralization is one of the main selling points of public blockchains. The same concepts have been used in decentralized finance as well as decentralized apps. There are different types of blockchains, with varying degrees of transparency and (de)centralization.
Information gathered from these references: