Decentralization – does it actually matter?
Decentralization – does it actually matter?
5. September 2022
Reading time: 3 minutes
Crypto is currently learning what a bear market is while the economy is about to face a recession. Ethereum is going through its second bear market whereas Bitcoin has done this about five times already. Many of the altcoins are down 90% or more, and we have just experienced the collapse of an entire blockchain ecosystem as well as the wipe-out of a top 5 coin.
In our whitepaper, we focus on what is core to blockchain and its applications: Decentralization. The architecture that is core and part of so many buzzwords like Decentralized Governance, Decentralized Finance (DeFi), Decentralized exchanges (DEX), and Decentralized Applications (dApps).
Too busy? No problem, we summarized the key points below.
What decentralization means
Decentralization is about ownership and control. If something is decentralized, it must not be ownable or controllable by one or just a few entities. It also must not be controlled by large entities such as companies or be regulated by any state. Decentralization brings in two key attributes: Security and stability. We can trust that the system will work as expected and in the best interest of most users as no majority would not accept the changes otherwise. This comes at the cost of a rigid system where decisions are slow and hard to be implemented and throughput is limited. As a result, decentralized protocols are useful for things that are foundational infrastructure for many such as public goods like money, payment systems, and smart contracts. Centralized systems on the other hand need to be regulated to work, such as property rights to create trust and safety.
Key differences between centralized and decentralized systems.
The decentralization hierarchy
With decentralization, there is a hierarchy of importance. The more power a stakeholder group has, the more it is important that it is decentralized. Since all power ultimately comes from the market price, the holders of the token, who make the ultimate price decision, are the most important. After that, there come the miners or validators who run the system, then the software, wallets and all the builders of the ecosystem.
Decentralization amongst coin holders is the most important aspect of decentralization.
The cost of decentralization
Decentralization is a means to an end. It is something you do not see but without it, blockchains cannot function. The features that blockchains provide only work flawlessly if decentralization is in place. As such anybody using or building on top of blockchains should be aware of it. If we want to trust a blockchain we must know that the mechanics of it work and that they are sufficiently decentralized so that it cannot be attacked or manipulated. Only then can amazing functionalities be unleashed such as a bearer asset and a system that settles transactions right away. Autonomously, automatically, safe, and digital – those are powerful and valuable attributes we get with decentralization.However, decentralization is quite expensive, meaning some costs and inefficiencies come with a decentralized system. This is called the blockchain dilemma, where there is a relationship between decentralization, security, and scalability. To gain scalability, either security, decentralization, or both have to be sacrificed. In other words, decentralization in combination with security leads to very slow performance. Hence, the rather limited transaction throughput of Bitcoin and Ethereum.
The blockchain dilemma states you can only pick two of its three core benefits: security, scalability, and decentralization. | Source: cryptolog.nl
Decentralization proved valuable
The current market cycle is driven by many problems in the crypto world, including the blowup of a top 5 blockchain, and the bankruptcies of several crypto companies. The most prominent ones were Celsius, Voyager and 3AC. Critically, in all cases, customer funds were lost or are stuck in long bankruptcy cases, similar to the Mt. Gox bankruptcies in 2015. DeFi had no issues in the downturn. The difference is the transparency that comes from decentralization and blockchains, where all transactions and ledgers are public, and thus so all risks. Any solvency problems are known and dealt with in real-time and automatically. This crisis shows the true value of decentralized systems: You know exactly how they work and can trust them because of their transparency.Conclusion: So, does decentralization matter?
Blockchains without decentralization make little sense for it is what provides the main benefit compared to traditional finance, even if it is just under the hood like the engine of your car – you do not see it, yet it generates most of the value of the vehicle.Decentralization in our blockchains is not perfect, but it is going in the right direction. Notably, the adoption of many users is providing the most basic foundations for further evolution. When it comes to the running of the network in a decentralized way, we see that the trend has gone the opposite way with mining becoming more and more dominated by few professionals. Yet, run in different countries and by different companies, it is still decentralized enough.
Overall, I am optimistic for the future. More people find use for crypto, and its tools as well as the technological foundations are getting ever stronger.
Author
Philipp Knirck
Philipp’s consultancy focus lies on establishing process-oriented organizational structures and creating value by implementing blockchain technology. He helps organizations to achieve measurable results with innovative business models.
Philipp Knirck
Philipp’s consultancy focus lies on establishing process-oriented organizational structures and creating value by implementing blockchain technology. He helps organizations to achieve measurable results with innovative business models.
Author
Melanie Zollinger
Melanie's focus is on marketing. She supports the Q-Team in bringing complex ideas to the point and has co-authored numerous articles on IT project management and digital transformation. Occasionally, she accompanies projects from a communication aspect.
Melanie Zollinger
Melanie's focus is on marketing. She supports the Q-Team in bringing complex ideas to the point and has co-authored numerous articles on IT project management and digital transformation. Occasionally, she accompanies projects from a communication aspect.
