Decentralization is a common term thrown about by authors, builders, and crypto enthusiasts alike.
But what is decentralization? It is not merely a concept that is confined to one sector, it applies to all aspects of life from policy making to economics. Decentralization is the elimination of a central party that has full control and access over a network.
Decentralization is one of the key points of the blockchain as it can create room for cost savings, less friction and more direct interaction between two parties.
The internet was supposed to be open and decentralized. The infrastructure of the internet, to a large extent, is still decentralized. Yet even if the Internet Protocol layer is decentralized, the next layer, that of the consumer web, is not.
There are many rampant issues in the World Wide Web, governments such as China can monitor and block content if they so desire, corporations can also monitor data and conduct forms of censorship as well.
Giants such as Facebook, Amazon and other such networks do have a level of centralization, this gives them their strength and significant valuation. Now, corporations may have a distributed network but it still does not make it decentralized.
Decentralization leads to a lack of a choke point, it is designed so that one participant in the network can not take control.
The concept of decentralization is important because it applies to privacy, value, and autonomy.
What is Decentralization in Currency
Very few inventions have the ability to disrupt financial markets, economics, and currency on a broad scale, and even fewer can prompt a new definition of these concepts as we know them.
The invention of cryptocurrency and its subsequent adoption has managed to do exactly that, as it questions and challenges the efficacy of our financial systems and introduces a new method of distributing and backing the currency.
One of the defining features of this model is that it is a digital, decentralized form of currency that derives its value and validity from its network of users. This differs prominently from the current system of fiat, centralized currency adopted throughout most of the world, with the defining characteristic being who holds the majority of control over the currency in question.
The concept of decentralization has often been used in economics to describe market types and power distribution. However, this has changed with the technological developments brought about in the past few years, which have influenced the term to be used largely in relation to currencies.
In order to understand decentralized currency, it is imperative to understand what centralized currency is and how it operates.
The best and most accessible example of this would be through the study of the U.S. Dollar, and its relation to the Federal Reserve.
What is a Centralized Currency?
As the nomenclature suggests, all aspects of a centralized currency are controlled and operated by a singular central power.
For instance, up until about 40 years ago, the U.S. Dollar received a portion of its value from the utilization of precious metals such as gold and silver in its coins.
This is evidenced by the increase in the value of silver dollars, as the price of silver has increased over time. However, as the U.S. government phased out the usage of these metals in their currency, all subsequent value was and is still backed by the federal government.
The Federal Reserve mediates this value by printing and distributing more or less money as it sees fit. Imprecise methods of balancing the amount of currency in distribution could lead to economic fluctuations in value, such as inflation or devaluation.
This value of a currency is backed by the government’s guarantee that it is properly handling its production and distribution. However, a government’s guarantee is just as good as its credibility and its status on a global level, which is why a governing power has to ensure that its status and its currency has consistency and longevity in worldwide markets.
If for any reason the government collapses or becomes consistently uncreditable, all of the physical currency it governs would become worthless. This has recently been noticed in currencies such as the Venezuelan Bolivar, which was put into so much circulation by its globally discredited government that the currency is now essentially dead.
This reliance upon a central entity is the exact situation which a decentralized currency attempts to avoid. In the case of decentralized cryptocurrency, there is an independent method of validation which verifies the currency, and a user run network which assigns value to it without controlling it in a supreme manner.
How Decentralization Works in Cryptocurrencies?
By definition, the implementation of decentralization means that a network is not being controlled by a central entity. While certain functions of a decentralized system can be influenced/upgraded by human intervention, the very basis of its model remains completely autonomous.
This is to ensure that even if a system loses a certain set of network connections or has irreparable damage to some part of its infrastructure, those events do not harm the network’s core operations.
The concept of decentralization can be applied to various mechanisms such as business organizations, educational systems, and government bodies. However, its most popular usage in today’s day and age is through the decentralization of currency, or to be more accurate, cryptocurrency.
Cryptocurrency is operated through the usage of blockchain technology, which brings about cryptographic security, immutability, and developmental accessibility to its end users. The technology has established itself to be provably efficacious and immensely secure, which is one of the core reasons why cryptocurrencies are being trusted by people all over the world to hold their wealth.
To understand how decentralization in cryptocurrency works, we first need to understand how the model of cryptocurrency functions in the blockchain sector: how it is issued, what drives its value, and which channels are used for its distribution and subsequent increment.
In its ideal form, the biggest factor that sets cryptocurrency apart from fiat currency is that it is not controlled through a central entity, but instead functions through preset coding mechanisms. These mechanisms provide each cryptocurrency network with a set of functionalities that help it work on its own and execute processes such as minting new units of currency.
The human intervention in these mechanisms remains limited. While they often supplement the fueling mechanisms that are required to generate new digital currency, they cannot directly create new cryptocurrency by actions as simple as the click of a button.
All of this is possible through the transparency and immutability of the blockchain technology, which prevents duplicate currency from being issued and only functions on a preset model that a blockchain’s creators share with their stakeholders.
These models are often called “Consensus Algorithms”, with denote to how a network and its systems agree on the validity of a transaction. These consensus algorithms more often than not lead to the issuance of new cryptocurrency units on its respective blockchain.
This is mediated by the process of “mining”. Mining is a form of collecting cryptocurrency in which computing power is expended to obtain a certain amount of cryptocurrency. By doing so, they are effectively verifying the validity of future and past transactions.
Built into the process of mining is a pair of keys, one public and one private. The private key is a user’s personal “wallet” which holds and provides access to their funds. The public key provides access to transfer addresses, previous groups of transactions, or blocks, which operate similar to a bank ledger.
When cryptocurrency is mined, one of these blocks is verified for validity, allowing new transactions to be verified as well. As new transactions are added to this block, forming chains, they are verified repeatedly as other users mine for cryptocurrency. This also ensures that no individual person or entity holds all the power over the currency; it can continue on unaffected if any single user leaves the system or loses their money.
Some of the most popular consensus algorithms include proof-of-work and proof-of-stake mechanisms. From a perspective of decentralization, proof-of-work allows any user to be able to participate in the process of mining; whereas, proof-of-stake limits it to a number of only those users who have a vested interest in the network by locking a certain level of cryptocurrency within it.
These models allow the participants, called “miners”, to earn rewards from their efforts of working on the network and helping it stay sustainable. Whenever new cryptocurrency is issued on networks that use these consensus models, the newly minted digital coins usually go to the miners, who often get the distinction of being the first channel of distribution for the newly issued cryptocurrency units. This is in addition to the fee that they earn, paid by another user on the network to get their new transactions confirmed. Since the miners are the driving force behind the network, they earn the fee rightfully by working on maintaining the network’s operations.
Since there is no central body that sets the price of a cryptocurrency or regulates its value against a set list of rules, the value of cryptocurrency is driven by speculation, by the market. While the same could be held true to some extent in regard to every fiat currency, the aforementioned factors of set rules and regulations still play a major part in denoting value to fiat’s centralized currency model.
This is both a benefit and a disadvantage that decentralization brings to the table for cryptocurrencies. While not being controlled or regulated by an external authority gives them the chance to flourish in an autonomous model, the speculation in pricing means that the current demand for a cryptocurrency is what mainly gives it its value. If the demand for a highly valued cryptoasset was to decrease for some reason, it would also take any users’ investment to plummet with it. This makes the speculative investment that much riskier to hold.
This means that similar to gold or silver, the value of cryptocurrency changes over time. The difference is that cryptocurrency is currently subject to sudden spikes in price as demand changes. These “sudden” spikes are noted at a rapid pace in the current day and age; however, economic law dictates that despite the possibility of spikes in price and demand, this trend would begin to fade. This, if a cryptocurrency sustained through the years, it would begin to even out in price.
It is also prudent to mention that despite being decentralized, a few cryptocurrencies such as Tether have their price pegged to U.S. dollar, where a single, fully-formed unit of the cryptocurrency is equivalent to 1 USD.
Where centralized currencies are issued by government-backed entities and distributed by central banks more often than not, decentralized cryptocurrencies are issued through the blockchain and distributed through various channels depending on the basic functioning model and the age of a respective blockchain.
For instance, at the time of their launch, several blockchains offer initial coin offerings (ICOs) for their own cryptocurrencies, where the initial coins are distributed among a large section of investors and stakeholders as their first channel of distribution. Usually, this is followed by the aforementioned process of “mining”, where the remaining cryptocurrency units are distributed to miners on a consistent basis until a currency reaches its defined goal of coins to be generated.
Apart from these channels, the currency units are distributed to cryptocurrency exchanges, where they are either traded for other cryptocurrencies or for fiat. Through these models, these cryptocurrencies are distributed among those who want to use them or invest in them.
The aforementioned procedures demonstrate how the normal process of creation, valuation, and distribution can be accomplished in a digital form with all aspects controlled by a network of users instead of one central governing entity.
What is Decentralization: The Different Aspects of Decentralization in Cryptocurrencies
While gradually yet certainly changing the concept of the economy as we know it, blockchain is also the driving force behind the increasingly passionate discussion of the different perspectives on decentralization.
As with most topics in the world, the concept of decentralization has been a subject of differing views. Some believe that decentralization is a term which defines the control that an entity has over any issued cryptocurrency and its larger network, while others are of the idea that the expression simply refers to the way the currency’s value and its post-circulation mechanisms are controlled.
In order to understand these views, it is important to take a look at these different perspectives on decentralization that have been adopted by various sections of the cryptocurrency community.
This would not only give you a peek into what different segments of people are thinking when they look at the wider concept of decentralization, but would also allow you to gather your own views on the subject as you move forward with operating in this space accordingly.
The Various Models of Decentralization
The concept of decentralization is extremely nuanced and one that changes its meaning according to how you approach it, how it is being enacted by a certain blockchain, and how it affects the overall currency that is being generated by said blockchain network.
This thought was echoed by Ethereum’s co-founder, Vitalik Buterin, in a detailed post that spoke on the meaning of decentralization and presented the view that decentralization can easily be segregated into multiple sections.
While Buterin is associated with Ethereum, the model he presented in February 2017 is seen as a highly relatable and effective view on decentralization within the larger blockchain space, and how it is applied throughout different segments in decentralized cryptocurrencies.
The 3 segments that Buterin covered in his post are:
- Architectural Decentralization.
- Political Decentralization.
- Logical Decentralization.
In the following section, we have presented the factors which define each section according to Buterin’s perspective, and have then elaborated on how these perspectives could be used to analyze multiple aspects of decentralization.
The definition of architectural decentralization was provided in a simple clause: how many computers are actually associated with the system, and if most of them broke down, whether the network has the sustainability model to continue to go on with a section of its support gone?
For instance, Bitcoin has an excellent model of architectural decentralization. Even if it loses some “nodes”, which are connections to the network, it does not mean that the network loses its functionality with them gone. Instead, it keeps continuing with the other nodes without being biased towards either the previous or existing nodes. As long as the nodes or miners keep doing what they are supposed to, it does not matter how tenured they are on the network or how much influence they hold on the blockchain.
Political decentralization was referred to as a way of analyzing how many entities are involved in operating the blockchain and how influential they are in its day to day operations.
Once again, blockchains such as Bitcoin remain free of the involvement of any influential nodes. While this pushes such blockchains off to an edge of the political decentralization spectrum where they are extremely decentralized, it does not always mean that it is a positive thing.
Putting political decentralization in effect through other means, such as the power of voting being given to all token holders, could often prove to be beneficial for a blockchain and its cryptocurrency. In a way, it is also a way of strengthening decentralization while also working for the betterment of a single blockchain.
Contrarily, blockchain networks such as DASH provide voting power to only a select few individuals who have a vested interested in the network by locking their tokens in a “staking” wallet (an aspect that was mentioned in the “Consensus Algorithm” discussion above). On these networks, only a select few individuals who themselves have been selected through various voting or staking procedures have the power to vote on influential decisions. But even that does not mean that it is a bad decentralization model by any means. It only works for the improvement of a blockchain.
For instance, a blockchain that works on decentralized voting could pass improvement proposals more efficiently, which could save it from performance issues such as the ones that Bitcoin is facing at the moment. Since such factors affect the value of a cryptocurrency, ensuring that political decentralization is being implemented in an effective manner is important for blockchains.
The term logical decentralization was associated with a network’s survival if it was severed into multiple segments. The reason behind this simple yet bold characteristic was presented to ensure if a network is in fact truly decentralized to the point where you could effectively take off a chunk of its nodes and place them in another contained setting, only for the network to keep functioning with them as it was with far more nodes at its disposal.
In the current day and age, most blockchains can effectively stay true to this model, and they do so as well. This is by far one of the most limpid aspects of decentralization which almost all entities agree to be essential to a decentralized cryptocurrency.
While this provides a good idea of exactly how decentralization could work, the model still leaves a lot to be desired for some entities in the cryptocurrency community, who believe that decentralization for a cryptocurrency goes beyond than just those three segments.
That is where additional perspectives for decentralization come in. While these remain widely opinionated and perspective-driven like the three segments mentioned above, knowing about them could prove to be just as effective.
What is Decentralization: Additional Perspectives on Decentralization
Some heavily argue whether all users get equal chances to participate in the network or if a certain cut of them gets preferential treatment.
This aspect criticizes proof-of-stake and similar models, where only a certain population of a cryptocurrency community is able to make important decisions on behalf of everyone else, even if they are being selected by community members after vesting their coins in the network. For some, this model of governance does not sit well with the overall ethos of not having certain entities control a cryptocurrency blockchain.
Another popular criticism comes in the form of high network and transaction fee, where some people argue that miners do not only get to mint new coins but also get to benefit from receiving network fees. According to the naysayers of this existing and very popular model of reward for miners, paying miners so much in terms of network fee unbalances the decentralization aspect for any cryptocurrency, which in their opinion proves to be detrimental to the power and financial balance in a network’s operations.
Decentralization is an Evolving Concept
Image credits: Walid Beno
While a centralized currency is largely unavoidable because of its prevalence, it’s reliance upon a central power has proven worrisome many times in the past. From the times of the Great Depression, where banks would literally run out of money, to the Great Financial Crisis of 2008, which required bank bailouts so customers wouldn’t lose their funds, it has been shown to have its drawbacks, with sometimes disastrous results.
Cryptocurrency’s ability to distribute imperative duties associated with the usage of currency equally amongst its users does not only represent the purest example of a free market but also provides a way to avoid the aforementioned incidents. Even though it is still in a period of development and its long-term consequences cannot yet accurately be measured, in its current form, it is most relatable to commodities like gold or land.
Even with any flaws that it currently presents in terms of decentralization, cryptocurrency is still achieving something which no other financial models have been able to do so far: to bring about an idea that could be a viable substitute to centralized currency.
The demand for the product dictates its value, and a network of consumers back and stimulate its growth. As we watch the process unfold, it is awe inspiring to ponder that this invention with no physical attributes could change the subject of economics worldwide forever.