Power to the people
Introduction
Decentralization is a common term that’s used within the crypto field. It is one of the basic philosophies with important properties. For those new to crypto, it can be confusing when people throw around decentralized finance, decentralized apps, and so forth. In order to demystify the usage of the word ‘decentralization’, I compare centralized vs decentralized, explain how crypto is using this term, and provide an overview of crypto decentralization types. After reading this article, you’ll be a decentralization expert!
Centralized vs Decentralized
In order to explain decentralization, you need to know what centralization means so that you can know what ‘de’ing centralization means. Centralization is where there’s a central authority that you trust to keep track of something or make decisions for you. Centralization of power means that there’s a single authority with power. In politics, the end result of centralization is dictatorship. The political power is centralized to one person. For finance, this means that there’s a central authority that keeps track of your money that you’ve entrusted, such as a central bank. The Federal Reserve Bank is a central bank where the banking system has been centralized in the United States.
Now that you know what centralization means, now we can talk about decentralization. For the political power example above, this means that a country is going from a centralized system (dictatorship) to a decentralized system (democracy). The political power is now distributed to multiple authorities instead of just one. For banking, your money is not entrusted to one authority but distributed to multiple authorities. Imagine if your account balance is validated by other users of the bank, i.e. multiple authorities. This would be a decentralized bank. Note that the key to decentralization is that the authority is distributed. For example, centralized banks are distributed, i.e. they have branches and subsidiaries around the world, but they are still centralized in authority. The authority is centralized in its headquarters and its CEO. Now that we have defined what it means for something to be decentralized, let’s start diving deep into how this is used in crypto.
Photo by Kanchanara on Unsplash Crypto Decentralization
Crypto Decentralization
As the decentralized banking example illustrated above, the idea behind decentralization in crypto is to distribute the authority that makes crypto work to be distributed but also decentralized in authority. Crypto uses the blockchain to decentralize authority and this can be outlined by using Bitcoin as an example.
The blockchain is nothing more than a ledger that stores the transactions of the coin. You can think of each block as a page in a ledger and each page needs to be verified before you can start recording transactions on the next page, i.e. block. As we’ll see, each part of the system making a blockchain work is decentralized. First, the storing of the blockchain information is decentralized. Anyone with a computer and an internet connection can run a node that receives transactions and stores them on the blockchain, as long as their computer is powerful enough to run the code, store all history of the transactions and fast enough internet connection to handle the number of transactions happening every second. Nodes also keep track of wallet balances and ensure that the same bitcoin cannot be spent more than once. You can check out the number of nodes currently running for Bitcoin on bitnodes.io.
As part of validating the transactions, miners solve a mathematical problem that enables the nodes to validate each block before updating the blockchain. For their work, miners are given some coins as a reward. Just like nodes, anyone can start mining as long as they have the right computers to solve mathematical problems efficiently. You can check out the Bitcoin miner map at chainbulletin.com.
Due to the decentralization nature of the blockchain and its operation, there are several benefits its users gain. First, you cannot censure anyone. That is, anyone can send/receive Bitcoin and participate in Bitcoin’s operations (nodes and miners). Only way to create false transactions or prevent transactions is if you had more than 50% of mining power or run more than 50% of nodes. Second, anyone can inspect the whole history of all transactions in the blockchain. You can run a node and the Bitcoin software will download the whole blockchain. This means that it is easy to verify which wallet received how much from which wallet and check the balance of any wallet. Due to these two properties, the system doesn’t need to trust any one authority, i.e. trustless system.
The distributed authority in operating a blockchain is the main usage of the word ‘decentralization’ in crypto. As you can imagine, decentralization has expanded to make other ‘things’ to be decentralized. Let’s explore further how this term has evolved.
Photo by Andrey Metelev on Unsplash Forms of Decentralization
Forms of Decentralization
As you can imagine, the concept of decentralization has been applied to more areas. Actually, a more accurate way to characterize decentralization is that the blockchain technology has been applied to these areas. First, applications (DApp) were decentralized with the introduction of smart contracts in Ethereum. The innovation is that you can now run code in the blockchain and therefore smart contract’s storage and its execution is decentralized. Now, what part of the application is decentralized is up to the application developer. You could store account information, digital rights, or unique ownership of digital goods (NFTs). All of these can be tied to transactions, i.e. exchange coins for gaining access. This way, all of the information can be decentralized. The benefit of this is that no one can take away what you’ve bought. However, if the DApp developer stops operating, then what you’ve bought would not be worth anything.
Second, crypto is decentralizing finance, Decentralized Finance (DeFi).Your basic services such as loans, margin, options, and other finance products can be done through blockchain without having to go through a central authority. Using smart contracts, the terms and the amount is stored in the blockchain using the contract. Any operation with the financial products will go through the contract. This means that the services provided are decentralized, i.e. available to anyone that has a wallet that can interact with the smart contract.
Third, Decentralized Exchange (DEX) is where crypto is decentralizing exchanges, a part of DeFi. On a traditional exchange such as Coinbase, a central authority keeps your coins for you. When you buy and sell coins, Coinbase matches the sell and buy orders and deposits appropriate coin/fiat currency to your account. In contrast, users can exchange a particular crypto for another without a central authority on a DEX, such as Uniswap. Users can exchange their coins directly with another user using smart contracts.
Lastly, the Decentralized Autonomous Organization (DAO) is decentralizing organizations. They don’t have any leader or some structure. Anyone can join, usually by buying governance tokens. These tokens enable the owner to vote on the topics that the DAO is interested in. Sometimes a DAO comes together to run a DAX, a blockchain or buy some art.
Conclusion
As a new crypto enthusiast, trying to understand the jargon can be daunting in the beginning. However, crypto is just a new way of looking at the same social contracts that exist today. If you can make the link between crypto jargon and existing systems such as central banks and political systems, all of these concepts become easier to understand. For instance, the decentralization of authorities is analogous to going from a dictatorship in one hand (centralized system) to a democracy (decentralized system). In crypto, the operation of the blockchain is decentralized, enabling anyone to participate in keeping the blockchain running. However, a decentralized system can become centralized if one authority gains access to a large portion of a centralized system. If one authority holds a majority tokens for a DAO or has greater than 50% of mining power, then the power is centralized to that authority. One famous example is the large internet companies. The internet in general is a decentralized system in which there’s no one authority that keeps the internet going. For popular applications such as Google, Facebook and Amazon, how we interact with the internet has been centralized as they tend to obtain the most traffic and therefore influence what we find, how we connect and how we buy on the internet. So we are living in interesting times where there are forces that attempt to centralize the internet while others are attempting to decentralize it. So see you on the other side to talk about how this turned out!
