What Is Decentralization? Achieving Trustless Financial Freedom
If you’ve ever wondered what truly separates cryptocurrency from regular fiat currency, the biggest factor is decentralization.
Decentralization defines crypto in the sense that it allows investors to be confident in buying, selling, and storing their tokens without being monitored and regulated by a third party, such as a bank.
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However, decentralization has taken many different forms. From blockchains to wallets and even the internet as a whole, the concept of decentralization is ushering us into a new age of financial freedom, which all crypto investors should be aware of.
Table of Contents
- What Is Decentralization?
- When Did Decentralization in Crypto Begin?
- How Does Decentralization Work in Practice?
- Proof of Work
- Proof of Stake
- Are All Blockchains Decentralized?
- Transitioning from Centralised to Decentralized Blockchain
- Decentralization and Centralization – The Debate
- Pros and Cons of Decentralization in Crypto
- Advantages of Decentralization
- Disadvantages of Decentralization
- Are Crypto Wallets Decentralized?
- The Future of Decentralization
- On the Flipside
- Why This Matters
- FAQs
What Is Decentralization?
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Simply put, decentralization in crypto means handling and managing assets without needing to rely on an intermediary. Decentralization, therefore, removes all connectivity with centralized authorities to grant better privacy and protection to everyday investors.
As many investors will already be aware, cryptocurrency is passed around within blockchains ; digital databases which keep a permanent record of every piece of data that enters their network.
Most cryptocurrency blockchains are decentralized and, therefore, will use their own methods and techniques to fill in the gaps for the lack of a third party. As a result, if the blockchain is decentralized, then, in turn, the cryptocurrency that it supports is decentralized.
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Though decentralization hasn’t always been easy to achieve, many people see it as the beating heart of cryptocurrency and, in many ways, the whole point of it.
When Did Decentralization in Crypto Begin?
Though the notion of a decentralized digital currency has been swirling around since the 1990s , it was Satoshi Nakamoto , the founder of Bitcoin (BTC) , who set it out in practical terms with his 2008 Whitepaper .
Nakamoto made clear that his central aim in creating Bitcoin was to allow ” any two willing parties to transact directly with each other without the need for a trusted third party.”
This appeared right after the disastrous 2008 financial crisis, which caused many people to seek out alternative options after the banks proved their long-term unreliability.
Nakamoto’s idea of decentralization and all the mechanics that made it a reality have been replicated and tinkered with by essentially every subsequent cryptocurrency developer since the Whitepaper was produced.
How Does Decentralization Work in Practice?
As a crypto investor, you probably won’t be able to ‘feel’ decentralization around you since it largely operates behind the scenes of a blockchain.
Usually, banks would be in charge of verifying transactions. Still, since cryptocurrency and blockchains are decentralized, they use alternative methods to ensure their networks don’t become infested with bad actors and illegitimate transactions.
To achieve this, decentralized blockchains will use consensus mechanisms, which involve the community verifying transactions in exchange for rewards. The two mechanisms that have managed to maintain a substantial amount of popularity are Proof of Work and Proof of Stake.
Proof of Work
The key players of Proof of Work are nodes, which work together to agree on a transaction’s legitimacy, and miners, who ‘mine’ the transaction block in exchange for rewards.
First, nodes spread across the network will confirm that a transaction is verifiable and then place it into a block. Then, a group of miners will compete to have the chance to attach said block to the blockchain.
They compete by trying to solve a difficult cryptography puzzle, putting in the ‘work’ to prove their worth.
The winner will then place their block of transactions onto the blockchain and be compensated with some crypto tokens.
Proof of Stake
Unlike Proof of Work, where miners are chosen based on their efficiency as cryptographers, Proof of Stake picks people based on the amount of crypto they stake.
Staking is when someone locks up some of their tokens on a network to earn rewards, which, in this case, is the chance to become a validator.
One person is chosen randomly from the staking pool to validate transactions on the network.
Most of the time, these ‘validators’ will reclaim their tokens and receive an extra sum for their work, but the exact reward depends on the network.
Are All Blockchains Decentralized?
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Not all blockchains are decentralized, though most are for crypto users.
The most common form of blockchain in the crypto landscape is the public blockchain, which is open and available to everyone.
These blockchains grant all decision-making responsibilities to the community, which also has full access to any data passing through the system.
On the other hand, permission-locked private blockchains are centralized with a single entity running the show. A blockchain being centralized isn’t necessarily a bad thing since it should always be designed to suit users’ needs.
For example, if a company has a hierarchy, it makes sense to use a private blockchain that is managed and controlled by top-level management.
However, Some blockchains will enter a transition period before becoming decentralized.
Transitioning from Centralised to Decentralized Blockchain
One example is Ripple (XRP), which initially owned 60% of all circulating XRP tokens and most of the network’s validators.
Many users, therefore, felt Ripple was far more centralized than its peers. Ripple confirmed this on its blog, stating that “This decision involved trade-offs to prioritize security and scalability ahead of decentralization.”
The ‘decision’ referenced here started with a centralized model in 2012. Only five years later, though, it became clear change was needed. 2017 saw Ripple announce its ‘Decentralisation Strategy Update’, which sets out how they will embrace decentralization going forward.
According to their blog, “To meet the growing needs of customers and increase resiliency and stability of the XRP ledger.” Modern crypto audiences highly value decentralization, even though it has also attracted its fair share of critics .
Decentralization and Centralization – The Debate
Decentralization is like a spectrum. It’s hard for a blockchain ever to be fully decentralized, and as a result, some crypto enthusiasts have shown concern about whether decentralized blockchains will slowly become centralized over time.
Two main issues people often cite for this concern are mining centralisation and developer influence.
Proof of Work miners play a big part in securing the network. However, while anyone can become a miner, doing so requires expensive rigs and computer equipment.
Therefore, the worry is that a small group of miners who possess the best and most efficient resources will be able to register and verify blocks faster than anyone else, creating a kind of hierarchy within the mining community itself.
The second issue is one of governance.
‘Crypto celebrity developers’ like Vitalik Buterin of Ethereum (ETH) and Justin Sun of TRON (TRX) can sway their platforms in a specific direction if they hold a certain agenda. Though these platforms are, therefore, designed to be free and decentralized, the majority of power still inevitably lies with those at the helm.
Pros and Cons of Decentralization in Crypto
Decentralising is what makes cryptocurrency so efficient as a form of alternate currency, but that doesn’t mean this concept doesn’t still have its fair share of issues.
Advantages of Decentralization
- Provides a Trustless Environment: Every transaction made in a blockchain is registered on a public ledger for everyone to see. This means no trust between users participating in a transaction needs to be established since the facts are clear as day.
- Security: Being decentralized means having no central point of failure. If a bank suddenly crashed, it would affect everyone who relies on it, but it can’t affect blockchains. Additionally, nodes on the network ensure that transactions are safe and eligible to enter the ecosystem.
- Immutability: It is impossible to tamper or edit with transaction data once it has been added to the blockchain. This prevents people misusing their tokens and committing devious acts, such as double spending for example, and it’s one of the main purposes and benefits of decentralization.
- Personal Financial Freedom: Not having a partnership with a third party grants greater confidence to the user concerning personal ownership they have over their funds. It also negates some of the fees and the bottlenecks that come with exchanging fiat currencies.
Disadvantages of Decentralization
- Risk of Growing Centralisation: Decentralized blockchains running on a Proof of Work model can face issues of miner centralisation. Additionally, network developers still hold a large influence in how certain networks evolve and perform.
- Energy Inefficiency: Maintaining a decentralized Proof of Work blockchain takes up too much energy. In 2021, Bitcoin was recorded to have used 90 terawatt-hours of electricity, which is comparable to the energy consumption of Pakistan. Decentralization comes with benefits, but the models that allow it to work, such as Proof of Work, can also dampen views on the concept as a whole.
- Token Volatility: The newness of decentralized blockchain technology means the tokens associated with the networks often fluctuate wildly in price. With nobody to regulate value, there’s no telling what sort of outside influences could raise or plummet a token, inserting a decent amount of risk into the markets.
- Scalability: This refers to the speed and overall efficiency of a network. As more users join up with a network, it will lead to an increased number of transactions that all nodes must verify. This can clog up the network and lead to a more sluggish overall experience, and it’s one of the biggest issues currently affecting decentralized blockchains.
Are Crypto Wallets Decentralized?
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This entirely depends on whether the wallet is custodial or non-custodial .
Non-custodial wallets are decentralized since they can function independently without binding the owner to an exchange.
What does this actually mean, though? Essentially, crypto wallets hold our private keys, which are needed to execute a transaction.
Non-custodial wallets will make the owner entirely responsible for protecting their key, but with custodial wallets, the key is handed to an exchange provider for safekeeping.
Both have their own benefits, but many crypto enthusiasts prefer self-custodial custody since having full ownership of your keys, and crypto is a big incentive for many serious traders.
The Future of Decentralization
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Decentralization has long been connected to cryptocurrency, but the plan isn’t for it to stop there.
Many developers believe the implementation and evolution of decentralization will one day lead to Web3, which can essentially be considered a blockchain encompassing the entire internet.
To clarify, Web1 signaled the birth of the internet, and Web2 in the early 2000s marked the era where users could start creating content at the cost of being monitored and having their data sold by corporations.
Web3 will be the natural evolution of this concept, creating a new era of the Internet controlled by the community, not centralized corporations.
The cryptocurrency ecosystem is already a step ahead in decentralization, meaning it will fit perfectly into this ambitious vision for the Internet.
With that being said, there are still a few lingering issues that first need to be addressed before Web3 can arrive:
- Mainstream Adoption: Web3 needs to be embraced by the wider internet community at large, and since it will be far less fine-tuned than Web2 currently is, it’s uncertain whether this adoption will provide sustainability.
- Lack of Protection Measures: As of yet, there have not been many successful protective measures put in place to safeguard consumers and investors on Web3, which has led to the failure of several Web3 projects.
- Heightened Regulation: Regulators have already begun sneaking centralisation into several concepts that would be integral for Web3. For example, blockchain-based contracts and KYC (Know Your Customer) are becoming more regulated by authorities, which could get in the way of Web3 being truly decentralized.
On the Flipside
- Keeping a blockchain decentralized isn’t always easy. As a result, some crypto networks can gradually move away from it even without realizing it, which can spawn issues like the centralisation of power in Proof of Work blockchains.
- Additionally, there’s no guarantee that the masses will accept decentralization as a concept, which could stunt its evolution speed.
Why This Matters
Decentralization has lost much of its meaning in modern times due to how liberally the term is used.
Therefore, it can help to go back to basics to understand how it works, especially since it’s the central concept that allows crypto investors to manage their tokens in a safe and comfortable environment.
FAQs
Decentralized applications are built on top of decentralized networks. They can be designed for many use cases, including granting access to financial services for trading purposes or executing smart contracts.
This refers to when decision-making processes are granted to lower-level local governments. This diversification of decision-making power allows on-the-ground councils to respond to local issues quickly and effectively.
Yes, it’s when a central government delegates functions and resources to lower-level elected representatives to be more involved with public service delivery. India, for example, has been using this decentralized system for over 30 years.
Disclaimer: The content of this article solely reflects the author's opinion and does not represent the platform in any capacity. This article is not intended to serve as a reference for making investment decisions.
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