Regulators aren’t as thrilled about the upsides of decentralisation as some of blockchain’s most enthusiastic supporters. With massive networks made up of independently managed nodes, each blockchain has its own architecture, rules, and participants, which makes for a tough environment to regulate. When you factor in the severe crypto-knowledge deficit of most government bureaucrats, you can understand why blockchain experts are worth their weight in Bitcoin these days.
But there’s a lot more to the decentralisation of cryptocurrencies than the headaches it gives to regulators. In this article, we’ll define decentralisation in the context of the crypto industry and look at its alternatives, benefits, and applications.
Decentralisation of cryptocurrencies vs. centralisation
A cryptocurrency is a digital currency that uses cryptography to secure and verify its transactions chronologically, recording them in a decentralised and immutable ledger known as blockchain. One of the most lauded features of cryptocurrency is decentralisation. Different cryptos have varying levels of decentralisation. In this context, decentralisation refers to the fact that no single entity is in control of the currency.
Most institutions in our society revolve around a central entity. To remain in familiar waters, let’s consider central banks for a moment. Only a country’s central bank can print that country’s currency. As such, it’s in control of the monetary policy, and although it often coordinates with the government, there’s nothing to guarantee its infallibility. As human institutions, central banks are vulnerable to mistakes and other bad decisions.
A decentralised cryptocurrency is free from such issues. As decentralised systems, they don’t have a single entity in control of the network, which is managed by consensus protocols that all participants agreed to obey.
We’ll get into the benefits later on, but you can understand how when a system operates under the control of a central entity, it is attractive to hackers because that usually means there’s also a single point of failure.
A distributed system is similar to a decentralised one, but with the added benefit of replication in several machines to ensure the network remains up and running. However, these distinctions are relative.
Within the cryptocurrency industry, you can have a highly decentralised, blockchain-based alternative to the traditional banking system such as Stellar. But you can also have Ripple, which is also viewed as an alternative to the current banking infrastructure, but with a relatively centralised network where Ripple Labs control most nodes.
Types of decentralisation of cryptocurrencies
As the founder of one of the most popular decentralised cryptocurrencies, Ethereum’s Vitalik Buterin has identified three paradigms of decentralisation to take into account when dealing with this grey area.
There’s architectural decentralisation, which refers to the physical aspect of a network; political decentralisation, which is mostly about who controls the system; and logical decentralisation, which focuses on the network’s design and efficiency.
Cryptocurrencies exist in many formats, but the underlying blockchain technology is predominantly politically and architecturally decentralised and logically centralised. The ledger is distributed across all the nodes of the network, and no single entity controls it, but all nodes obey the same protocols.
What are the benefits of the decentralisation of cryptocurrencies?
Decentralisation is the perfect deterrent. When a network doesn’t have a single controlling entity, it also doesn’t have a single point of failure. The more decentralised a network is, the higher the cost of hacking it, as taking control of more than half of the machines would be an incredibly costly endeavour. It also deters collusion among potentially malicious nodes through designed security protocols.
But let’s consider for a minute that it would be logistically possible to hack a decentralised network. If a well-funded group with the most talented hackers on the planet took control of a crypto’s blockchain, that crypto’s price would immediately plummet since it would no longer be a trusted store of value.
A popular blockchain-based cryptocurrency has a network that consists of thousands of (in most cases) separately owned machines, each containing the same version of the shared, distributed ledger of transactions. This built-in safety mechanism ensures that, in theory, a machine can be taken out of the network without any disruption.
However, blockchains that employ a proof of work consensus protocol are more vulnerable to the centralisation of nodes in mining pools owned by a single entity, while proof of stake ensures all managing nodes have a vested interest in behaving well.
A final thought
It’s important to note that the concept of decentralisation and its many varied applications are still being tested. While the benefits are evident, there’s no denying that problems exist, in both the threat of regulation but also the technological development.
That means the issues decentralisation raises need to be addressed so that the market can grow with institutional investment and a renewed belief in the technological potential of blockchain and cryptocurrencies.
For more information about cryptocurrencies, read our other guides here.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.