An analysis on current “decentralization” in modern technology; what it is, the pros and cons, why it’s a spectrum for consumers and businesses (including more on NFTs and DAOs), and a teaser on our next article “Real World Problems Being Solved with Blockchain Technologies.”
Enjoy the read.
What is decentralization?
Decentralization when talking about blockchains alludes to the transfer of control and decision-making away from a centralized entity such individuals, organizations, or groups thereof to a distributed network. For example, rather than having a single corporation decide whether an individual can use their goods / services, it’s decided upon a distributed network of people.
In the land of cryptocurrencies, decentralization is the key ingredient in their functionality. Blockchain is a distributed ledger technology that allows the history of data to be recorded immutably through a process called consensus.
We talked a bit about consensus in our ETH Merge article, but there are countless different ways in which different blockchains can reach consensus (agreement to make a decision).
Rather than having a significant financial institution setting direction and overseeing operations, millions of participants build cryptocurrency networks together from the ground up.
On the other hand, centralized systems are systems that use client / server architecture where client nodes are directly connected to a central server (usually hosted by a business or organization). An example of this in the cryptocurrency sector would be Binance Smart Chain, where there are only 21 validators securing their network.
What are the benefits of decentralization?
1. Facilitates a Trustless Setting
In a distributed network like Ethereum, there is no need to trust other users. In any case where any member’s record is attempted to be modified in anyway, it will be rejected by the majority of the market participants that are actively securing the network with their nodes.
2. Independent Control and Decision-Making
Decentralization allows you to maintain independent control and decision-making. The direction and future of your system aren’t dependent on the integrity of any single authority. If a single authority ever becomes corrupt, damaged, or compromised, the entire organization has the potential to collapse.
3. Improves Data Efficiency
Public and private corporations regularly trade information with their partners, storing that information in the company computer, banker’s box, or even telephoning the information from partner to partner which is prone to information decay, corruption, and even fraud in some instances. That information is also only accessed / available when someone needs to transfer it, there is no open ledger detailing all of that company information. Blockchains, by contrast, allow for data transparency and data integrity in use cases from the smallest of projects to Fortune 500 companies.
4. Fewer Vulnerabilities
Decentralization is trustless by nature and disallows any bad actor or group to take control over the network. The only way to attack a decentralized blockchain is by hostile forces colluding together to obtain majority control (at least 51%) over the network’s nodes, therefore gaining influence over it. Take Ethereum, for example. With a current market capitalization of $161B and the network securing itself using a Proof-of-Stake (PoS) mechanism, the hostile wallets would need roughly a little over ~$80B to execute an attack. This is true for CEOs with majority control having a bad day and making rash decisions on behalf of the company and perhaps stockholders as well.
The Blockchain Trilemma: Scalability, Security, and Decentralization
- Scalability – How many transactions per second (TPS)?
- Security – How resistant to attacks is the network?
- Decentralization – How many nodes are there? Are they concentrated in a center of power?
Decentralization, security, and scalability are three essential features a highly functional blockchain platform needs to possess at an optimum level. However, integrating these three features while developing a blockchain network has been a core problem for developers. Oftentimes blockchain developers are forced to sacrifice one of the three important features to accommodate the remaining two.
The Blockchain Trilemma is the inability of blockchains to achieve an optimum level of scalability, decentralization, and security simultaneously. Ethereum’s co-founder Vitalik Buterin made the concept popular, and developers are now focused on finding lasting solutions to this problem. Let’s look at each of the blockchain features causing the trilemma below and some of the solutions new blockchain projects are implementing to mitigate it.
The main idea behind cryptocurrency and blockchain technology is that it should be uncensored and uncontrollable by a third party. This implies that no single person or group should have control over a network. As explained in depth earlier in the article, the standard decentralized protocol for blockchain networks is to be open-source with the network’s control equally distributed to all participants.
Security is a basic feature every blockchain must possess, and it shouldn’t be compromised. it’s the main requirement to have a successful and functional blockchain network. The blockchain security should be impermeable and resistant to malicious attacks. A lack of security mechanisms of every blockchain usually varies with developers, and to ensure safety the must usually audit their blockchain and smart contracts to identify potential loopholes for attacks.
Scalability is the ability of the blockchain network to handle more transactions per second. It is a necessary feature that affects the global adoption of blockchain technology because only a highly scalable blockchain can serve billions of users. The inability of most blockchain platforms to attain optimum scalability is why global adoption of blockchain technology isn’t moving at the predicted rate.
Increased adoption of blockchain technology at this point will only lead to more participants, more time to distribute and process information, and less transactions processed per second. Reducing participants and data addition would increase speed and scalability, but it will reduce the network’s decentralization and weaken security. This is why the blockchain trilemma exists, and in this next section we look into some of the most effective solutions that new blockchain projects are leveraging.
Possible Solutions to Solving the Blockchain Trilemma
Although there are still no actual solutions to the Blockchain Trilemma, the approaches of many blockchain developers toward mitigating the problem have yielded encouraging results. We review some of these approaches below:
- Sharding Solutions
This is a layer-1 blockchain scaling solution. It involves partitioning blockchains or other databases into smaller units, each unit managing a specific data segment. This reduces the workload of managing the network’s transactions and interactions on a single chain. The smaller units of the divided blockchain are known as the Shards.
Each Shard has its ledger where transactions are recorded. They’re able to process transactions on their own, while the main chain, Beacon chain, manages interactions between them. Sharding involves changing to the blockchain’s mainnet, and it solves the issue of transaction speed without interfering with decentralization and security.
- Layer 2 Scaling Solutions
Unlike layer 1 solutions, this method doesn’t alter the fundamental structure of the underlying network. Rather, it builds on the existing network structure, i.e., adding an additional layer. Side chains and state channels are two common layer 2 scaling solutions approach blockchain developers utilize.
Side chains involve connecting a separate chain to the main chain and optimizing the connection to enable smooth interaction between the two. In turn, this will improve scalability and transaction speed. The state channels, on the other hand, involve leveraging smart contracts to establish interaction with the main chain. It doesn’t need a separate chain, and the blockchain only record the start and end of the channel.
- Consensus Mechanisms
Most blockchain platforms are transitioning from the energy-demanding and slow PoW (Proof-of-Work) consensus mechanism to a more energy-efficient PoS (Proof-of-Stake). Developers believe the PoW consensus contributes to the blockchain trilemma. New blockchains use a form of PoS consensus either fully or in tandem with another consensus.
PoS and other consensus mechanisms apart from PoW have yielded great results in ensuring platform security without sacrificing scalability or decentralization, and developers are exploring that as a solution.
The Blockchain Trilemma has been a core problem impeding blockchain technology from reaching its optimum potential. However, the increased awareness about the issue and concentrated efforts of developers towards solving it has grown exponentially over the years allowing substantial progress to be made giving hope that blockchain technology will fulfill its purpose of being the global technology to change the world.
Examples of the Trilemma
Bitcoin, Litecoin, Dash, ZCash, Monero – Decentralized & Secure, but not Scalable
Ethereum – Decentralized & Secure, but not Scalable until PoS, now it could solve it
Binance Coin, Solana, FTT, Ripple, Stellar – Secure & Scalable, but not Decentralized
Cosmos, Polkadot, Cardano – Decentralized & Scalable, but not Secure
Decentralization is the idea of spreading out power (decision making) between members of an organization, entity, fountain, company, ecosystem, or any other group of people / decision makers… however, in reality, as seen above, perfect decentralization is extremely difficult to achieve, which is why it’s helpful to think about decentralization as a spectrum.
For example, a single member LLC is one of the most centralized entities that could possibly exist as one person is making every single decision on behalf of the entire company and all of its fiduciaries. An extreme example of centralization in the public markets is Interactive Brokers, whose Chairman, Thomas Peterffy, has among the greatest share of ownership of any public company at ~78%.
On the other end of the above spectrum is Bitcoin, Ethereum, The Internet Computer, and other protocols / ecosystems that outsource decision making to a spread out consensus network or consensus mechanism. The important takeaway is that consensus mechanisms are supposed to be immutably set in code, meaning that they will execute the exact same way every time a request needs approval from the network in order for that “request (likely a decision or action) to go through.
The most common use case for decentralization is tracking data on a blockchain to create an immutable ledger that stores data so that it is transparent and can’t later be changed. This technology has become incredibly valuable and we believe will only get more valuable over time as the data driven economy continues to be built out both in and out of the web3 space. Our next article will go into more depth on some fascinating real world problems being solved with blockchains on a massive scale.
Even BTC, ETH, and ICP on the far right of the spectrum touch centralization in some way by the time they make it to your hands (the user). What we mean by this is that you are most likely purchasing these assets on your iPhone or MacBook from a very centralized company, Apple, of which large institutions hold over 59.5% (many of these large institutions are simply investing retail investors’ capital). Not to mention that the exchange you are purchasing those assets on is likely centralized too.
The other end of this spectrum, which we will talk more about in our next article, would be using solar power to plug in a StarLink to power your self-built computer to mine BTC and contribute to that decentralized network, purchasing as many of your assets as possible in BTC. However, even in this extreme example, the consumer is purchasing items from likely centralized companies (solar panels, WI-FI router, and parts for their computer).
Breaking down decentralization to a spectrum helps people understand it better, but most people still don’t understand just how big of a role centralization plays in their lives. This is because often there are actually major benefits to centralization that many people don’t talk about like having a strong leader to look to as a reliable decision maker. This is seen at all levels of organizations across the world from clubs to politics to Greek organizations to businesses; when it’s decision time and nobody wants to make a difficult decision, the entire group looks to one person, the leader, to be the one to decide on behalf of the group and to stand by that decision, even in the face of scrutiny.
Another way to help understand decentralization is to look at different industries as segments and different projects as individual ecosystems- this helps to classify where those respective things should lie on the spectrum of decentralization. The key takeaway to understanding decentralization is that everything is only decentralized (or centralized) relative to one another.
It’s interesting to us how misused the word ‘decentralized’ is, especially in the modern web3 space. Mostly retail but even business development folks working on startups make this mistake, and large-scale companies are guilty of the exact same thing.
Metamask is a great example of this in the sense that most consumers are under the impression that Metamask is a decentralized company because it advertises itself as so. For example, “The Decentralized Web Awaits” is displayed when opening the web extension.
While it’s true Metamask helps give you access to decentralized ecosystems and opportunities, in reality it was actually developed by a (relatively) centralized entity called ConcenSys Software Inc., a corporation based out of the east coast.
Decentralized Autonomous Organizations (or DAOs) are supposed to bring the best features of corporations to the blockchain, similarly using technology for governance. However, DAOs, companies, and even certain NFT projects are still supposed to be registered with a set of bylaws, operating agreements, regulatory agencies, etc.- but many aren’t right now- and once again, in reality, oftentimes people still end up taking domain over the “DAO,” meaning there is usually one person who initiates the set up, handles the formation, and keeps up with operations / organization (a leader).
FranklinDAO is a very interesting group at Penn that has figured this out better than any other group we have observed. FranklinDAO allows anybody and everybody to make proposals and for proposals to pass by majority vote, with everybody getting an even vote- decisions are finalized in code and everything is perfectly transparent.
We will explore NFTs, DAOs, and the spectrum of centralization when it comes to capital raising throughout our next two articles in more detail, but for now we would like to contend that complete decentralization does not actually exist unless you are looking at it in a specific context as even decentralized ecosystems rely on centralized infrastructure to operate in almost every possible scenario.
Our comment section and inboxes on Twitter, Instagram, and email will always be open if you would like to share any thoughts or push back on any of ours- this is a new and exciting frontier that is not well understood, and even though we spend a lot of time working in and researching this space, we recognize that we can always learn more.
Thank you for reading and happy investing!
The Black Mountain Investment Group and Jupiter Fund GP Team