Is Decentralization just a Pipe Dream in the Crypto Sector?

Data & Research / 29.09.2020

When you think of cryptocurrencies, what comes to mind? Probably visions of decentralized networks that function in a peer-to-peer and trustless nature. The entire premise of Bitcoin is built around this belief that decentralization is at the core of the blockchain revolution. However, due to a variety of reasons, the majority of assets in the ecosystem today don’t qualify as decentralized. Sadly, many of the most popular cryptocurrencies function in a highly centralized manner that is akin to traditional central banks.

What Makes a Blockchain Project Decentralized?

There are a couple of key factors one can examine to determine the decentralization level of a project. The first thing to review is the project’s censorship resistance. If the project’s leaders have the ability to alter, delete, roll-back, or edit transactions directly, the project is centralized. What’s the difference between using a central bank and a cryptocurrency if both transactions are held to the whim of the controlling intermediaries.

Another critical point to decentralization is the ability to be free from project leader influence. There are many projects in the market today that are dependent on their figurehead remaining relevant. Whenever you have a situation where the founder is the figurehead of the project, there is an unbalance between the users and the organization behind the platform.

Centralized Nodes

As of late, newer blockchains have done away with the traditional consensus mechanisms and introduced hybrids. These versions improve transaction times by allowing only special nodes to validate transactions. These nodes act as the central controlling powers in this scenario. Consequently, these blockchains are not decentralized by any means.

Studies Reveal the Truth

The problem of centralization is worse than you think. A recent study conducted by the crypto research firm, Cryptocompare revealed some abysmal statistics in terms of market decentralization. The 80-page report titled a “Cryptoasset Taxonomy Report” analyzed over 200 different projects in the market. The report reviewed 30 key metrics to rank and classify each of the world’s top cryptocurrency projects at this time.

The report revealed that only 16% of cryptocurrencies qualify as decentralized today. More than half of the market, 55%, can be categorized as centralized or only partially decentralized. The report revealed that even among simple payment tokens such as Bitcoin and Litecoin, only 37% of the coins available today actually represent decentralized options.

Importantly, researchers analyzed these assets from a variety of perspectives. They delved deep into the projects and reviewed vital data such as regulatory classifications, access and governance, market cap and volume data, level of decentralization, and distribution and supply concentration. All of this information was used to make a determination on the final score of the project.

What Makes a Crypto Project Decentralized?

After learning the current state of the market, you may be wondering “What makes a crypto project decentralized?” Decentralized projects possess specific traits. They are open-source and don’t rely on a central issuer to function properly. All transactions are handled in a peer-to-peer fashion and there is no central organization to censor your payments.

Bitcoin is the perfect example of a decentralized network. For one, the platform is highly decentralized in terms of leadership. There is no figurehead aside from the project’s anonymous creator Satoshi Nakamoto. The chances of this individual coming forward now to regain control of the project are slim to none. In this way, Bitcoin is run by its community.

Centralized Blockchains

With so many projects in the market today that claim decentralization, it’s crucial to take a moment to examine what makes a platform centralized. Primarily, all centralized platforms will be governed or managed by a single group or organization. This group functions kind of like your central bank. They can approve, deny, and refund transactions as they deem necessary to keep the network functioning.

There are plenty of examples of centralized blockchains that are successful today in the market. Ripple is the perfect example of a centralized blockchain. For example, all 100 billion XRP was created in Ripple Labs. This fortune has remained in the Ripple vaults ever since their issuance with the firm periodically dumping large amounts to obtain revenue. Additionally, Ripple has all the options of a central bank. It can freeze customer balances if they desire or refund transactions. There is also a serious lack of node distribution within the network as well. Here are some other highly centralized blockchains in terms of leadership.

Decentralized Blockchain – Centralized Leadership

Where many projects fail today isn’t in their technological aspects but rather in their governance. For example, Ethereum’s biggest weakness is its centralized leadership. One could argue that much of Ethereum’s future success depends on Vitalik Buterin remaining involved in the project.

Additionally, there have been instances where Ethereum developers rolled back the blockchain to avoid taking major losses due to hacks. This event, in of itself, means that Ethereum can only ever be a hybrid blockchain at best.

Centralization in Mining

Another area of the market that needs more decentralization is in the mining sector. For over five years, miners have complained of increasing centralization in the market. The introduction of high-powered ASIC (Application Specific Integrated Circuit) miners has pushed Bitcoin’s network hash rate to over 70 million terahashes per second.

Sadly, the majority of this hashing power comes from one country – China. Reports have put Chinese mining pools control of the network hash rate at 70%. To make matters worse, the mining rig manufacturer Bitmain currently runs the two largest mining pools in the country. According to reports, it would currently only take collusion from four mining pools to successfully pull off some sort of mining-related attacks such as transaction censorship or a blockchain reorganization.

In a recent interview, longtime Bitcoin developer Matt Corallo spoke on the current state of centralization in the market. He explained that Bitcoin’s centralization is mostly in the mining pools. He went on to explain that when you look at mining itself, you see hundreds of players. He pointed out that it’s extremely rare for anyone to control more than a percent or two of the network hash rate at this time.

Centralized Exchanges

Another major area of centralization in the blockchain sector is exchanges. Since the dawn of the crypto market, centralized exchanges have been a major choke point for the sector. Exchanges such as Binance are by far the most common way for investors to buy and sell cryptocurrency. These exchanges act as a middleman in these transactions. As the middleman, they hold the responsibility to help traders find others in the market to transact with and to ensure that the transactions complete safely and in a timely manner.

Centralized vs Decentralized Exchanges

Centralized exchanges are the most popular option in the market today. These exchanges serve the all-important role of fiat onramps to the market. To accomplish this task, centralized exchanges must meet strict regulatory requirements. For example, all users must complete KYC and AML compliances. Centralized exchanges also hold their user’s funds in a digital vault. It’s this concentration of funds that make centralized exchanges a favorite target for hackers.

True DEX

Recently, a new type of exchange has emerged in the market. DEXs or decentralized exchanges operate without a central authority. In this way, they create a “trustless” environment for users to conduct transactions. These exchanges provide a true peer-to-peer trading experience. For example, assets are never held by an escrow service. Additionally, all transactions execute utilizing smart contracts and atomic swaps. Best of all, DEXs provide anonymous trading to users.

DEX Hybrid

The term DEX has seen some misuse as of late with exchanges claiming to be DEXs when they are really hybrids. For example, Binance DEX is billed as one of the top DEXs in the world. However, a closer look reveals the truth about this platform – it’s very much centralized in certain aspects. For example, Binance still has the power to take control of your assets, and they know your identity.

Additionally, the technical aspects of the project feature centralization. The project runs on the core blockchain of BinanceChain. In order to allow users to trade for popular cryptos such as Bitcoin, the protocol creates a pegged BinanceChain version of those popular tokens. This system requires users to put all of their trust into Binance. They must trust Binance to stay true to their 1:1 peg and they have to trust Binance to remain secure and not lose funds due to hacks. Lastly, the platform does require you to fully disclose your ID.

Threats to Decentralization

Another threat to decentralization is less obvious, loss prevention. The crypto market has always been a hotspot for hackers seeking to gain some ill-gotten gains. The overall newness of this technology and uninformed investors makes the industry ripe for hackers and scamsters. Sadly, hacking in the sector has gone up over the last couple of years. While these hacks are no doubt a major threat to the stability of the market, what platforms do to prevent losses is the real risk to decentralization.

For example, this month saw the popular exchange KuCoin fall victim to a hack that cost the company $130 million. Rather than take the losses and continue on its way, KuCoin reached out to its vast network of blockchain partners to help freeze all the accounts found to be associated with the hack.

Specifically, Orion Protocol has updated its smart contract to render $8.5 million stolen tokens obsolete, Covesting has frozen the $520,000 stolen, and KardiaChain has invalidated $9 million worth of tokens and the list goes on.

It’s understandable that KuCoin would do everything in its power to prevent such a major loss, however, the freezing of accounts in the decentralized economy is a no-no. These are the terms and actions of centralized systems. Words such as refunded, blocked, or erased, shouldn’t exist in a decentralized economy.

The ramifications of this decision could have far-reaching results moving forward. The more censorship that occurs in the market, the more regulators will feel entitled to force these actions if they feel necessary. There may come a time when regulators make blockchain project rollback transactions directly due to this dangerous precedent.

Decentralization – It’s Possible but not Easy

The goal of a decentralized economy is still a noble cause for the market. Keenly, it’s time to recognize that the blockchain sector encompasses a huge range of platforms nowadays, and most of these projects are centralized in nature. That being said, blockchains such as Bitcoin still hold their commitment to create a truly decentralized economy at its core.

David Hamilton aka DavidtheWriter is a long time Bitcoinist and cryptocurrency journalist. Currently, he has over a thousand articles published on blockchain technology. His expertise and experience makes him one of the most reputable writers in the sector.