Decentralization and Crypto: The Perfect Match

Cryptocurrencies, given their coterie of distinct features, hold the capacity to transform the global economic landscape fundamentally. A discerning look reveals to us that, despite their volatility, they are a unique financial technology and share several characteristics with their traditional counterparts but can also be used as platforms for developing far more sophisticated financial/investment products and beyond. One feature that sets cryptocurrencies apart from conventional fiat and other digital currencies is that they are decentralized, i.e., controlled by none and all.

Confused? Let’s binge on some explanations before discussing why cryptos and decentralization are the perfect matches, especially for the upcoming web3 era of the internet.

The Advent of Cryptocurrencies

Let’s thank the 2008 global recession for the advent of cryptos. In 2009, one pseudonymous individual, Satoshi Nakamoto, decided to take matters into his own hands and wrote a paper titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ presenting an alternative to the inefficient and heavily centralized banking systems. The Bitcoin whitepaper literally defined how to take the matter into our own hands, talking of a monetary system (peer-to-peer network) where the ultimate control would be in the hands of individuals with no intermediary or central governing body dictating the terms.

The concept of electronic cash wasn’t new in 2009, too, but there was a significant roadblock - the ‘forgeability’ of electronic information, which could easily lend umpteen power to bad actors to create money out of thin air. The systems also relied on centrally managed systems and were vulnerable to hacks. Nakamoto’s paper had addressed all these concerns via the concept of decentralization (though the word was never mentioned in the paper, only the term peer-to-peer system was mentioned).

The Bitcoin paper talked about the peer-to-peer network that cryptographically chain-links transaction records and places them on a decentralized network of computers which we now know as the Blockchain. The blockchain, via its decentralized, self-propagating network, became an immutable and transparent ledger that could be used to support umpteen possibilities in the future - cryptocurrencies being one of them.

Taking Bitcoin as an example again: the decentralized network allowed users to store and transfer value, i.e., it effectively functioned as a bank. Also, it was almost impossible to hack or shut down the network being spread across computers, each having its individual copy of the database. And there was no longer a need for a trusted third party to verify transactions.

Today, there are thousands of cryptocurrencies functioning on decentralized blockchain networks, each solving a unique use case. Cryptocurrencies can function as a commodity, security token, asset, native token, or simply as a currency.

Why are Cryptos and Decentralization Well-matched?

To know the feasibility and utility of any cryptocurrency as a good financial network, we can measure its decentralization spectrum. In simple terms, the more decentralized a cryptocurrency is, the more stable and secure it will be. This is the sole reason why the Bitcoin network is considered one of the most secure crypto networks in the world, being based on a Proof-of-work consensus mechanism where each individual can be an equal participant in the network.

A cryptocurrency ICO and coin issuance in which a high proportion of the coin issuance is pre-distributed to a few insiders cannot be considered fairer and is more towards the centralized spectrum. Cryptocurrencies like Yearn. Finance had no pre-mined or distributed issuance and could be considered decentralized in the truest sense. The node count and network hash rate are also good determiners of the level of decentralization in a crypto network.

Cryptos as Decentralized Social Networks

Cryptocurrencies will fuel the decentralized economy of web3 and metaverse where we will exist in our digital avatars - an extension of our physical realities. Amidst the ongoing Defi boom and the growing relevance of DAOs, social networks of users of a network and the people participating in a particular ecosystem are becoming even more significant concerning the decentralization spectrum.

As the user base grows, so do the technical opinions on the system, making the system’s software more robust and likely to survive. With a greater number of reviewers and coders on a DAO or Defi platform, errors and wrongdoing can easily be caught and corrected.

Economic Relevance of Decentralization in Cryptocurrencies

Cryptocurrencies mark the ascent of independent, decentralized, “government-free” global money into the world economic order.

If we look at purely the currency aspect of cryptos, decentralization allows cryptocurrencies to bank the underserved and unbanked population. Globally, there are some two billion unbanked people that could become a part of the global economy using just their smartphones.

Cryptocurrencies have low adoption costs and are divisible into small fractions, and require practically no minimum eligibility criteria.

The unbanked populations are not restricted to third-world economies. Developed nations such as the US have a sizable unbanked population. We are already witnessing an increasing acceptance of cryptocurrencies and efforts for their subsequent regularization at state levels. Cryptocurrencies could add synergies by bringing greater financial inclusion and additional tax revenues for the state.

Additionally, being decentralized, they offer an alternative avenue to preserve, manage, and transfer wealth. No wonder cross-border remittances are increasingly being done via the crypto route.  Also, cryptos offer a hedge against inflation, unlawful government seizures, and the associated political risks that can dismantle the financial standing of any centralized currency, but not that of cryptos.

With Defi, cryptocurrencies have found several use cases in alternate banking and financial services, given their decentralized nature - the biggest of which is lending and borrowing. Users can earn much more interest on their crypto holdings than regular bank deposits.

Many cryptocurrency platforms are now the new crypto banks providing a gamut of banking services. For instance, BlockFi offers interest-bearing accounts like banks. Kraken Bank, which will soon undertake retail deposits, and Compound, a decentralized automated lending and borrowing system are some other examples. These Defi platforms have been designed to become independent from their developers over time and ultimately be governed by a community of users holding the protocol’s tokens.

Decentralization does bring some inefficiency to the blockchain protocols- like low transaction throughput and higher costs per transaction which adds to their inadequacy to be adopted as public infrastructure. But cryptocurrencies are still an evolving class of digital assets.

While we have veterans like BTC and ETH bringing in upgrades to enhance their speed and scalability, protocol networks like Cardano are already proving their mettle as highly energy-efficient, interoperable, and fast networks, in league with traditional financial systems, without compromising on network security and user privacy.  Despite their shortcomings, cryptos and decentralization survive in a symbiotic relationship and have gathered enough economic momentum to change and transform how we spend and transact money.