Different levels of decentralization in cryptocurrency
Decentralization is the key feature of cryptocurrency, but not every crypto has the same level of it. Some have more than others, and many crypto believers are critical of coins like Ripple that have a more centralized approach. At the same time, bitcoin has often been considered one of the most decentralized, leading to its popularity along with the fact that it was the first to market.
But with all these variations in the level of decentralization, is there a way we can measure and express it mathematically? As it turns out, there is a decentralization score (DS) that can be calculated for any financial instrument. We can compare cryptocurrencies by comparing their DS values.
Factors at play
Without getting too deep in the mathematics, there are several different calculations that can be made to create a DS. One that is often used is the Herfindahl–Hirschman Index, or HHI. This formula measures the decentralization level using market share and number of users, but it really doesn’t tell the full story.
Many other factors must be considered to truly get a full picture of the level of decentralization of any single cryptocurrency. A truly decentralized cryptocurrency will have a wide user base, a large number of nodes that are trusted to validate the blockchain that underpins the currency, and either a large leadership group or true open-source ownership.
Company owners have to have control over to the user base and open-source developers if they want to truly be considered decentralized. Let’s take a look at a few popular cryptocurrencies and compare all the factors that one should consider when comparing level of decentralization.
As of this writing, there are over 10k public nodes in the bitcoin network, down from a year ago when it peaked at over 12k. Each and every node records the network data and helps to verify transactions. This makes bitcoin’s distributed ledger one of the most decentralized of all the cryptocurrencies.
From the leadership perspective, bitcoin has high marks as well. With its creator Satoshi Nakamoto remaining anonymous and unlikely to reappear to take control, it is hard to see any one entity controlling this first cryptocurrency.
With a similar number of nodes to bitcoin, Ethereum has a good level of decentralization as well. While bitcoin’s nodes are concentrated in China for the most part, Ethereum has a more even distribution as detailed in a Cornell University report.
But that only tells part of the story, as each blockchain uses a different verification method for transactions. Bitcoin’s Proof-of-Work method means that each node has to spend resources to approve transactions, while the Proof-of-Stake method that Ethereum uses just requires nodes to agree with transactions. Many feel this leads to more risk of intervention, and Ethereum’s success hinges on creator Vitalik Buterin staying with the company, leading to a less decentralized leadership structure.
While positioned as a cryptocurrency, the moniker doesn’t really fit if you consider decentralization. All XRP tokens were created and generated by the parent company, and Ripple gateways have the ability to freeze customer accounts.
Even though it’s based on a blockchain architecture, there’s really very little that is decentralized about Ripple. The parent company has strong executive leadership who control every aspect of the currency. Major banks around the world are using Ripple to underpin financial transfers, contributing to a weak decentralization score.
Other popular currencies
With thousands of nodes, Litecoin has a decent level of decentralization but suffers from centralized leadership. Neo’s nodes are almost all controlled by the parent company, leaving it low on the decentralization list. Monaro has a fair number of nodes, but a strong central leader. Stellar is run by ex-Ripple executives, and has a similar architecture — leaving it only marginally more decentralized.
What is the point of having a decentralized cryptocurrency and trading it on a centralized exchange? Choosing a decentralized cryptocurrency exchange is a key part of supporting a decentralized ecosystem. Several high profile hacks of exchanges such as Mt. Gox and Bitfinex have spooked investors and led to the rise of more decentralized exchanges.
Some key elements of a decentralized exchange (DEX) are the following:
– Users’ full control over their crypto funds
– No single failure point like a centralized server
– Lack of third-party partners
– No government interventions possible (i.e. not being vulnerable to being shut down)
– No control by a single company or group of companies
– Privacy and anonymity for users
Using a DEX limits the risk of losing your crypto to a malicious attack, but they can have their own risks associated. Research your options closely and choose the most trusted ones you can find.
Decentralization and the future of cryptocurrency
While decentralization is one of the key tenets of the idea behind cryptocurrency, future solutions must integrate robust anti-money-laundering, anti-terrorism and know-your-customer systems. While true decentralization is desirable, for widespread adoption these controls have to be robust.
The real winners in the future of crypto will be the ones that strike the best balance between these factors, and keep control of the system in the hands of the users.