Core to the concept of “decentralized” is the idea that if any portion of a system gets knocked out, that its ability to operate will not be impacted – in other words, the service won’t go down. Rather, other parts of the system will be able to adjust and compensate for the issues being experienced. And that is at the heart of the decentralized vs. centralized debate with blockchain applications.
Decentralization is akin to democratization. Leveling the playing field so individuals can be on equal footing with larger enterprises and authorities – rather than being beholden to them. Whether that is in the realm of investing and finance, the music industry, real estate, games, and art, just to name a few – individuals are being given a level playing field and removing what have been the powerful middlemen and gatekeepers.
In blockchain and crypto – are the projects actually decentralized?
Maybe the only way to answer this is to say “YES”. Why? Because “decentralized” in crypto seems to mean “on the blockchain”. That’s where the data is stored. That’s why the conversation about “node distribution” takes center stage. Since each node is a full representation of what is stored on-chain – knowing that a blockchain has lots of nodes, operated by different entities, and distributed across different data centers and hosting providers, is the “decentralization” that is the subject of crypto project “decentralization”.
It’s the consensus protocol that determines any given block placed on the chain – and that data (block) is then replicated across every node – we now have an “immutable” record. Illicit or unauthorized changes of an individual node will not change the data on the other nodes. Given the consensus mechanism that determines what is written on the blockchain, compromising or changing one node is not going to work. There would have to be a coordinated conspiracy across all (or an overwhelming majority of) node providers to alter the data on the chain.
But beyond that, is there anything else that constitutes “decentralized”?
If we examine DeFi protocol decentralization, I think that they are “decentralized” mostly in name only – not in practical sense. What must be examined are their validator nodes, the number of those nodes can indicate the level or degree of decentralization. For example, in two protocols that were compromised recently, it was the node quantity (and likely some other things – check out our blog post on the hacks and exploits that have occurred) that enabled the protocols to be compromised.
Beyond the number of nodes, it’s also worth exploring how the nodes obtain their private keys, the levels of encryption, and where those are stored.
And the final aspect of this is to make sure that a large number of the validators are necessary to approve the transactions – not just a nominal number — which has proven is able to be compromised.
What about Decentralized exchanges?
Let’s explore how DEXes qualify as “decentralized”…
It’s simple – and it adheres to the model above. DEXs are collections of smart contracts that run on the blockchain. So by the definition above, they are “decentralized”. They also DO NOT take over custody or management of any funds (as centralized exchanges do) – instead, decentralized exchanges are peer-to-peer marketplaces where transactions are made directly via smart contracts. Peer-to-peer refers to a network that links together buyers and sellers.
Not all of a DEX is decentralized. The User Interface (considered a Web3 Application) is centralized – in that you access it in a centralized location or URL – (or via a mobile app) – but the “smarts” of the trading, the automated market maker logic, etc. is all done via smart contracts that reside on the blockchain. If it’s “on-chain” then it’s decentralized as it exists on every node in operation for that blockchain.
So the notion of “decentralized” as it pertains to blockchain is really a function of the number of independent “nodes” that are in operation. That’s why we see mention of the companies that operate one or more nodes, and the data centers where nodes are housed (like Amazon or Google), which could cause some concern about just how “decentralized” a chain (or a protocol) actually is. The more nodes run by independent entities across a broad swath of hosting providers, means the blockchain has achieved “decentralization” in the sense that if a major player went down, the entire blockchain wouldn’t also go down. And that the data on the chain cannot be messed with or changed by a rogue entity.
In addition, these DEXes don’t collect any user information – or I should say they don’t REQUIRE any of your personal information – all they know is your wallet address. This is very different from a centralized exchange that must collect extensive know-your-customer (KYC) information about their accounts or users, and are regulated by the government(s).
Web2 Apps are Centralized
I’ll start by saying that there are many systems that are in widespread use, and centralized – in that the company who offers the application, has full say in how that application is managed, and the rules for users to interact with and utilize the application. The company pays the freight for the servers on which the application runs, and the database that stores the data for the application. Their “employees” write and maintain all of the codebase, and it is not generally open source, but in a private repository, owned by the organization. Should the company go out of business, their applications would cease to function or be accessible.
Facebook, Google, Twitter, Salesforce.com, LinkedIn (owned by Microsoft), Medium (where a lot of crypto startups post their blogs), and Reddit, are all of them centralized systems – owned and controlled by a company. The source code that provides the functionality is not open source, but is proprietary and controlled by the company.
In the crypto realm, the main on ramps and off ramps (going to/from Fiat currency to a Crypto token like BTC or ETH or DOT or ….) are all centralized. Here in the US, Coinbase and Gemini come to mind. There’s also Kraken, Binance (and Binance.US), FTX, and more! All of them are companies – and centralized. Their source code is proprietary – and they make the rules for their platform.
As I mentioned above, In the U.S., these organizations all must implement KYC (know your customer) – in that they must collect your information, citizenship, and you must prove you are legitimate. Most of them have made it an easy process to get your accounts set up – but these are not “decentralized” applications; and their code is not open source.
What characterizes the Decentralized moniker for Crypto?
I called it out above… but in case you missed it, It’s the Blockchain itself (where the data is stored), silly!
If there is no central authority or organization, what makes the decentralized system “work”?
Decentralized doesn’t mean free. It means that those who utilize it, pay to store their data on the blockchain, and that payment provides remuneration to the entities who are operating the node and maintaining and evolving the blockchain in question. The node where the transaction was processed – or that assembled the block that through the consensus mechanism, got approved to be added to the overall ledger (i.e. the chain) – that node gets the reward or “payment” for their work. That’s how the token associated with a blockchain is utilized – to make payment for transactions that occur on its chain.
Decentralized doesn’t have to mean “on chain”…
While decentralized started as the notion of “stored on the blockchain” – that isn’t necessarily required. As blockchain applications have evolved, we’ve seen new “decentralized” architectures that assist necessary processing and functionality, but don’t store data on the blockchain in question.
These are widely considered “essential” functionality that are necessary to applications that need real-world processing speed and must include real-world data.
Going forward, likely most blockchain apps will be a mix of on-chain as well as off-chain processing (or side-chains), so a robust mix of essential functionality can be provided. Here are a couple of examples:
The Graph (GRT)
In the event that you need to query data on the blockchain, and don’t want to wait an eternity for your results – there are projects like The Graph (GRT) that is essentially indexing the data in blockchain(s) so that data can be easily queried. But these indices do NOT reside on a blockchain – even though they are in fact “decentralized”. The Graph is the web3/blockchain equivalent of Google. Get the data you need without having to troll through the data on the blockchain to find it. Decidedly necessary if we are going to have widespread adoption of Web3 applications that perform.
Another essential protocol that is foundational for Dapps, especially in the DeFi space, is the Chainlink Oracle Network. Essentially Chainlink provides real-world data in a format that smart contracts can understand. It’s a decentralized solution for pulling data from real-world applications, and aggregating and verifying the data that is provided back to the smart contract. It’s a terrific blend of integrating real-world data (centralized but multiple sources) in a decentralized manner (Chainlink has smart contracts that run on the blockchain, and can be called from smart contracts on the blockchain).
The architectures underlying both The Graph and Chainlink, are examples of decentralized systems that provide essential services to blockchain-based applications, so they can increase their throughput as well as have access to necessary real-world data critical for DeFi, and other blockchain applications to function well and at scale. And that’s just the start. More protocols are popping up and being developed that are adding to “essential services and capabilities” that are decentralized, yet “off-chain”.
Both The Graph and Chainlink are not blockchains in their own right. Rather, they have been extended to work with many different blockchains to provide their services for the chain in question, and have smart contracts that are on each blockchain they support, that can be accessed by applications on that chain, who need their specific services.
Their tokens (GRT and LINK) are used to “pay” for the utilization of their services, and then pay their “node” operators who service the requests. So while they are decentralized, they are not actually their own “blockchain”.
Will blockchain be able to maintain its “decentralized” moniker and get the performance needed for mainstream adoption?
The reality is that to create Dapps that scale and perform well, the decentralized storage on blockchain will be augmented with off-chain, side-chain, and possibly even some centralized services. If you’ve got a blockchain startup, or an idea that could be realized as an app on the blockchain – you want to make sure you’ve got experienced developers, who understand the architectures, and trade offs, so you have an app that can grow and scale.
The innovation and evolution will continue to provide ever more efficient services that will allow more advanced features and increased performance possibilities to be achieved.
As that evolution continues, it will likely be a “best of” answer that will combine on-chain, off-chain, side-chain, and centralized in the best architecture to achieve the project vision and have the ability to handle mass user adoption. At the end of the day, blockchains are for growing the users that utilize applications on their chain. Just like Microsoft vs. Apple – it’s about the user adoption!