If you’re going to invest — your time and/or money — in blockchain because it’s “decentralized” then you should probably have some working criteria for qualifying projects that are “really decentralized” vs. “sorta decentralized.” Let’s explore “decentralization” and see if there are any useful frameworks for understanding the concept.
Blockchain technology brings two specific feature innovations to networked computer systems:
(A) a decentralized immutable environment
(B) a tokenized program of incentives
It’s important to understand true blockchain technology requires that there be complementary implementation of both features within an open-source framework. This is because a cryptographically secure environment spread across various computer systems (laptops, desktops, etc.) must use some mechanism for infrastructure maintenance. The only program that currently incentivizes such maintenance is the cryptographically secure token model.
In the most general sense, implementation of these systems can be broken up into two categories: public blockchains and private blockchains. We can think of public blockchains as environments that are openly accessible and private blockchains as closed-off environments. Neither of these systems are inherently good or bad. It’s best to think of them as tools designed for different jobs (i.e. Philips vs. TORX screwdriver).
Public Blockchains
A few individuals have made attempts at nailing down a functional definition for decentralization. Vitalik Buterin, the co-creator of the ethereum protocol, brought some clarity to the debate last year. The two most useful measures are enumerated below:
- Architectural decentralization is concerned with the physical infrastructure of computer systems that makeup the blockchain protocol. An extremely centralized architecture (i.e. database on single server) requires the shutdown of just one node for the whole system to fail, while a decentralized architecture can tolerate many failures.
- Political decentralization is concerned with the governance model that manages the blockchain protocol. An extremely centralized governance model (i.e. president with absolute power) can influence the shutdown of the whole system, while a politically decentralized system is less susceptible to the whims of autocracy and is theoretically more democratic.
A truly decentralized system, however, is still not the paragon of blockchain technology. This is because architecturally decentralized systems take time to propagate through the network (i.e. they’re painfully slow) in order to achieve single state consensus. At the moment, an ideally decentralized blockchain protocol can handle a very limited number of transactions per second (tps).
For example, the Bitcoin protocol manages only 7 tps. To address this problem, a variety of scalability solutions are currently being developed. Zilliqa, for instance, is developing a solution called “sharding” — not to be confused with a rare bodily mishap — that should significantly improve tps.
Some blockchain protocols do promise increased throughput or “efficiency,” but deliver this at the expense of decentralization. As a result, a variety of potential problems are augmented:
- Increased risk for system failure
- Greater attack exposure
- Collusion vulnerability
This then becomes a game of tradeoffs. The gains made in network efficiency are, in some cases, worth this sacrifice — as we will now touch upon for private blockchains…
Private Blockchains
These closed, more centralized, systems do not require complimentary implementation of both feature innovations. Instead, they can be designed around just a single feature.
For instance, a traditional enterprise software company can implement an architecturally decentralized network of servers that host a cryptographically secure environment (i.e. database) and then bill itself as “the new cloud” or “distributed ledger.”
The same company may also incentivize the usage of specific services on their platform using a cryptographically secure token and call it “e-gold” or “coins.” Those investors taken-in by such companies — with claims of “the next big efficiency breakthrough” — have only themselves to blame.
A wonderful example of a closed blockchain system is the Chinese owned company NEO. Some have heralded NEO as the new alternative to Ethereum. After all, NEO offers roughly 1,000 tps compared to Ethereum’s 20 tps.
Yet in October of last year, without notice, there was a network-wide blackout. An event such as this can only take place with heavily centralized systems. The real question now is where does NEO actually fall on the spectrum between centralized and decentralized? There are some clues:
NEO currently has 7 nodes architecturally decentralized under some ambiguous political leadership. On the other hand, Ethereum has roughly 15,000 nodes architecturally decentralized under the control of various political regimes.
This is not to say NEO is absolutely without utility. The protocol may have plenty of use cases. For instance, totalitarian regimes (i.e. China, Russia, etc.) require centralized oversight and can likely make good use of such a system. Likewise, enterprise companies tend to operate under a similar framework and could benefit as well.
Investors must ask the difficult question: How much of NEO’s $12 billion market valuation is the result of rampant speculation vs. credible network value? A clear answer is still lacking because centralization introduces tremendous uncertainty into the value equation.
Final Thoughts
Public blockchain protocols are, generally, easier to valuate for two reasons:
- Greater decentralization reduces a variety of risks (see above).
- Greater decentralization should result in infrastructure tokens that more accurately reflect value inherent to the whole network.
Tom Lee of Fundstrat Global Advisors believes that the bitcoin protocol layer can be valued using the logarithmic function of the number of wallets. All this means is that the more public keys (wallets) are created to store some bitcoin, the more dollar-value bitcoin should hold.
There is another method for valuating network decentralization. For instance, Balaji S. Srinivasan of Coinbase has proposed a minimum threshold measure of system-wide decentralization by quantifying different subsystems of open blockchain protocols. This measure has been tentatively dubbed the “Nakamoto coefficient” and can be read here.
In my opinion, a quantifiable measure for decentralization is still an insufficient measure of protocol value. Future models will likely require an interdisciplinary approach combining game theory, blockchain engineering, cryptoeconomics, and traditional methods. It’s getting weird…
