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Decentralization vs. Centralization

Nov 24, 2022
10m
Rosalia Mazza Ariel Monjes

Centralization and decentralization are well-known topics in the traditional business space. Blockchain technology takes both of these to a whole new level – but with any technological development, there are both pros and cons. 

What’s the Difference Between Centralization and Decentralization?

Centralization is an organizational setup that involves a central authority that manages the entire system. Many businesses – especially traditional ones – use this model. However, the biggest concerns surrounding centralization are a lack of privacy and security.

In decentralized systems, the management process is spread among different people. As a practical example, traditional businesses that use decentralized systems tend to divide a company into different sectors, managed by different authorities, leaving important decisions to the managers of different segments of the business (instead of giving full power to a unique entity). 

Centralized systems have a central authority and management system. In traditional decentralized structures, many participants are in charge of decisions for specific sectors. 

Decentralized structures are not new to traditional systems, but blockchain has dramatically improved this structure. The system functions as a network of participants that work towards a common goal, even if participants don’t necessarily know each other, don’t need to constantly communicate, and don’t need to be in control of specific subsectors. 

For these reasons, blockchain technology has been utilized to create more inclusive systems that are in line with people’s needs, as well as to solve some concerns (especially surrounding trust). 

Even when they’re decentralized, traditional structures need to rely on trust, and users need to trust those who run these structures. This can become a pivotal concern when it comes to sharing private data. 

A few examples of decentralization: 

  • The first DAO (Decentralized Autonomous Organization) is named “The DAO.” It was launched in 2016 and managed to create a whole new concept for how businesses can be run. 

  • The transition from Web 2.0 to Web3, which we’re still witnessing, 

  • The launch of the first generation of decentralized exchanges (DEX) in 2014. 

How Blockchain & Web3 Have Improved Decentralization

Even though it wasn’t the first cryptocurrency, Bitcoin is the coin that made blockchain technology popular. From a technical perspective, Bitcoin took many characteristics from the first attempts to create digital money using cryptography (like Bit Gold and HashCash). 

It’s the oldest cryptocurrency still in existence, precisely because it revealed some of the main disadvantages of centralized systems. Born after the 2008 financial crisis, it wasn’t just a payment method: Blockchain and its underlying technology allowed for full decentralization and control over financial assets. 

Bitcoin’s initial goal was to improve financial privacy and allow people to make transactions without intermediaries. Peer-to-peer (P2P) transactions are still the main purpose of Bitcoin, but in the years following its release, the crypto space, and blockchain technology have made great strides in numerous industries and sectors (e.g. financial, healthcare, real estate, supply management).

They’ve also found more applications in everyday activities. Following the principles detailed in Bitcoin’s whitepaper, a major advantage of blockchain is its capability to protect people’s privacy and independence. As a result, blockchains can be used to improve activities where privacy is a major concern. 

A practical example of this is the transition from Web 2.0 to Web3 (where users are reclaiming ownership of their digital presence and identity). 

Improved Security & Scalability 

To use most Web 2.0 services, intermediaries are required to access websites, provide our data, and verify our identities. Since inclusivity is its main strength, blockchain technology is the perfect fit for decentralization: It allows the creation of scalable, secure systems where anyone can participate. 

Blockchain provides people with a secure alternative to centralization – and Web3 is one of the main systems benefiting from this technology. The newest version of the web shows us that blockchain is flexible enough to create inclusive systems where users can have control of their data, despite certain disadvantages (more on that below).  

Web decentralization means that people don’t need to rely on any intermediary – and that data doesn’t need to rely on the security of centralized databases. 

Blockchain is the perfect technology to lay the foundations for Web3, ideated by Ethereum co-founder Gavin Wood. Here, the control of the web isn’t in the hands of a few big companies that collect user data: It’s a web that’s owned by those who actually use it, and they can decide to interact with it (without having to share sensitive information).

Web Navigation

Blockchain and Web3 improve decentralization by integrating a common use case: web navigation. 

From the user’s perspective, navigating Web3 is not different from navigating Web 2.0 services. The difference lies in how data is managed. 

To navigate Web3, users need to connect their decentralized wallets. They can use the decentralized applications (DApps) with their public address, which works as a pseudonym that doesn’t reveal any sensitive data. Moreover, since DApps are based on blockchains, it’s not necessary for them to use third-party services in order to store users’ activity.

Are There Centralized Blockchains? 

Some blockchains may be centralized. It might sound weird, but a blockchain is just a database made up of a chain of blocks of transactions. No one can prevent you from creating a private blockchain. 

Private blockchains are still distributed but not decentralized, and there is a pivotal difference between decentralization and distribution. While distribution means that the computational activity needed to maintain a blockchain is spread across multiple entities, decentralization means that no one can control the activity of another participant (i.e. everyone acts as an independent entity). 

Centralized blockchains still have an entity in charge of controlling the activity that occurs on the blockchain. While they can decide who’s allowed to participate, they benefit from the security of distribution. 

Vitalik Buterin and The DAO Case

It’s interesting that Vitalik Buterin addressed the difference between distribution and decentralization. He’s the protagonist of one of the most controversial cases in the history of blockchain technology. 

In 2016, one year after the launch of Ethereum, the decentralized network was used to build “The DAO” (the first Decentralized Autonomous Organizaton [DAO]) which was later hacked. The cause: a bug in the smart contract that governed it. 

What is a Decentralized Autonomous Organization (DAO)? 

A DAO is a system that organizes participants around a common goal in a decentralized way, using smart contracts and crypto. DAOs can have their own treasuries, act as legal entities which can own assets of any kind, and are governed entirely by their communities. 

With the intention of giving investors their money back (about $50 million), part of the Ethereum network followed Vitalik Buterin’s initiative to hard fork the mainnet. The hard fork was implemented to use a fail-safe mechanism integrated with The DAO, allowing it to block funds for 30 days. The forked chain would serve to reverse the rules of the smart contract used to govern the DAO, then move the funds to a recovery address. 

While part of the network adhered to the forked chain, another part continued using the original mainnet, renaming it Ethereum Classic. This happened because blockchain purists considered it wrong to manipulate the blockchain –even if the fork was implemented to prevent the failure of a revolutionary project like The DAO. 

After the hack, many people started arguing that blockchains could realistically be altered. But tamper evidence – and the impossibility of manipulating them – should be two main pillars of blockchain technology. 

However, Vitalik Buterin needed the approval of at least part of the network to keep the forked blockchain alive. In a centralized system, he could have made the decision for everyone. 

Pros and Cons of Centralized and Decentralized Structures

Pros of a Centralized Structure

The DAO hack provides a good opportunity to reflect on some of the advantages of centralized organizational structures. 

1. Easier Decision-Making Process

Centralization can be useful in systems that benefit from quick, unilateral decisions. In a centralized structure, a project owner has the ability to make decisions autonomously (or at least to reduce communication with collaborators). Changes to the project or its goals can be implemented more easily. 

Compared to a DAO, a centralized organization would often be much faster to make decisions and act. A DAO would require time-consuming public debate and voting.  

2. Lower Costs 

Centralized structures can be predetermined and can easily adhere to costs planned in advance. Moreover, since each member has specific responsibilities, it helps to avoid the duplication of roles within the organization.  

3. Hierarchy of Commands

In centralized structures, everyone has a specific role and responsibilities. The entire structure can be built according to a specific chain of command, improving organization, delegation, and awareness of collaborators’ responsibilities. This can also reduce conflict among team members.

Cons of a Centralized System

On the other hand, centralized systems also have downsides. 

1. Trust

In centralized organizations, collaborators need to trust each other and users need to trust projects. As long as the project works correctly and ethically, trust should be pretty straightforward. However, if the project runs into issues, a collaborator doesn’t work properly, or a customer isn’t satisfied with the project, trust is negatively impacted.

2. Poor Security

We’re not saying that centralized organizational structures aren’t reliable or secure, but it’s important to consider that the centralization of a structure involves data and transaction management. Centralized systems use centralized databases, meaning that bad players can attack a single database or server to derail projects. 

3. Limited Scalability

When it comes to scalability and expansions, centralized structures incur higher costs, potential geographical boundaries, and they don’t rely on the power of countless participants (that could otherwise join a decentralized system). 

Pros of Decentralization in Crypto

After considering the pros and cons of centralization, let’s focus on its counterpart.

1. Security

Security is a huge advantage of decentralized systems. Not only do they use cryptography to secure data, but every participant who wants a copy of the ledger can obtain it. Even in case of an attack, data isn’t lost and the source of the attack is quickly made evident. 

2. Inclusivity

As long as a blockchain is public – and the network can be joined without any permission from centralized management – everyone can be a part of it. This means obtaining voting rights according to the organization’s structure, verifying the activity which occurred on the blockchain, and easily using products and services offered by networks (based on this kind of blockchain). 

3. Control

Blockchain-based decentralized networks have full control over their projects. This is because they don’t need any intermediaries, thus reducing costs and trust requirements. It also helps to eliminate external influences on project management. 

4. No Need to Share Sensitive Data

Traders can use decentralized crypto exchanges without having to share any details. They only need to connect to a decentralized wallet. Advantageous for privacy and inclusivity, people can access financial accounts (despite their credit history), borrow assets, and control their financial activity without having to deal with a bank. 

Cons of a Decentralized System

Despite the advantages of decentralization, some drawbacks need further attention. 

1. Illegal Activities

Pseudonymity (and full anonymity in some cases) favors illegal activities on decentralized public blockchains. Since people aren’t required to share personal data, it’s extremely hard or even impossible to identify responsible parties when such events occur. 

2. Higher Costs to Set up Necessary Systems

Ecosystems of decentralized applications built on the blockchain, primarily rely on smart contracts to function. This allows for automation, full control, and inclusivity. However, with decentralization, the cost of development rises due to an increase in complexity. This also makes processes like auditing more difficult. For instance, developing a custom decentralized exchange from scratch could cost hundreds of thousands of dollars. 

3. Higher Volatility

Blockchain-based decentralized projects use cryptocurrencies to fuel their internal economies but these cryptocurrencies often experience high volatility. 

Since there’s no centralized management, it can be hard to attract institutional investors (which tend to rely on the reserves collected by centralized structures). 

In fact, CEXs collect and store the funds of all their traders: this centralized mechanism makes it possible to show traders and investors an order book – a sort of electronic ledger where you can see buy and sell orders, and to collect larger quantities of assets – which make it difficult to manipulate the market and to experience high levels of volatility.

It’s also harder for DEXs to attract as many everyday traders, especially since they’re less user-friendly when compared to their centralized counterparts. This slows down the adoption of such technologies and reduces the available amount of liquidity for the market, leading to volatility-related issues. 

4. Less user-friendly

Knowledge and experience in the crypto space are still considered entry barriers to decentralization, thus preventing wide adoption of decentralized structures. 

For example, decentralized exchanges for trading cryptocurrencies aren’t the first choice of crypto beginners. Users need to be in full control of their accounts, know exactly how exchanges work, and understand how to connect their wallets to the exchange. And since DApps lack support teams, owners, and managers (except for their communities which can sometimes offer support) – if you experience issues – you’re left to fix them by yourself.

5. Conflict

When more users have the same voting power, it’s easy for conflict to arise. That’s especially true when they’re contributing anonymously to a decentralized system. 

The DAO hack is a prime example of how simple disagreement can split a community. This isn’t always a negative element: Healthy disagreement results in constructive debate, which can often lead to innovation and progress. 

What’s Next for Decentralization?

Decentralized systems – as well as blockchain technology – are still under development. 

There are many issues that need solving, but there are numerous projects already working on them. 

Actually, there are already examples of decentralized verification systems. These can be used to maintain customers’ privacy while still being able to identify them (in order to mitigate illegal behaviors). Or interoperability-related crypto projects which make the sector more convenient for developers, business owners, and everyday traders. 

While there’s so much left to discover and improve about decentralization (and the use cases made possible by blockchain technology), one thing is for sure: Thanks to inclusivity, decentralized systems are here to stay. 

Sonar is a project that aims to solve blockchain-related issues – especially by giving users all the information they need to improve their knowledge and understanding of this disruptive technology.

We’re building an all-encompassing ecosystem of Web3 tools to help you become a better investor and have fun in this exciting new space. 

 

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