Blockchain & Cryptocurrency #6: Centralization vs. Decentralization

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In this post we are going to talk about Centralization vs. Decentralization, which is one of the main features of cryptocurrencies.

Centralization problem

In the previous post, we constructed a cryptocurrency called Scrooge coin. It achieved a lot of what we want in a cryptocurrency based on a distributed ledger, except for one big problem. In fact, it relies upon a single centralized authority: Scrooge.

So now, the question we want to answer is: how do we de-scroogify this currency? How do we construct a decentralized version of it?

Decentralization

Decentralization is an important concept in general. In fact, this notion plays an important role for different digital technologies. And almost no system is purely decentralized or purely centralized and a good example of this is email. Fundamentally, it is a decentralized system. In fact, it's based on a standard spaced protocol, SMTP, that anyone can use. But, at the same time, we can see that there are a few different web mail providers that dominate the scene, which are sort of centralized service providers.

Bitcoin decentralization

This might be a good model for understanding what happens to Bitcoin. For Bitcoin we can start with some questions:

1. Who maintains the transactions ledger?
2. What is the authority that decides which transactions are valid?
3. Who creates new Bitcoins?
4. Who determines how the rules of the system change?
5. How do Bitcoins acquire exchange value?

In this post we will analyze the first three questions. When we say that Bitcoin is decentralized, we refer to these first three aspects. In fact there are other things beyond the protocol such as Bitcoin exchanges (conversion of Bitcoins into other currencies), wallet softwares and a variety of other services provided by specific companies. So, even if the underlying protocol is decentralized, these services, developed on top of it, may be centralized or decentralized.

Bitcoin network

The Bitcoin protocol works on a peer-to-peer network, where all the users are network nodes. To become part of the network it is enough to download a Bitcoin client that can run on every laptop or PC with enough disk space. Currently there are several thousands of Bitcoin nodes.

So, this really resembles to a peer to peer decentralized system. But that's not the only component of Bitcoin. There's also Bitcoin mining, that requires a very high capital cost. It's a consequence of how the system evolved. So, now there's a high concentration of power in the Bitcoin mining ecosystem, and the community frequently sees this as a possible problem.

Finally there's a third aspect: updates to the software. While one can conceptually imagine that every Bitcoin node will look at the Bitcoin specification, and maybe even create their own software, of course that's not how it works in practice. In fact, the community trusts the core developers. So they have a lot of power when it comes to determining what Bitcoin software each of these nodes will run on their computer.

In future post we will analyze further all this aspects, so stay connected! And of course follow, upvote and comment if you are interested in what we are talking about!