This is Part I of a multi part series in which I will take an in-depth look at the role decentralization plays in Crypto Networks. In this article I will explore the tradeoffs between decentralized and centralized networks and the role decentralization plays in blockchain protocols. I will also highlight some of the key factors that influence how distributed a network is in both number of participants and power. The remaining parts of the series will be a collection of 6 case studies of existing protocols that explores the different strategies they have employed to decentralize their networks, how that has influenced the behavior of network participants, and some of the pros and cons of these decisions. Now let us get into Decentralization!
Decentralization is the essence of blockchain technology. Ever since the release of the Bitcoin whitepaper in 2008, the idea of a decentralized, peer-to-peer network for exchanging digital value has been the cornerstone upon which all other subsequent protocols have been built. However, it seems that the reasons why Bitcoin had to be decentralized from the start and what decentralization actually accomplishes are consistently overlooked. Instead, decentralization has become inherently associated with ‘good’ and centralization has become analogous with ‘bad’. Yet, decentralization is not binary, nor simply a state of being. It is a far more nuanced concept that comes with varying degrees and serves as a tool to meet a network’s needs.
Decentralization, and the degree thereof, influences everything from a blockchain protocol’s architecture and physical distribution, to how consensus is reached, and how network governance decisions (i.e what is updated and when, how incentives are aligned, etc.) is managed. ( A great breakdown of these different components of decentralization can be found here). Seeing as decentralization touches every aspect of a blockchain network, it is understandable why this is such a hotly debated topic. It is still far too early to tell which approach, or approaches to decentralization will prove the most optimal in the long-run, but there are a plethora of lessons to be learned from the strategies different networks have tried and the outcomes (culturealley, technically, and economically) of their decisions.
In an effort to provide a comprehensive overview of the ways protocols are approaching decentralization, I will present case studies on several blockchain networks and assess the strategies used to decentralize their network, the implications of these decisions economically, technically, and politically, and extrapolate some lessons learned. In sum I will explore the role of decentralization in the following six networks: Bitcoin, Factom, Cosmos, Celo, Terra, & Kusama (Polkadot’s experimental ‘Canary’ network). However, before we dive into the different shades and hues of decentralization, its first important to understand the goal of decentralization and the different factors that it influences in a blockchain protocol.
The Goal of Decentralization: A System’s Level Perspective
Systems are put in place to create a reproducible set of outcomes with constraints that optimize for certain criteria. Hence, when building a system, it is critical to identify the desired end goal and then what optimizations are needed. From this perspective, centralized systems and their distributed counterparts are simply different system designs optimizing for different criteria.
Consider the outcome that most crypto networks are designed for at the most fundamental level: recording digital transactions. Is this not the same outcome that more centralized payment processors seek as well? Both of these methodologies strive to maintain accurate accounts of all transactions they process. The difference, however, is in the design of these systems and what they are trying to optimize for. Centralized payment processors are designed to record as many transactions as possible, in the least amount of time, and do so by assuming total control of the process and responsibility for the data and its security. In short, these systems are optimized for speed and control. Decentralized systems, on the other hand, are meant to optimize for trust, immutability, and uncensorable transactions by giving participants sovereignty over their own data. The process of signing transactions, verifying they are legitimate, and arriving at consensus takes time. However, because of this, all transactions have finality, the ledger is immutable, and people have full control over their funds and what is done with them through their private key. Centralized systems like Visa can process over 60,000 transactions per second at peak demands, but take days to clear and they have the ability to freeze funds, move them, or edit the transaction history if they suspect fraud or otherwise. Hence, it is less a question of if centralization is bad or good, but rather one of the value of complete participation in a system by all participants and their ability to control their own funds.
Factors Influencing Decentralization
As you can see, decentralization is not simply a yes or no decision, but a design choice for a blockchain protocol that determines how the network will behave as it records transactions. So how do protocols factor decentralization into their network design? As we said earlier, decentralization touches every part of a crypto network and fundamentally shapes how it operates at scale. Consequently, it is important to understand a few of the key mechanisms by which protocols attempt to engineer and control the decentralization of their networks before we dive into an in-depth examination of the decentralization strategies of the six networks mentioned earlier.
Governance is perhaps one of, if not the strongest shaping forces in a blockchain network for how decentralization will propagate at scale. At a high level, governance refers to how network participants decide on what changes are made to the network and what needs to be done across the broader community. Governance decisions often result in changes to the code base for the network and consequently correlate with major updates, or hard forks. A network must decide if it will have on chain or off chain governance. If they elect for the former, they must decide on factors like how voting power is distributed, if all participants are included, and how proposals are made by network participants for network updates. This also brings with it a sizable technical investment as all of this logic must be programmed into the network itself. All proposals are written in code and broadcast to the broader community to vote on over a particular time horizon. If they elect for an off chain governance model they must determine what is made transparent to the community broadly, if they should include community members in decisions, or if only core devs should be included in the discussions on updates and product roadmap.
The financial incentives structure for how network participants are rewarded is another one of the strongest forces for shaping the decentralization of a crypto network. How a network rewards its participants defines how the network will perpetuate. One of Bitcoin’s innovations was creating an incentive structure for miners to ‘play by the rules’ this allowed the network to grow to the strength it is today. There are other factors to consider as well; are all participants rewarded evenly or is it only advantageous for a small handful? Are the largest investors in a protocol or top technical contributors the most rewarded (Think Proof of Stake or Proof of Work)? Are developer efforts rewarded in the community, or are only the core devs compensated? How a network answers these questions determines how wide a reach the network will have, how many different parties run their software, and the motivations behind the participants running their software. It also determines what kinds of technical contributions are made to the protocol and signals what types of projects or community members are valued.
Lastly, a network must decide if all of its participants operate at equal levels or if there are tiered classes of participants. For example, many Proof-of-Stake Networks have different layers of network participants that come with different levels of responsibilities, requirements, and rewards. Validators are rewarded for participating in consensus, investing in high quality infrastructure to support the network, ensuring network uptime, and handling updates and governance. Others, however, can still be rewarded by trusting their funds with a Validator and being proportionally compensated for the amount they ‘stake’. This provides the network with decentralization though may consolidate the majority of the economic and political power in a smaller cohort of participants. In other, typically proof of work, protocols participants are divided between miners and node operators. Miners are rewarded for their donated computing power and while node operators are not directly compensated, they chose what version or fork of the software to follow and thus can control the outcomes of software updates (see BIP 91 and SegWit2x). If miners want to increase their economic rewards, they must invest into more of the same infrastructure, but this seldom comes with added responsibilities like governance as is seen in a more tiered infrastructure like the proof of stake model. Instead any committees or pseudo governance structure tend to be a self-formed group of motivated participants who work together on upgrading and evangelizing the protocol.
As you can see, there is much for a network to consider as it attempts to engineer decentralization into its network, and this is just scratching the surface. In the next article, I will start diving into the case studies surrounding different networks’ approaches to decentralization. I’ll go back to where it all began with the Bitcoin network, and assess how the network decentralized over time, what approaches it took, and how that has translated to the network being what it is today.