Cryptocurrencies are becoming integrated into the traditional finance space. ETFs, bull markets, integrations of custody licenses in most major financial jurisdictions, and AI authenticity verifications have all been working to remove the stigmas associated with blockchains and cryptocurrencies. That being said, a lot of professionals in the traditional finance world don't seem to understand the ‘why’ behind people’s excitement about blockchain. In this article I will explain what decentralization is, the driving force behind blockchain’s value, to get traditional professionals up to speed.
We are all familiar with centralized organizations. Centralized organizations have barriers to entry and concentrate absolute power in the upper-echelons of organizations and governments. For example, we’ve probably all experienced banking frustrations over the phone or in person with tellers. Sometimes wires don’t land despite correct entry of routing and account numbers. We’ve all experienced a customer support person hanging up on us after waiting an hour on the phone. However the worst experiences related to centralization usually come from unspecified removal of access to funds. To this day, glitches in online interfaces can temporarily set your account balance to zero.
In all of these cases, we direct our frustrations towards the bank. Frustration towards a third party gate-keeping entity is a first clue that the entity is centralized: we have someone to blame. In fact, the bank has centralized power within itself as a centralized entity, because when you complain to the support line worker, they will tell you: “Hey, listen, I just work here, I don’t make the rules!” Thus, the ultimate decision-making power often lies in the hands of the compliance or operations department within the bank. However, the chain of command continues from there. Banks compliance and operations departments answer to ruling bodies within the presidential executive branch and also must conform to laws enacted by congress. It seems that nearly every centralized gatekeeper has an additional gatekeeper of their own.
Therein lies the issue with centralized entities: the unilateral ability to make decisions on your behalf and to your detriment. If they decide to freeze your account tomorrow, they technically can. If they decide to debit 10% of all Savings accounts, they technically can. More saliently, if they decide to over-invest liquid funds such that users cannot feasibly remove assets all at once, they technically can. Actually, they always do. Obviously there are checks and balances in place: licenses that require massive surety bonds, legal red tape, etc. Historically though these roadblocks have not always been particularly resistant to political turmoil. Add to this the KYC and fees associated with traditional banking, and you can see why users may feel dissatisfied with the constraints imposed by centralized financial systems.
So, what is a blockchain? Blockchains are just a type of ledger that does not have Delete or Modify functions. Ledger entries cannot be deleted from the ledger, nor can they be modified. Blockchains can be Read, you can view all previous entries, and new data can be Created, you can append new entries. This is contrasted by regular databases which usually offer CRUD functions: Create, Read, Update, Delete. Right off the bat, blockchains increase data transparency. Numbers can’t be fudged as easily and the added immutability makes the ledger easier to audit. That’s it, that’s what a blockchain is.
The star of the show when it comes to making a blockchain decentralized is something called a consensus algorithm. As described above, centralized entities operate using veto power and power of the majority. Decentralized entities, however, use the power of consensus. Decisions can only be made if all participating parties agree. In the case of a blockchain, those ‘decisions’ are which transactions to write to the ledger. Common consensus algorithms are proof-of-work and proof-of-stake, which you may have heard of, and they are complex, mathematical algorithms that guarantee that all entries are agreed upon by each participant before they are entered into the ledger. These algorithms are also sybil resistant, meaning that it would be prohibitively expensive economically for malicious actors to try and overtake the network and append false transactions.
The final step in making decentralized technology is making it public. Unlike centralized entities, there are no or low barriers to entry for someone wanting to interact with a public blockchain like the Bitcoin Network. You can join as a miner, meaning your computer is running the consensus algorithm for the network, thus keeping it decentralized, sometimes in exchange for a small amount of Bitcoin. You can join as a validator, meaning you verify that transactions are legitimate, thus ensuring the security and veracity of the network. Finally, you can just use the blockchain the way you would a regular bank and open a wallet (like a bank account.) Now that the blockchain has become public, there are additional benefits. Users are anonymous, peer-to-peer networking reduces middleman costs and allows for 24/7 transacting, and the assets are bearer so they cannot be compromised by a larger entity making decisions on behalf of the asset holder.
Obviously there is a lot of debate surrounding decentralization and the pros and cons of blockchain, but the philosophy of sovereignty that underpins modern public blockchains has compelled a lot of people to use cryptocurrencies as an alternative store of value. I hope this brief overview made sense!
