Investing

Why Decentralization Is Crypto's Greatest Strength and Greatest Threat

24/7 Wall St. Staff

Published: March 31, 2022 9:52 am

By Peter Daisyme

Decentralization is the future of finance, at least for the world’s cryptocurrency investors. There’s no question that decentralization holds many advantages over centralized organizational control; it’s one of the biggest reasons why cryptocurrency has gotten popular in the first place.

But how exactly does decentralization work, and does it also hold drawbacks?

What is Decentralization?

Decentralized finance, otherwise known as DeFi, is all about moving away from centralized authorities and toward a distributed network of participants. So, for example, rather than having a single bank or credit agency decide whether an individual is creditworthy, you can call upon a distributed network of people to verify a piece of that person’s creditworthiness.

In the world of cryptocurrency, decentralization is the basis for operations. Bitcoin and most other cryptocurrencies rely on the blockchain. The blockchain is a distributed ledger technology that allows financial transactions to be recorded. Then, it is verified by millions of different, independent devices, all working as individual nodes in the broader system.

Rather than having a significant financial institution setting direction and overseeing operations, millions of participants build cryptocurrency networks and manage them from the ground up.

The Power of Decentralization

Let’s take a look at some of the best advantages of decentralizing your financial system:

Independent control and decision-making.

Decentralization allows you to maintain independent control and decision-making. The direction and future of your system aren’t dependent on the integrity of any single authority. If a single authority ever becomes corrupt, damaged, or compromised, the entire organization has the potential to collapse. But a system without any corruptible authority can maintain better protection and independence.

Trustless connections.

Cryptocurrency is built on a system of trust-less connections. You don’t need to trust an individual device to know that it has verified a transaction accurately; instead, you can trust the emergent wisdom of thousands or millions of devices working together to keep each other honest. No individual bad actor can possibly compromise this system.

Better data reliability.

Data reliability in a traditional financial system is questionable, as each stage of the data storage and exchange process opens the door to opportunities for fraud, corruption, and decay. For example, when one company sends data to another, they typically store it in a data silo. And, it only emerges when someone needs to transfer it. Distributed networks, by contrast, allow for more transparency and data integrity.

Fewer vulnerabilities.

In many ways, decentralization leads to distributed vulnerabilities and, therefore fewer vulnerabilities. As stated in a previous point, the system of trust-less connection inherent in most cryptocurrencies disallows for the possibility of a single bad actor forging a transaction and corrupting the system; instead, more than 50 percent of the nodes in the network would need to cooperate unanimously to gain influence over the system. The larger the system, the smaller this possibility becomes. The distributed network model also minimizes potential threats. This is because even though attackers may threaten or ultimately compromise any single node within that network, it still wouldn’t jeopardize the overall system.

Resource distribution improvements.

Distribution has the potential to improve resource allocation within the system as well. Distributed networks can engage nodes, as needed, to produce the most consistent performance. Though, as we’ll see, distributed blockchain performance also struggles because of how it interacts within itself.

Financial independence.

People also like the appeal of total financial independence. Because of cryptocurrencies like Bitcoin, they don’t necessarily have to go through a bank to finance a major purchase, nor do they have to create an audit trail that infringes on their privacy. Individuals within the network can exercise much more independent decision-making.

Possibility for competition.

Decentralization also introduces more possibilities for financial competition. In our modern financial system, it’s nearly impossible to start a new institution (such as a bank) to threaten influential players or provide better services to consumers. But, in the world of decentralized digital currency, it’s the Wild West.

Appeal to investors skeptical of centralized authorities.

The decentralization of cryptocurrency is also appealing to investors interested in removing themselves from the influence of centralized authorities. In our current financial system, centralized authorities are almost impossible to avoid. For example, the Federal Reserve System has generated significant criticism in recent years. This is because it was making questionable decisions regarding interest rate adjustment, quantitative easing, and monetary policy overall. At the same time, if you live in the United States, it’s impossible to ignore the influence of the Federal Reserve System. Cryptocurrency gives investors a way to opt out of the current system.

How Decentralization Is Also a Threat

That said, decentralization can also pose some threats to your financial system and the individuals within it, such as:

Lack of authoritative direction.

Cryptocurrencies lack any sort of authoritative direction. Crypto developers spend a lot of time developing the product from the ground up before releasing it. And, you could argue that they still retain at least some control over the product, even after it they distribute it and it begins operations. Still, a decentralized system neither monitors nor evaluates Bitcoin transactions in the same way authoritative control monitors transactions. Having this authoritative direction potentially leads to more significant insights, more robust security, and other advantages.

Difficult maintenance.

Most cryptocurrencies are designed to be autonomous and mostly maintenance-free; Bitcoin transaction processes today are nearly identical to Bitcoin transaction processes several years ago. However, if maintenance ever does need to be performed, it can be difficult to impossible in a decentralized system. Suppose it follows the tenets of true decentralization. In that case, no single person will have total control over the system, which means any changes, updates, or modifications will need to be introduced with every individual node in mind.

Reduced performance and higher costs.

Relying on a distributed network of different decision-makers, rather than going through a single authority, typically reduces the system’s performance and leads to higher costs. We see this demonstrated by the fact that cryptocurrency uses more electricity than some entire countries; every transaction needs a review and verification by a network of different individual computers, each processing very complex cryptographic problems, thereby spiking energy consumption. In cryptocurrency, this can be its own strength; the high-demand transactions serve as an added security feature. However, this could lead to a full-blown energy crisis on a large enough scale.

Direct threats from centralized organizations.

Centralized institutions often feel threatened by decentralized powers. People in charge of organizations that are used to being the central authorities usually have disdainful opinions of the decentralized systems that threaten the existence of their control. We sometimes see this attitude exhibited directly by authoritarian governments who fear the ramifications of allowing their citizens to use cryptocurrencies for everyday exchanges. The diverse advantages of remaining decentralized make cryptocurrency more threatening, putting a target on its back and increasing the chances of being criminalized or directly attacked.

Decentralization is a mixed bag, but its benefits far outweigh its disadvantages. While decentralization may ultimately come to threaten the integrity and adoptability of cryptocurrency, it’s also cryptocurrency’s most prominent and most unique feature.

In the future, we may see more cryptocurrencies developed, specifically designed to retain all the decentralization benefits while also eliminating some of the downsides; if this is the case, the power of decentralization is only going to become stronger.

Originally published at ValueWalk