This guide to centralized cryptocurrencies takes a deep look into the features that makes a coin centralized, as well as a brief look into the concept of decentralization.
If you've been in the Cryptocurrency markets for some time now you'd be well aware of the dissent against any form of centralization, be it banks, or governments or even centralized cryptocurrency exchanges. Why is the general cryptocurrency community against centralization?
Core Philosophy: Decentralisation
We have to understand that at the root of cryptocurrencies is the idea of decentralization, which goes against any centralized systems that humanity has been used to. Basically, any single entity that possess full control in managing a system is termed as a centralized entity and that ecosystem that is controlled is termed as a centralized system. Governments are centralized because they possess the power to make, maintain and remove laws that governs us. Banks (and central banks) are centralized because they control our monetary system, which is the core of our economy. Firms are centralized because the CEO has the last say towards any corporate policy and rules in the pursuit of profit maximization. (Read more: Crypto ICO vs. Stock IPO: What’s the Difference?)
Decentralization refers to the distribution of power and control away from a central, authoritative entity over to the general population within a network.
Cryptocurrencies – and the underlying technology, Blockchain – goes against any form of centralized control and instead, empowers all participants to have a say in managing and contributing to an open and transparent system.
Features of a Decentralized System
Before taking a look at centralized coins, it is vital to understand the concept of decentralization. As Vitalik Buterin (Founder of Ethereum) has theorized, there are 3 main categories of a decentralized system:
- Politically Decentralized: No single entity controls the blockchain
- Architecturally Decentralized: There is no central point of failure (A centralized system stops working or is compromised once a part of the system fails)
- Logically Decentralized: The network agrees to one common state (set of data) of the network, behaving like a single, collective computer
Blockchain systems are therefore meant to provide a mechanism for open and immutable systems to be stable and resistant to attacks. The first decentralized cryptocurrency – Bitcoin – was created to provide a viable alternative towards the centralized monetary system, allowing users to transfer money without the need for intermediaries (banks and payment processors). The decentralised nature of Bitcoin enabled various benefits that include:
- Cheaper Transfer Fees: Users had to pay a fraction of the cost in transferring cryptocurrencies as compared to huge fees charged by intermediaries
- Fast Confirmation Time: Users had to wait minutes to transfer their cryptocurrencies (to anywhere globally), as compared to days when using banks. This is especially relevant when making cross-borders transaction.
- Secure: Decentralized systems are less-likely to suffer from single-points-of-failure. Additionally, its much more expensive to attack a decentralized system due to the lack of lack sensitive central points
- Transparency & Immutability: Users can verify every single transaction down to the exact timestamp, value and participants on the blockchain history. They can also be assured that all transactions cannot be changed or altered.
From the very beginning, decentralisation has been a synonymous feature of the cryptocurrency world. Therefore, resentment towards centralization – or any form of it – is high within the general cryptocurrency community. Let’s take a look at the different forms of centralization that exists in the cryptocurrency world.
Types of Cryptocurrency Centralization
Centralization in the context of cryptocurrencies come in 2 main forms, which include:
1. Concentration of Pre-mined Token Ownership
Perhaps the most obvious trait of a centralized cryptocurrency is that the majority of supply is owned by a single entity, usually by the entity (company or foundation) that created the coin in the first place. Centralization would be even more obvious if that entity is a for-profit company. Having majority ownership in the coin supply grants the entity greater power in controlling and managing the entire network. This is no different than a centralized company that fully controls all aspects of its operations and management.
Additionally, tokens that are pre-mined has a higher probability of being centralized since the entire token supply has been created at the start and there will be no further creation of the tokens in the future. This is in stark contrast to coins that can be mined such as Bitcoin and Ethereum, where miners possess the opportunity to earn more coins through the process of mining. This guide explains further the differences between coins and tokens.
An example is Ripple (XRP), where Ripple Labs – a for-profit payments company that founded Ripple – and its founders owns approximately 60% of the total pre-mined supply of XRP in circulation. This means that only a minority of XRP is owned by the open public. This is viewed negatively by the cryptocurrency community since it goes against the notion of decentralization that cryptocurrencies afforded.
2. Mining Centralization
Under the category of mining centralization, there are 2 main elements:
a. Centralized Nodes
This category of centralisation refers to the degree of nodes owned by the project itself. If the majority or all the nodes belong to the entity that created the coin itself, then the coin is referred to as centralized. Since nodes are required in any blockchain to verify and validate transactions, a blockchain that is mostly controlled by nodes from a single entity would compromise the integrity and openness of the network. This would render the blockchain susceptible to interference, either from the controlling entity of external parties such as corporations of governments. Additionally, a blockchain that is controlled by a single entity would be vulnerable to a single-point-of-attack, a situation where the entire network goes down if the nodes were to fail (shut-down).
NEO is an example of a project that has only 7 validation nodes which are all controlled by the NEO team. Although NEO has stated that decentralization would be gradually achieved in their roadmap, the current situation still renders NEO to be centralized. If more than a third of the nodes go offline, consensus cannot occur and the blockchain will effectively shut down. This means that that no more than 3 of the 7 NEO nodes can go offline at any time.
(Read also: Guide on Identifying Scam Coins)
b. Centralization of Hashing Power
Hashing power refers to the computational power of nodes in the network. The centralisation of hashing power occurs when the majority of computational power belongs to a single, centralized entity. Also known as ‘51% attack’, miners that control the majority (51% or more) of the hashing power would be able to prevent new transactions from gaining confirmations, monopolize mining of new blocks (and keep all the rewards), block any transactions at their disposal and most dangerously, they can double-spend the coins. This attack compromises the security and immutability of the blockchain.
Double spending is the possibility of a coin being spent twice. This is a fraudulent act where the holder could make a copy of the digital token and send it to a party (or a merchant) while retaining the original.
An example of a ‘51% attack’ happened to Bitcoin Gold – a hard-fork of Bitcoin – on May 2018. The ill-intentioned actors managed to control a huge amount of Bitcoin Gold’s hashing power and managed to double-spend the coins over several days. They were successful in stealing over $18 million worth of Bitcoin Gold. (See more: Guide to Bitcoin Hard Forks: Bitcoin Cash, Bitcoin Gold, Segwit2X & Bitcoin ABC)
Summing It Up
There are various ways that a cryptocurrency can be labelled as centralized. It is true that cryptocurrencies were created initially with the philosophy of decentralization, and any variations that goes against this ideology would be negatively viewed by the community. There are definitely merits to a centralized solution – namely performance, scalability and stability – that warrants a close look, but ultimately, the inclusion and participation of the community is a vital trait that cryptocurrencies and blockchain technology offers.
(You might also be interested in: Guide to Market Capitalization: Everything You Need to Know About Market Cap)
Beneficial Resources To Get You Started
If you're starting your journey into the complex world of cryptocurrencies, here's a list of useful resources and guides that will get you on your way:
Trading & Exchange
- Crypto Guide 101: Choosing The Best Cryptocurrency Exchange
- Guide to Bittrex Exchange: How to Trade on Bittrex
- Guide to Binance Exchange: How to Open Binance Account and What You Should Know
- Guide to Etherdelta Exchange: How to Trade on Etherdelta
- Guide To Cryptocurrency Trading Basics: Introduction to Crypto Technical Analysis
- Cryptocurrency Trading: Understanding Cryptocurrency Trading Pairs & How it Works
- Crypto Trading Guide: 4 Common Pitfalls Every Crypto Trader Will Experience
- Guide to Cryptocurrency Wallets: Why Do You Need Wallets?
- Guide to Cryptocurrency Wallets: Opening a Bitcoin Wallet
- Guide to Cryptocurrency Wallets: Opening a MyEtherWallet (MEW)
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