What is decentralization — and why does it matter?
If you’re new to the world of cryptocurrency, you may have seen or heard the word “decentralization” mentioned a lot. To understand what it means — and why it is considered by most within the cryptocurrency industry to be a good thing — it’s a good idea to first become a little familiar with centralization. So, what exactly is centralization?
Find out in our handy guide to centralization, decentralization, and the pros and cons of both.
What is centralization?
Centralization, in a nutshell, is the process by which a central entity facilitates, controls, and often regulates the actions of its members, users, employees — or whatever they may be. One of the simplest examples of this is the government. No matter where you reside in the world, the government that leads your country is, to some extent, centralized. Most of the power lies with those at the top, who define things like the laws we live by, the taxes we pay, the distribution of state finances, and more.
In the cryptocurrency world, centralization is a word often used to describe the traditional banking and financial systems. There are central banks, which supply and control the amount of money in circulation and set interest rates. And then there are commercial banks that feed off those. They not only have most of the power, but they facilitate all transactions between users, businesses, and more.
What is decentralization?
Decentralization, as its name implies, is the opposite of centralization. It takes the power and control away from individual entities or small groups and puts it into the hands of the community. This eliminates the possibility of one person or one organization (or a small group of them) making decisions that may detrimentally affect the wider community for the benefit of a small few.
Many businesses, such as franchises, use a decentralized model in which major responsibilities, including decision-making, are shared out between larger groups of people. Store managers are largely responsible for their own stores, and they typically report to a regional manager, who reports to a head office. This is mostly beneficial for both the business and its customers, since it typically speeds up the decision-making process (store managers don’t have to wait for those above them to approve things). And because they have a better understanding of their own stores, they are better placed to determine what’s best for their customers. A change made in one store may not be best for all stores.
Decentralization in finance — specifically cryptocurrency — takes this concept a step further. There are no managers or small groups that hold the majority of the power, and no regulators to determine what is or is not allowed. It is instead the responsibility of the community to make decisions and maintain itself. It is also up to the community and its users to protect themselves.
The beginning of cryptocurrency and decentralization
Bitcoin, now the most valuable and most recognizable form of digital currency, started the whole cryptocurrency movement when it landed in 2008 — right in the middle of the Great Recession. An individual or group known as Satoshi Nakamoto designed it to be a decentralized form of payment that could be transacted without banks (or similar third parties) using a network of computers that come together to make up what we now call a blockchain. The first “block” was “mined” in early 2009.
In the early days of Bitcoin, mining was the only way to obtain tokens. This meant using a piece of open-source software to join the blockchain and generate new coins or verify Bitcoin transactions for a small fee. It is this network that allows cryptocurrencies to be maintained by the community, rather than traditional financial systems that charge excessive fees and have complete control.
The first proper Bitcoin transaction took place in 2010, when a Florida man purchased two pizzas valued at $25 for 10,000 Bitcoin tokens. It seemed like a great deal at the time, when Bitcoin was worth very little and its future was still unclear. But as things stand, those tokens would now be worth more than $384 million. And that’s after a rather significant drop in Bitcoin’s value over recent months.
Since then, other blockchains — such as Ethereum, which has become one of the biggest since its launch in 2015 — have entered the market. They all operate in broadly the same way by using a distributed database made up of blocks that is shared among a vast network of computers to process transactions.
The pros and cons of decentralization
There are many advantages to a decentralized financial system like Bitcoin and Ethereum. Not only are they open to anyone anywhere in the world, unlike regular banks, but in theory they can also eliminate the hefty fees that often come with traditional banking — particularly when sending money between different countries. (Although gas fees can make this questionable when it comes to certain cryptocurrencies.) What’s more, cryptocurrency transfers can be anonymous.
Although it’s a myth that digital currencies are completely untraceable, they are significantly more difficult to track than other currencies. Cryptocurrency wallets and transactions use a long string of letters and numbers, rather than traditional names, for identification in the blockchain. It’s nearly impossible to find out who a wallet belongs to using that string of digits alone.
Cryptocurrencies and blockchains are additionally not regulated in the same way traditional currencies and banks are. That means they are not required to verify user identities or obtain certain user information, which is used by traditional banks for all manner of things. They can also have complete freedom, which not only lowers operating costs but additionally allows for faster, more expansive innovation.
Of course, there are disadvantages as well. The anonymous nature of cryptocurrencies and blockchains makes them more susceptible to scams and similar attacks. And without regulation, there are no protections for users who fall victim to these things and lose their assets. Although blockchains are inherently designed to be secure, it is up to users themselves to keep their own assets safe.
Learn About Decentralization and Earn $AAG
To incentivize our community to learn more about decentralization, we will award 10 $AAG tokens each to the first 100 people to correctly answer the questions about decentralization. The subsequent 900 people will then receive 5 $AAG tokens each.
Please click here to submit your answers.
