Crypto: Is It Really Decentralized?

May 25, 2023
The advent of cryptocurrencies like Bitcoin and Ethereum brought about the idea of a decentralized financial system free from the influence of traditional intermediaries like banks and governments. However, recent statistics have revealed that Bitcoin's mining power is highly centralized, with only five mining pools controlling over 50% of the network's hash rate.

This raises questions about the actual level of decentralization of cryptocurrencies. In this article, we will delve deeper into the concept of decentralization, explore metrics used to measure it, and assess the current state of decentralization in the crypto ecosystem.
Key Takeaways
    • There are still several centralizing forces at play in the crypto ecosystem.
    • Mining pools and node hosting on AWS and Infura contribute to centralization.
    • Models and metrics have been developed to measure the decentralization of blockchain networks, such as the Gini coefficient, node count and distribution, mining power distribution, Sybil resistance, and governance.
    • Maintaining a high level of decentralization is crucial to ensure the security and reliability of the technology.
    • Efforts are being made to increase decentralization in the crypto ecosystem, such as developing alternative mining algorithms and decentralized exchanges.
    The Reality of Centralization in Blockchain Technology
    In recent years, cloud-based hosting services like Amazon Web Services (AWS) and Infura have become increasingly common among blockchain developers. While these services make running nodes easier and more cost-effective, they also have drawbacks.

    Firstly, relying on cloud-based hosting services means a single provider, such as AWS or Infura, hosts many blockchain network nodes. This concentration of nodes with a single provider creates a single point of failure, making the network more vulnerable to attacks and other types of failures.

    Secondly, using cloud-based hosting services means the provider can access the data on the nodes. This creates a potential privacy risk, as the provider could theoretically access or even manipulate the data on the nodes.

    Finally, the use of cloud-based hosting services leads to a concentration of power in the hands of a few prominent players. For example, in the case of Infura, most Ethereum nodes are currently hosted on the service. If Infura were to go down or become compromised, a large portion of the Ethereum network would be affected.
    The Case of Bitcoin
    Bitcoin, the first and most well-known cryptocurrency designed to be a decentralized alternative to traditional forms of currency, has been the subject of much debate.

    One of the main concerns with Bitcoin's decentralization is the concentration of mining power among a few large mining pools. Bitcoin mining creates new bitcoins, and transactions are verified and added to the blockchain. Miners use powerful computers to solve complex mathematical equations and are rewarded with bitcoins.

    In the early days of Bitcoin, mining was relatively easy and could be done on a regular computer. As the network has grown, mining has become more complex and requires specialized ASIC hardware. As a result, mining has become more centralized, with a few large mining pools controlling a significant portion of the network's mining power.

    The centralization of mining power in the Bitcoin network poses significant threats to its security and stability. If a single mining pool gains control of over 50% of the network's mining power, it can execute a 51% attack. Such an attack could enable the malicious miner to double-spend coins and prevent transaction confirmation, resulting in severe financial losses and undermining user trust in the network.

    Another issue with Bitcoin's decentralization is that many users rely on third-party services to store and transact their bitcoins. These services, known as exchanges, are not part of the Bitcoin network and are subject to regulation and government oversight.

    This reliance on third-party services for storage and transactions goes against the core principles of decentralization, which aim to eliminate the need for intermediaries like banks and governments. It also creates a potential point of failure, as governments can hack or shut down exchanges.

    Luckily, efforts are being made to address these issues, including developing alternative mining algorithms and using decentralized exchanges.
    Calculation Models to Check Decentralization
    Various methods have been devised to quantify the degree of decentralization within a blockchain network. These models possess distinct advantages and drawbacks, and no one model is considered the ultimate metric of decentralization. The following table presents the most prevalent models, including their definitions, real-world applications, calculations, and the pros and cons of each technique.
    The examples and calculations provided are for illustrative purposes only and may not represent the current state of the respective blockchain networks.
    Using centralization check methods we can conclude that:
    • Over 40% of the Bitcoin network's hash rate is controlled by the top three mining pools;
    • Infura could be running between 25-50% of Ethereum's nodes;
    • Binance Smart Chain (BSC) is not necessarily 100% centralized, but it is highly centralized due to the control of the single organization;
    • USDT and USDC are both 100% centralized stablecoins because they are issued by a single centralized entity
      Wrapping Up
      The issue of centralization remains a challenge for the crypto ecosystem. The good news is that it is possible to measure the level of decentralization using various models and metrics. As the crypto ecosystem continues to evolve, the future of decentralization remains uncertain.

      But one thing is clear: maintaining a high level of decentralization is crucial to ensure the security and reliability of the technology. By striving for greater decentralization, we can ensure that the promise of crypto - to create a more open, transparent, and equitable financial system - is realized.
      See also