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Understanding The Benefits Of Decentralization - Part I

Published 1.12.2023

The adoption of blockchain technologies is slower than many expected. In the efforts of people to deliver more attractive services for users, the most important thing is often forgotten, i.e. decentralization. Many projects even sacrificed decentralization for higher TPS. It's important to remind people of the importance of decentralization and to know what characteristics distinguish blockchain from traditional financial services. This article will explain the properties of decentralization and its benefits to newbies. We will focus on the most important ones.

The article will be divided into two parts. In the second part, we will consider whether people are interested in the described benefits and why adoption is slow.

Self-custody And Peer-To-Peer Interaction

Self-custody and the ability of participants to interact with each other in a peer-to-peer (P2P) manner are definitely among the biggest benefits of decentralization.

Blockchain users can exclusively own value without a third party and freely dispose of that value without being restricted by anyone.

P2P interaction allows participants to exchange value without an intermediary, i.e. essentially directly. A good analogy is the passing of a physical object (such as an apple) from hand to hand.

It is important to emphasize that there is an intermediary between the participants, namely a decentralized network or a deployed application (smart contract) originating from a third party. However, this is not an individual (who can fail or have dominant control), but a group of independent participants who collectively participate in the operation of a decentralized network.

Blockchain must be perceived as a service that does not have a single owner who would have full control over the processes performed by the network. Users rely on the fact that most network operators will be honest and will behave according to the rules of the protocol or some kind of social contract based on the principles of decentralization.

The resistance to censorship of transactions is based on the assumption that if one participant in the network consensus (block producer) from the group decides to censor a specific blockchain address, the other participants will not censor this address.

One rogue participant can only partially limit the principles of decentralization.

The network is accessible to anyone and there is no need to ask anyone for permission. There is no contract between users and those who operate the network (pool operators, miners, stakers, etc.).

What value can you own and transfer?

In the case of a first-generation blockchain such as Bitcoin, this value is the native coin. For example, BTC coins. Users join a group of other participants who share the meaning and significance of the Bitcoin network and the coins are valuable to them.

In the case of Cardano, these would be ADA coins.

The next generation of blockchain networks can do the same. In addition, what they can usually do is mint custom tokens and deploy applications (smart contracts).

The value is not limited to native coins only. Tokens can represent anything, such as tokenized fiat currencies. Applications increase the possibilities of interaction between users.

Bitcoin is a transaction network that can send BTC unconditionally. P2P interaction is limited to sending coins from address A to address B.

Cardano is a smart contract platform. The transfer of value between participants may be conditional.

Smart contract (SC) platforms will enable interaction between participants who do not know and trust each other.

The most common interaction between participants is the exchange of something for something. If both values are digital (two types of tokens), or values can be tokenized (tokenized assets such as fiat money or shares), the SC platform can ensure an interaction in which neither party can cheat the other.

Control Is Put Back Into The Hands Of The People

Self-custody and P2P interaction give people back control over their assets, data, and identity. This will allow them to make decisions freely and be less dependent on their surroundings, i.e. banks, the state, and other entities.

It is possible to use private services (Monero, Midnight) and thus hide your activities from the outside world. The surrounding world has almost no chance to learn about what you do with your property.

However, most blockchain networks are transparent. All activities are publicly searchable and can be analyzed in detail. This feature, together with decentralization, ensures the fairness of the system. All users are (largely) equal, and an individual cannot easily gain a significant advantage over other users.

For example, it is possible to prioritize your transaction for a higher fee (for blockchains with a fee market), but all network participants have this chance. It's almost impossible to get block-space more profitably or stealthily in a way others won't notice.

Everyone has an equal chance to use all the benefits of the blockchain network. All users are connected similarly to the Internet and can interact with each other. The ability to exchange value without an intermediary (without banks) is important. This allows people to become digital nomads.

Anyone can create and deploy a new service (application) and become an entrepreneur. Everyone has a similar chance to succeed. It is not necessary to ask someone for permission to do business.

Although this may change with regulations, for now, it is still true that DeFi is not limited in any way (there is an exception, the developer of Tornado Cash is in prison).

Decentralized Applications

As explained above, decentralized applications (deployed smart contracts) expand the possibilities of mutual P2P interaction between participants.

This group can also include second layers, which can be less decentralized but more scalable. This will allow participants to interact more often, faster, and cheaper.

Centralization can take many often hidden forms. Accumulating capital on a single node or in a smart contract is one of these forms. A decentralized system should not have a single point of failure. However, to achieve higher efficiency, it is necessary to make certain compromises.

On decentralized exchanges (DEXs), large capital is held in liquidity pools. This can be a potentially weak point of decentralization (i.e. a single point of failure). If someone manages to hack the smart contract (or some other kind of failure occurs), more users will be harmed.

Many second layers have similar problems with a lower level of decentralization.

New concepts are emerging in the Cardano ecosystem allowing the creation of a DEX without accumulating capital in one place. This will significantly increase the security of the system because hackers suddenly do not have a single weak point that they could attack. We will talk more about this in the second part.

The transaction network essentially only allows pushing value from address to address.

Applications allow developers to easily create decentralized custody services with pre-programmed behavior. This makes it possible to create a trusted autonomous custodian of value. This custodian can evaluate pre-programmed conditions and take defined actions.

A value can be held and sent to an address conditionally. In addition, these two seemingly small functions greatly expand the possibilities of decentralization. It is thus possible to replicate many financial services.

An important aspect is the immutability of rules that are once defined. This applies especially to the functions of blockchain networks, i.e. to self-custody, monetary policy of the project, and value transfer via native code implemented in full nodes.

For the most part, this also applies to applications, but it is necessary to pay attention to the details. Ideally, it should not be possible to change the functioning of the smart contract.

Global Ubiquity And Resilience

A blockchain network is inherently ubiquitous much like the internet. This means that it connects all people on the planet who have access to the Internet.

Banks or services operating in markets in developed countries may not be interested in operating in developing countries. Blockchain makes no difference. The DeFi service on the blockchain is available everywhere in the world. Anyone can start using tokenized dollars, save in BTC, stake ADA, borrow money, trade on DEX, etc.

Blockchain is a distributed network. It consists of multiple nodes operated by people around the world (often the nodes are operated from developed countries). Blockchain networks are very resistant to attacks and hacks. Most blockchain networks can easily withstand, for example, DDoS attacks.

High robustness is due to the decentralization of the network. Blockchain services are available 24/7/365. The risk of failure exists, but it is very low.

Having a global market available from anywhere in the world and being able to participate freely (without restrictions) in any way as a user or entrepreneur is among the significant benefits of this technology.

In the next part of the article, we will focus on settlement and potential in financial services.

Fast Global Settlement and Efficiency

A huge advantage of blockchain networks is that settlement is fast regardless of national borders. It doesn't matter if you're sending a value to a friend who lives next door or if they're on another continent. The fee will be the same as well as the time of settlement.

This advantage is severely limited by blockchain scalability. The topic of the article is benefits. We will deal with the shortcomings in the second part.

Replacing human labor, especially bank clerks, with automated processes is potentially another big advantage.

Tokens on the blockchain and smart contracts can replace old paperwork processes. This brings many benefits including removing frictions and delays, streamlining services, and reducing counterparty risk. Automated processes can be more efficient and reliable than humans. These advantages can be used for global trading, clearing and settlement, consumer banking, and lending. This can also be used outside the financial sector.

Not only ordinary users but also large banking houses can benefit from a globally available system.

The blockchain industry is still very young, so the automation of financial processes on a decentralized blockchain is used by retail in a sector called DeFi (decentralized finance).

Trust

Decentralization is seen as an important feature that relates to trust, whether in the relationship of people to each other or in the relationship of people to institutions.

Blockchain is sometimes referred to as a trust machine. It's kind of a new layer of the internet for trust.

People's trust has been abused many times in the past and it still is. The one in control also has power and usually more options. Blockchain technology has a huge potential to change the functioning of society precisely because it changes the rules of the game of what is essential for society, i.e. trust.

The possibility of creating non-state money is unique. It is possible to take another step. It is possible to build decentralized financial services or even a new better version of state institutions. On the one hand, this is a highly ambitious and perhaps unattainable goal, but on the other hand, the idea of success is tempting.

At the moment, no one knows when blockchain technology will change society and how fundamental this change may be. It is very likely to be a very gradual change similar to the adoption of the Internet.

Faster adoption is hindered by certain technological shortcomings, missing or unclear legislation, and a few things. We'll talk about that next time.

Conclusion

I have discussed the most important benefits of blockchain technology. We will go deeper into the details in the next part. We will explain why, at first glance, the amazing technology is not more adopted. We will focus on the limitations and shortcomings of blockchain and what some criticize.

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