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Understanding The Benefits Of Decentralization - Part II

Published 5.12.2023

In the first part, we explained the biggest benefits of decentralization. In this article, we will discuss why the adoption of blockchain technology is lower than expected and whether the described benefits are beneficial for ordinary people. In the same order, we will go through all the benefits that we listed in the previous article.

Self-custody And Peer-To-Peer Interaction

The success of any blockchain depends on whether people learn to use self-custody wallets. Blockchain technology only makes sense if people don't rely on centralized custodial wallets. We'll explain why below.

If people are not interested in self-custody, it can be interpreted as meaning that they are not interested in blockchain and therefore DeFi services.

Unfortunately, people are afraid of the self-custody of assets. It is too much responsibility for them. It's easy to make a mistake and lose your assets forever. There is no way to fix the error and restore the assets.

Using blockchain wallets is complicated. Copying blockchain addresses is risky.

When people want to send a larger amount, they usually send a smaller amount upfront. Subsequently, a larger amount. Not only newbies but also experienced users still need to do it this way.

BTC value is held on 44M blockchain addresses. Everyone who holds BTC in their wallet usually uses multiple addresses. Furthermore, the addresses of exchanges and other services are included, so there are few self-custody holders. It is estimated that it will be in the order of millions, which correlates with the number of HW wallets sold (many self-custody users own multiple HW wallets).

The popular Metamask wallet, which is used for DeFi services not only on the Ethereum platform, has been downloaded by more than 22M users (data reported in August 2023). DeFi users can be the same amount, or just slightly larger, than BTC holders.

Cryptocurrencies are estimated to be held by roughly 550M people on the planet. Only about 2-5% of these people hold assets in a self-custody manner.

Without self-custody, peer-to-peer (P2P) interaction between users is not possible. People holding assets on centralized exchanges do not use the blockchain, but neither do the Lightning Network or DeFi services.

If the number of users does not grow, the network effect does not grow either. What must be attractive for newcomers is the possibility of interaction with others.

Social networks are successful because of the network effect. It's a bit of a chicken and egg problem. Blockchain and all other services built on top of it need users for more users to come. How to get users on the blockchain?

The biggest utility of blockchain is self-custody, which is however difficult to adopt due to the mentioned risks and shortcomings. What many people consider to be the biggest benefit of blockchain is not attractive to the majority of the population.

Logically, people who own property do not want to lose it through a stupid mistake. The argument 'BTC can never be confiscated by a third party' will not convince people to use Bitcoin if they are afraid that they may lose coins through their fault.

If people don't even hold BTC, let's not expect efforts to tokenize real-world assets to succeed. Those who try to do this face the same problem, i.e. people's fear of using new technology.

The exception is tokenized dollars, which people from developing countries are forced to use. However, they can use centralized exchanges. Exchanges, but also traditional companies like PayPal, see the potential and are trying to integrate tokens on the blockchain into their centralized solutions.

Custodial wallets will be a suitable solution for part of the population. The question is what this means for the adoption of DeFi services and the long-term economic sustainability and security of blockchains.

It is necessary to improve the user interface if we want people to use self-custody wallets. We need to replace blockchain addresses with something simple like names or phone numbers. We need to figure out how to prevent people from making stupid mistakes, or how to 'recover' assets sent to a wrong/non-existent address. I know these seem like insurmountable problems at this point.

Control Is Put Back Into The Hands Of The People

Cryptocurrencies are said to put the power back in the hands of the people. The biggest argument for the existence of Bitcoin is that we will create non-state money. In the case of Cardano, it is said that we will build alternative financial services.

Now we know that people are not interested in that. Or at least not now.

Taking power into your own hands means to stop using money or financial services that we are all used to. The network effect, but also the reliability and user-friendliness of existing services is high.

With a bit of exaggeration, it can be said that self-custody is the only thing that works perfectly on the blockchain (let's neglect the user interface for a moment). Blockchain networks do not scale well at the moment. Payments are slow and expensive. Local bank transfer on business days is instant, reliable, and free in many countries.

Blockchain can compete in the case of cross-border transactions. However, most people don't need it.

If people trust the institutions of a given state, they do not need to distance themselves from them or look for alternatives. You need to realize that. Most people do not see the difference between self-custody and money held in a bank account.

If you earn money in a normal way as an employee, you are not involved in some shady business and you buy normal things in the store, you can almost be sure that you will not have problems spending your money. This applies to the majority of the population in developed countries.

Replacing fiat money with cryptocurrencies is another strong argument of the crypto community. It's hard for most people to understand. Volatility is a problem in itself that makes most people happy to use relatively stable fiat currencies.

There are many other questions associated with the replacement of central banks that experts do not have answers to. For example, what happens without the ability to print money when a crisis comes? Some bitcoiners offer some anarcho-capitalist answers. This is unacceptable to most people on the planet.

We find that blockchain will be used mainly where there is no reliable financial infrastructure or even where states are not doing their job well. That is, in developing countries.

In the first part, I wrote that the blockchain gives people back their right to privacy, ensures fairness, is transparent, and ensures the immutability of rules. All these things people expect from the existing system. If they feel that the system works as they expect, they have no reason to look for alternatives.

People associate the use of an alternative system built on new technology with risk. People will not take risks unless they feel threatened or deceived.

Blockchain adoption does not have to happen by suddenly replacing one system with another. It will very likely be a very gradual process lasting several decades. People will slowly integrate blockchain into existing infrastructure in places where it makes sense. In terms of adoption, the crypto community may be ahead of the mainstream in some cases.

I believe that putting power back into the hands of the people can happen, but I don't expect it to be as easy as replacing fiat currencies with Bitcoin. The majority of the population does not want such a change, they are afraid of it, we are not technologically ready for it, and a serious debate about the economic effects has not even started yet.

Decentralized Applications

If the concept of decentralization succeeds, so will the SC platforms. In other words, if people get used to self-custody wallets, the next logical step is to use L2 networks and DeFi.

It is necessary to take the first step to be able to take the second. It is clear from the above that we have not yet taken the first step. Let's not expect DeFi to be more successful than HODL.

Money is about financial services. Financial services are about mutual interaction between users. The blockchain industry is not about HODL from my point of view, but about financial interaction.

I think DeFi is a very good reason for self-custody. If you hold assets on a centralized exchange, you cannot use their value to get extra yield (although it is possible to stake PoS coins).

The large number of downloaded Metamask wallets in proportion to BTC holders indicates that the DeFi sector is doing well.

DeFi services need to be more integrated with traditional finance. There must be more capital in them. This is likely to happen. Banks are exploring DeFi services and are interested in tokenization. Sooner or later, some big banks will tokenize not only fiat money, but also stocks and other financial assets, and DEXes will be used for trading.

People sometimes ask what real problem blockchain solved. I think the answers to this question will come from second layers and DeFi.

Self-custody is a feature that in itself is not directly useful for the masses. Interaction is useful. What DeFi must deliver is reliability and useful financial services instead of pointless farming. This will only come through the growth of users and capital.

DeFi will only succeed if a blockchain loan has some advantages over a regular bank loan. The advantage must not be (only) self-custody, privacy, transparency, fairness, and things that the masses do not appreciate very much. The benefits must be economic, i.e. more favorable conditions.

This can be realized through the higher efficiency of automated services. This brings us to the next parts of the article.

Global Ubiquity And Resilience

Blockchain does not care who its users are and does not choose them. It does not distinguish between nationalities. This is a huge advantage.

For example, it is disadvantageous (meaning costly and risky) for banks to open branches for poor people in developing countries. A DeFi service or a second layer on the blockchain doesn't care. Blockchain can connect the whole world. Tokenized dollars or DEX on Cardano can be used by the poor and the rich.

Cross-border payments can be cheap, fast, and reliable. With the development of decentralized identity, Oracles, and other services, there will be a unified global infrastructure that will be run primarily by the wealthier people of the West, but that can be used by poor people in developing countries.

Financial services, especially micro-loans, can be made available to people from developing countries who have never had such an opportunity before.

Global ubiquity is a utility that people understand and can be motivated to use self-custody wallets.

However, it is necessary to realize that in developing countries there is less education, poorer access to the Internet, people have less capital, often do not have an ID card, etc. Even in places where blockchain makes the most sense, adoption will not happen overnight. Many problems need to be addressed.

Motivation is important. People from the West do not need to change anything if they are satisfied with the services they can use. People from developing countries are not so well off, and for them, blockchain is primarily a hope for change for the better.

Fast Global Settlement and Efficiency

Blockchain will succeed if it streamlines existing processes.

The Internet succeeded for the same reason. It streamlined access to information, sped up some processes, and made some services cheaper.

Today, cross-border transactions are slow, expensive, and error-prone. This is because the transaction is processed by several institutions.

Cardano will send any amount from China to Africa or America in a few seconds and a tenth of a dollar. It makes economic sense to start using blockchain for this service. Not just for the tokenization of money, but essentially for the tokenization of all financial assets.

This reasoning can be continued. Is it possible to streamline financial operations and replace old paperwork processes through the execution of smart contracts? Of course, it does.

It is possible to reduce delays and remove friction in the system. Automated processes increase reliability and are less prone to errors. It is usually cheaper to pay for computing power than for human labor. If something is more efficient, it may be cheaper for the end user. This is the reason for using DeFi and at the same time the chance for adoption.

To build on top of blockchain and harness its potential, it is necessary to continue to improve the technology. The biggest obstacle to adoption is the low scalability and technological immaturity of L2s.

As huge as the potential seems, without the scalability of the first layers, this technology is almost unusable for the masses.

In this regard, the expectation of the crypto community is far ahead of the readiness of the technology. People want to see higher adoption and solutions to real problems and don't realize that it's still too early for people and businesses to start using blockchain daily.

Volatile fees and congested networks prevent real usage. Although decentralization is the most important thing we should talk about, from a practical point of view it is scalability.

If the blockchain is poorly decentralized and does not scale well, it is not interesting for business. If it's decentralized well but doesn't scale well, it may be attractive for the community but unusable for the masses.

Those blockchains whose teams preferred scalability over decentralization are best poised for adoption. For example Solana and Avalanche.

It makes sense for businesses to build on these blockchains because they are not interested in decentralization. They are primarily concerned with utilities. They think that future users will not be interested in decentralization so they can overlook it as well. They may be right. It is difficult to predict the future.

Ideally, we would have a decentralized and at the same time well-scalable blockchain. Those who are aware of the importance of self-custody and the disadvantages associated with third parties would be happy with such a network, while at the same time, it would enable mass adoption in this decade.

Unfortunately, the reality is different. It will take at least another 5-10 years for such a network to exist. Of course, we can argue about what quality decentralization looks like. However, this is not the topic of the article.

My personal belief is that decentralization is the Alpha and Omega of this industry. Centralization has always led to problems that this industry wants to address and improve. In practice, however, we see that even the Bitcoin community is not so keen on improving decentralization (in the belief that Bitcoin is the most decentralized and secure blockchain and nothing better can come about). The primary concern for most holders is spot ETF approval.

Will the topic of decentralization be in the limelight in the future and will there be a serious debate on this topic? We don't know.

Trust

In the first part, we wrote that blockchain technology can change the functioning of trust in the relationship between people and in the relationship between people and institutions.

This will only happen if people trust blockchain technology and learn to use it. This is a huge challenge. I can't imagine anything more difficult than changing how trust works in society.

People who invest in crypto assets and hold them in custodial wallets do not use blockchain. They probably believe that this technology has potential because they bet their fortune on it. However, they do not understand this technology or do not trust it enough to use a self-custody wallet.

However, success will never come without blockchain users. If people only speculate, we will only see partial use. Crypto will be attractive to technology enthusiasts, minorities on the edge of the law, and some institutions that will streamline some processes.

Trust in blockchain technology is a complex matter. Adopting a crypto project means choosing a network or multiple networks, a specific service, an economic model, or perhaps becoming a member of a community (or multiple communities).

Trust in the blockchain is reduced by toxicity between communities, tribalism, scams, fraud, theft, hacks in DeFi, lies, corrupt media, unclear regulations, and the difficulty of navigating complex topics. One could talk about any topic for hours.

With the adoption of the Internet, it was easy because, from the users' point of view, there was only one network. The only problem was slow data downloads, but that gradually improved. Gradually, new services were created that found their users.

The blockchain industry could be described as a battle of small groups. Individual communities (whether larger or smaller) are trying to promote their chosen blockchain and think that theirs will be the chosen one and become the backbone of the world.

It's like 10 dwarves fighting each other and a million others watching or not caring at all.

Not even experts have a chance to orient themselves in this highly diverse and forward-looking industry and to predict future developments. What chance do newcomers have?

In the early days, no one could estimate the impact of the Internet on society, its future use, the number of services, or the number of industries that would be disrupted. Does anyone think they can do it in the case of blockchain?

I can imagine dozens of diametrically different scenarios and I wouldn't be able to choose one to bet on.

Conclusion

The technological progress that the blockchain industry makes every year is astounding. This is positive, as neither project is ready for the mainstream at the moment and won't be for a long time. Cardano has a chance to succeed because the IOG team is one of the largest and most experienced teams in the industry. The community cares about decentralization. There is a plan for scalability. The second layer is being built. DeFi is booming.

However, this is not enough for success. Cardano is not the internet. There is huge competition in the industry. It is impossible to say what current or future features or circumstances will decide the fate of any project.

In every ecosystem, we can observe the development of interesting technologies and the effort to succeed. Keeping building and responding to market or user needs promptly is probably the best advice to give communities.

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