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Blockchain and finance in 2019
Is Decentralization a Practical Solution?
The burgeoning field of blockchain technology is an exciting area of development that has gripped the greater public. With the prospect of the disruption of traditional systems, plus the permeation of transparency and stability, advances in distributed ledger technology are projected to power the evolution of industry.
The key feature of the promise of blockchain technology is decentralization, which refers to the distributed architecture of participants with the ability to validate transactions and record data in a transparent and stable manner that is immutable and transparent. Given the hype around blockchain and distributed ledger technologies as a whole, this article will dive deeper into the mechanics of the technology and its application, to assess the actual practicality of implementing decentralization in the real world.
What is Decentralization?
Decentralization refers to a distributed architecture where the functions and powers of a system is dispersed across all the participants – or nodes – within the system, with no central point of control. Popularized by the creation of Bitcoin, decentralization has been a core focus for blockchain technology. To understand decentralization more intimately, the three fundamental axes of software decentralization – according to the creator of Ethereum, Vitalik Buterin – must be explored.
Architectural Decentralization refers to the structure of a system that is contingent on the number of physical computers connected to the network. The higher the number of connected computers, the greater the decentralization of the network. A network’s decentralization strength is also dependent on the system’s tolerance for individual computers breaking down at any point in time.
Political Decentralization refers to the degree of control of an individual or organization in the network. A system is centralized if more than half of the computers (nodes) in the system are controlled by a single entity.
Logical Decentralization refers to the degree in which the interface and data structure of the system. If a system is maintained like a single monolithic object, then it resembles a centralized system. On the other hand, a system resembling an amorphous swarm is fundamentally more decentralized.
Traditional businesses and organizations are centralized across all three of the aforementioned options. The Chief Executive Officer (CEO), who is ultimately in charge (politically centralized), a head office in a specific jurisdiction (architecturally centralized), and the business or organization moves as a single, monolithic unit in achieving their corporate objectives (logical centralization).
Despite the prominence of blockchain as a decentralized system, blockchains are both politically decentralized (in that no one has any control over the entire network) and architecturally decentralized (in that there is no infrastructural point of failure) but they are logically centralized, since there is a consensus on an agreed state at any point of time, ergo the network behaves like a single virtual computer.
Benefits of Decentralization
The pursuit of decentralization – albeit fervent – is unified trait that is inherent in the cryptocurrency community. There are numerous advantages of a decentralized architecture over a centralized one.
A decentralized system is much harder to attack or penetrate given that there is no single point of attack.
The broad distribution of participating and equally-powerful computers means that a potential attacker would need to acquire a tremendous amount of resources (energy, hardware and human) to attack every single computer in the network to destroy or manipulate transaction data – an impossible task, given the finite resources available.
The window of attack would also need to be coordinated simultaneously on all computers within a short time frame (mere minutes), which further reduces the likelihood of a successful attack.
In a decentralized environment, theoretically everyone has equal power; no one node or computer has greater control or power than another. This ensures that no single entity controls the network, and facilitates an empowering environment, where literally anyone can be part of the ecosystem that validates, propagates and secures the system.
This shared sense of collective responsibility represents a natural alignment of incentives for all users. The case of Bitcoin in decentralizing the monetary system is a prime example of how the masses can fundamentally participate in the money creation process; facilitating total transparency and accountability within the system – something conspicuously absent from the traditional financial system.
The strength of a decentralized system is directly contingent on the dispersion and number of computers in the network, each of which are separate components, independent from each other.
This means that when a single computer fails, the network will not fail or be disrupted, since the rest of the computers in the system are insulated from the functions of the failed computer, and will therefore continue running.
The independence of nodes in the system contributes to the fault-tolerant properties of blockchain networks.
Perhaps the major benefit from an operational perspective is the reduction in the reliance of intermediaries or middlemen, which is a common dependency in traditional systems. The peer-to-peer (P2P) nature of decentralized systems fosters direct exchange and communication between participants within it, thereby preventing absolving any other third party from interfering in the process.
Dis-intermediation saves tremendous amounts of time, and also cost, for end users, and streamlines the entire operational process. Just as with Bitcoin, the cost of transaction is a fraction compared to a traditional exchange via the conventional banking system, with transactions taking an average of minutes compared to the two-three working day clearance time for transactions in legacy financial institutions.
Practicality of Decentralization
The benefits of decentralization might lead many people to think that decentralization is a panacea for issues faced by traditional systems. The cryptocurrency market justifies this presumption, given the vast amounts of coins and tokens that exist to solve a specific real-world problem.
Add to this the novelty of the technology, and the hype surrounding the ground-breaking advancements of blockchain, and one could believe that blockchain technology is fast gaining traction and mass adoption. However, there have been several debates around the feasibility of blockchain integration to our current systems, and it seems that blockchains may not be a panacea for all industries and sectors.
Let’s examine the limitations of decentralization regarding blockchain.
Scalability has been the most apparent issue inherent in blockchain, and its significance is evident from the dedication and focus of blockchain projects in solving this complex case. The decentralized nature of blockchain necessitates that all participating nodes in the network must process, validate and store every single transaction in the ledger, which means that every node must constantly and instantaneously maintain the most updated state of the ledger.
The aforementioned benefits of decentralization come at a cost of scalability, since there are predefined limits on the throughput (the number of transactions that can be included in a block at any point of time) and latency (the time taken to incorporate blocks into the blockchain). For instance, the average time to produce a block in the Bitcoin blockchain is 10 minutes, with an average throughput of 5 transactions per second (tps). The fixed block size of 1MB for a block equates to a limit on the amount of transaction that can be processed at any one time.
This is a huge concern for blockchains that are competing with current traditional systems such as Visa, which can process more than 2,000 tps. The limited scalability of blockchain prevents institutions from transitioning into distributed ledger technology, because enterprise-level capabilities have yet to materialize, at least from a public blockchain perspective.
Lack of Smart Contract Verification
The use of smart contracts is a major use case for decentralized blockchain technology. It allows the dis-intermediation of a traditional multi-party settlement process, through pre-programmed, codified, self-executing contracts. Smart contract functionality can be applied to any use case that requires interaction between stakeholders, enabled through the decentralization afforded by blockchain.
However, a main obstacle for using smart contracts – particularly in an enterprise setting – is the absence of formal procedures for verification of the smart contract. The most widely-used platform for smart contract functionality – Ethereum – uses a computing language called Solidity, which, while robust, lacks formal verification (the ability to generate mathematical proof that the code has compiled properly).
Since the credibility of smart contracts depends on the codes that set the parameters of operation, being able to check and verify certain error vectors is essential to the performance of the contract, especially in the deployment of a large-scale, enterprise infrastructure setting.
The data stored in the immutable decentralized blockchain ledger requires heavy storage, since nodes are required to store every single transactional data on their server.
This imposes future incremental costs, when the size of the blockchain expands, and further increasing the barriers to blockchain network entry; also causing a strain on nodes, since more transactions require additional hardware to maintain the ever-increasing storage of information, which translates to additional costs.
While decentralization has tremendous benefits associated with it, there are still real-world issues that hinder the feasibility of adopting distributed ledger technologies, especially on the enterprise level.
The constraint on scalability, formal contract verification, and storage, among other things, are key considerations that must be solved before organizations can practically consider blockchain as a feasible solution for their operational needs.