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  • Writer's pictureMartin Schmalzried

Cryptocurrencies: the underestimated centralization risk that is hardly ever discussed

Time and again, we see articles pop up that discuss the centralization risks linked with some cryptocurrency. For instance, the risks of “super nodes” on the Bitcoin network, mining pools controlling more than 51% of total miners in a given cryptocurrency, or the excessive power some of the founders of cryptocurrencies possess over the community (as was denounced when the DAO hack was reversed via a hard fork on the Ethereum network).

These debates happen for a very good reason: arguably the whole purpose of blockchain technology is decentralization. If any type of blockchain based project (be it cryptocurrency based or not) starts to become centralized again, then we may as well scrap it and replace it with a fully centralized traditional database behind a ton of firewall and other protection, managed by a central authority.

But one form of centralization risk is seldom discussed, for ideological reasons: the centralization of tokens or cryptocurrency. The tokens that underpin the workings of many blockchain technologies including cryptocurrencies have a variety of uses:

  • a simple database entry with no real use besides payments/store of value (Bitcoin, Dogecoin, Litecoin,…)

  • a token used to pay for a specific service provided by the blockchain technology (website hosting for Siacoin, decentralized computing for Golem, a way to pay for running decentralized apps for Ethereum)

  • a claim on future profits of a blockchain project similar to a share in a company (like the Iconomi token which enables to benefit from the performance of the investment platform)

But what’s more interesting is how much “power” or influence it gives each token holder over the blockchain project itself. For instance, Dash created a system of “masternodes” which require users to lock up a certain number of Dash tokens in order to get voting rights on the network (how the network is managed, upscaled, updated etc.) That power or influence varies depending on the token and blockchain project.

One pretty much universal “risk” of having a concentration of tokens in a few hands is coordinated “pump and dump” schemes. For instance, there are various articles pointing to Telegram groups that coordinate their pump and dump on Bitcoin. This is only possible if you hold a significant portion of the tokens otherwise your coordinated action will not make much difference. Such schemes can further consolidate the concentration of tokens by manipulating the market (buying tokens from panicking newbie investors in crypto).

Much of the ICOs also reserve a non negligible amount of tokens for the creators of the blockchain project. This is how Vitalik Buterin became one of the richest people in the crypto space. And this is not a critique of their merit, but simply the recognition that there are some forms of centralization of power or influence still at play inside blockchain projects via the control of a large part of the tokens. I spoke already about pump and dump, but concentration of tokens also gives rise to the dump risk. The development team behind a specific project can easily dump their tokens and disappear into the wild leaving crypto-enthusiasts with nothing but unusable bits of bytes stored somewhere in cyberspace. It requires to have a lot of trust in the team behind a new blockchain project, given the power they have (dumping their tokens and disappearing with your money). Examples of such problems include: the very recent Confido exit scam, or the current problems inside the team of the Tezos over the $232 million raised during the ICO. This risk of centralization has been well underlined by Vitalik himself, and obviously, a centralization into the hands of a “trustworthy” person may appear harmless until… For instance, the price of Ethereum plummeted when there was a rumor about Vitalik dying in a car crash. That’s when you know that there is a centralization risk: when the value of your tokens depends on some people being dead or alive as opposed to the number of nodes in the blockchain’s network…

But even if a project doesn’t rely on any single person, there are problems of centralization: imagine that sometime in the future Bitcoin becomes a massively adopted currency which you can pay with or at least, a store of value. Think about how much “power” early adopters and initial creators would have. It is estimated that Satoshi Nakamoto’s accounts, whoever that is/they are, hold about 1 million Bitcoins. Of course, since he was predominantly mining Bitcoins in the early days, he got most of the rewards. But think about just how much power that person(s) would have if tomorrow you can buy anything and everything with Bitcoin. When you have 1 million dollars, you can buy nice stuff, but when you own 1 billion dollars, you can buy power and influence. Whether the Bitcoin maximalists want to recognize it or not, this is also a form of centralization: the centralization of power derived from the number of tokens you control in a world which has switched to cryptocurrency.

The morality of the story: never underestimate the tendency for centralization. It can creep back in via the most unexpected ways. The challenge for the future, will be to address centralization issues whenever and wherever they arise.

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