The Hierarchy of Decentralization in Crypto

And what does decentralization actually mean?

Nov 29, 2021

Hello readers,

I hope everyone who celebrates Thanksgiving had a wonderful holiday break. Thanksgiving is about gratitude, so I hope everyone had a chance to reflect on what they are grateful for.

This week I’m scratching an itch that has been bugging me for some time: the decentralization debate amongst blockchain communities.

Decentralization is why we’re all here. It absolutely matters. But, like most things in this world, there is quite a bit of complexity to explore when it comes to decentralization. It’s a big buzzword in the space. In this report, we are going deep on the nuance around the decentralization debate within blockchain networks.

Topics I’ll cover:

Why do blockchain communities fight with each other over decentralization?
What are the key tenets of decentralization?
What is the hierarchy of decentralization and why does it matter?

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Let’s go.

Defining Decentralization

The decentralization debate amongst blockchains is largely focused on the below key issues:

Was there a pre-mine of the coins?
Did the market form organically with supply and demand coming from the users of the network itself?
Is there a central team making decisions around the direction of the protocol?
Is the governance of the protocol handled by the community of users?
Can the rules (consensus mechanism, monetary policy, etc) be changed by a central party?
Can anyone easily run a node (the ledger of the transactions) and participate in the consensus of the network?
Are the majority of the nodes hosted by a centralized service (such as AWS) that could in theory shut down the network?

These are the elements that determine how decentralized a public blockchain actually is. They are also the areas of contention within the blockchain industry. But why do some blockchain communities fight with others over this?

Animosity around Decentralization

There is quite a bit of it. Most of this debate is happening on Twitter. And there is no question that the animosity starts with the Bitcoin Community. Bitcoin Maximalists (a small but loud subset of ardent users who believe Bitcoin is the only relevant blockchain and all other blockchains are “scams”) are guilty of propagating the idea that Ethereum (and all other blockchains) are not properly decentralized and are therefore inferior or morally reprehensible.

For the most ardent Bitcoiners, decentralization is at the absolute core of the protocol and must be protected at all costs. It is the only way that Bitcoin can ensure that the consensus rules of the network are adhered to. For example, consensus via decentralization ensures that the monetary policy and core tenets of the protocol cannot be changed.

If Bitcoin cannot maintain its decentralization, it would eventually begin to look more like our current monetary system - where the rules change on a whim and are made by a small group of individuals. Bitcoin would no longer be able to benefit the most people if it lost its ability to be decentralized - the benefits would likely accrue disproportionately to those in control vs those outside control.

This is at the very core of what Bitcoin stands for. These ideas align with my values and understanding of how centralized systems can create poor incentive structures that oftentimes result in unintended consequences and corruption. There is no conspiracy theory here - it is simply true that power often corrupts. Therefore, an incorruptible monetary system that is built around the consensus of the people using the system would be preferable. After all, we do live in a democracy, right?

This simple question illustrates my position on the matter: would you rather live in a society of 100 people where 1 person gets to control the money, and that person is not you? Or would you rather live in a society of 100 people where nobody controls the money and where everyone votes on the rules of the monetary system?

Gold was not created by governments and stood as the base layer of the monetary system for thousands of years up until 1971. How quickly we forget.

Should Bitcoin be held to a higher standard vs all other Blockchains?

Yes. There is no doubt about this in my view. Bitcoin is unequivocally the most decentralized blockchain. There is no debate here. But what we do not hear folks talk much about is that Bitcoin has to be the most decentralized blockchain.

Bitcoin is the only blockchain that has the ambition to become the base layer of a new monetary system. It must be incorruptible. This is where the decentralization debate goes off the rails. Ethereum has no ambition to be the base layer of a new monetary system. Etherum functions more as a world computer that uses smart contracts to automate processes that are typically handled by intermediate middlemen today. Its application is broad and could be disruptive across many industries including finance, insurance, social networks, gaming, music, etc.

Bitcoin doesn’t care so much about all of that. It just wants to create a fair monetary system - and decentralization is paramount to this.

So why are Bitcoiners defensive about the fact that Ethereum is less decentralized than Bitcoin?

In my opinion: economic incentives.

The most ardent Bitcoiners have most of their wealth tied up in Bitcoin. So, when Ethereum goes on a bull run and eats into Bitcoin’s market cap, it is perfectly understandable to see the decentralization debate resurface.

To be clear, we should all be grateful to the ardent Bitcoiners in the early days that pushed Bitcoin into the mainstream culture. It’s incredible to think about how much Bitcoin has already gone through in its short life: from Mt. Gox to Silk Road, to Fork Wars, to the China Ban. 80% bear markets. Bitcoin has proven to be anti-fragile. It’s here to stay. This is a $1 trillion dollar asset now.

So I cringe sometimes when I see the animosity of Bitcoin maximalists toward other blockchains. It’s unnecessary and it turns the average person off to the Bitcoin community.

Ethereum (and a few others) are doing really interesting things in the space as well. It would be silly to ignore this.

In Defense of Ethereum

In this section, I am going to cover the gripes that Bitcoiners have with the Ethereum Community. Some of these are fair. Others are not. Keep in mind that Ethereum should not be held to the same standard as Bitcoin since its ambition is not to be the base layer of a new monetary system.

Bitcoiner argument #1: Ethereum had a pre-mine of the coins to insiders

On the surface, this is true (and it’s true for every blockchain not named Bitcoin). But there is nuance to understand here so let’s dig into it. When Ethereum was launched, they raised $18 million dollars so that the developers could have resources to build out the network. This was achieved through a pre-mine of 72 million coins. 60 million of these coins were purchased by the general public (83%) and the rest went to the Ethereum Foundation and the developer community. Today, Ethereum has a market cap of $510 billion. So, in 6 years, the Etherum Foundation has achieved a 28,333x return for the early investors. This doesn’t include the mountain of protocols built on top of Ethereum, of which many have achieved similar levels of success on a smaller scale.

At the risk of sounding harsh, if anyone thinks this is a Ponzi scheme or bad use of capital, they need to go back to the whiteboard. This narrative simply does not jive with the facts of what has transpired.

Comparing Ethereum’s launch to Bitcoin

When Bitcoin came into existence, its anonymous creator began running the software and mining the coins. Soon after, others joined. But because Satoshi’s coins were earned by mining via the proof of work consensus mechanism, Bitcoiners point to this as proof that everything was above board and fair. Satoshi gave anyone that wanted it a fair shake at mining alongside him when the protocol launched. There was no insider preferential treatment. Furthermore, the software was released to the public two months before its launch (first block mined). Anyone could have lined up to mine, copied the idea, forked the code, etc.

To this day, we can see the coins on the Bitcoin blockchain that were mined in those early days. 99.9% have not been moved. If Satoshi were to emerge and claim his coins, he would be one of the richest people in the world today. With that said, this does not make Bitcoin centralized in any way. Satoshi would have no more control over the network as you or I if he did come back (assuming he’s alive).

Below is a nice visual of how tokens are allocated across some of the larger blockchains in the space. You’ll notice that Bitcoin does not appear on the list - this is because there was no insider allocation of coins.

Bitcoiner Argument #2: The majority of Ethereum nodes (which store the ledger of transactions) are primarily hosted on Infura, a blockchain developer suite, which uses Amazon Web Services cloud servers (centralized host)

This is true. And it is a weak spot for Ethereum. This means that in theory, Ethereum could be shut down by Amazon. There isn’t much more to add here besides the fact that Ethereum is looking to move away from Infura and AWS so that they can be more censorship-resistant.

Bitcoin does not have this problem. But again, Bitcoin should be held to a higher standard - it is trying to be the base layer of a new monetary system and Ethereum is not.

Bitcoiner argument #3: Ethereum nodes hold much more data and cannot be hosted by the average participant on the network.

Again, this is largely true. Ethereum nodes are complicated to set up, hold over 4 terabytes of data, and are more expensive to run.

Bitcoin nodes on the other hand, are easy to set up, can be run on just about any computer, and cost less than $200.

The output of this is that Bitcoin’s blockchain optimizes for more decentralization. It’s that simple.

Bitcoiner argument #4: The governance of the Ethereum protocol is centralized and therefore the rules and monetary policy can change.

Again, I would say this is accurate. But again, there is nuance. The Ethereum Foundation is steering the direction of the Etherum blockchain and protocol upgrades. As a result, the monetary policy and even the consensus mechanism have changed (proof of work and now moving to proof of stake).

With that said, we need to consider that if the users of Ethereum and those hosting the nodes did not agree with the changes proposed by the Ethereum Foundation, they could not accept the changes. So, consensus still wins. Now, if the nodes are expensive and hard to run then you can argue that “consensus” is not really achieved by the broad community of users. I think that’s fair.

This is also how changes are made to Bitcoin, like the recent Taproot upgrade. Bitcoin Core developers can also propose changes to the Bitcoin blockchain, which they have. This follows a similar path to that of the Ethereum foundation - if the decentralized network of nodes does not accept the changes, then Bitcoin doesn’t change. Either the nodes download the update or they don’t. It’s really that simple - every blockchain has a core developer team. But this does not mean that they can arbitrarily make changes to the protocol.

Key takeaway: there are core developers at the center of every blockchain. They have the right to propose changes to the protocol. If the community (nodes) accept those changes, they are implemented via consensus. Access to nodes by the general public and the number of nodes on the network is critical in this process.

Bitcoin nodes are by far the most accessible and widespread.

Bitcoiner argument #5: Ethereum’s move to proof of stake will centralize and consolidate power over time.

Again, I think this is a fair argument. But again, Ethereum is not trying to be the base layer of a new monetary system.

Ethereum is moving from a proof of work consensus mechanism (which is what Bitcoin uses) to proof of stake.

Proof of stake allows holders of Ethereum to “stake” their ETH assets (their consideration) which is used to validate transactions on the network. Stakers earn fees for doing so.

Bitcoiners believe this unfairly rewards large holders of Ethereum. The rich get richer. The argument is that this looks much more like the current monetary system than the more fair system that Bitcoin is proposing. But again, Ethereum isn’t trying to be a monetary system.

Ethereum vs Solana (and other L1s like Avalanche)

Interestingly, as we see a rise in Ethereum competitors, the Ethereum Community is now pointing at the competition with the same claims lobbed at them by the Bitcoin Community. Why?

Economic incentives.

As the Ethereum Community is threatened by these rising competitors, they are pointing at the number of nodes, who controls the nodes, and the cost to set up the nodes as reasons that investors and developers should stay away from Solana and other layer 1 competitors.

Similar to Bitcoiners, the Ethereum Community is largely correct here. But Solana is a newer blockchain (just a few years old) so it would be difficult for them to be as decentralized as Ethereum from the jump. Decentralization increases with time as more developers build on the network and more nodes participate in consensus.

In any event, it’s an interesting development considering what the Ethereum Community has had to endure from the Bitcoin Community.

Conclusion

Decentralization is a hot topic and a buzzword in crypto. I find that the loudest voices on this topic oftentimes don’t even fully understand what decentralization means and for which blockchains it is most important.

At the end of the day, every public blockchain network (including Bitcoin) has a core team of developers at the center of it. If this core team wants to change the protocol they can do so, but the network of nodes must accept their changes.

For example, today Solana’s nodes are primarily run by the developer team. So, the people building the blockchain and proposing changes are also voting on those changes. This is not decentralized in the way a Bitcoiner would define it. Could it become more decentralized over time? Sure. But it is important to understand how this all works.

It is also critical to point out that all public blockchain networks are open-source. This means anyone can access them, copy the source code, build applications on them, etc. This is what it means to be a public blockchain.

Furthermore, public blockchains that have proper incentive structures are able to organically create supply and demand amongst the users of the network. This is true of Solana. So, while there may be a core developer team at the center, the marketplace is forming organically. The network wouldn’t function if not for the users, of which they are economically incented to be there.

Developers want to build applications on blockchains that have network effects (developer community exchanging ideas), are open source (all public blockchains are), and where the consensus rules of the network cannot be arbitrarily changed by a small subset of leaders controlling the network.

The final point I want to make is around tokenomics and the allocation of coins to early investors, developers, and foundations. There seems to be some confusion in this area as folks will point to this as if it’s some moral issue. What is really interesting and powerful about crypto networks is retail gets access basically at the Series A stage of these networks forming. With a traditional company, VCs will seed and invest through a series of rounds. There can be 5-7 rounds of dilution before retail gets access during an IPO. So, what is actually happening here in crypto, is we are allowing retail to get access much earlier in the process. Before all the dilution happens. With this context, I’m not sure why anyone would have a problem with this.

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