The Future of Crypto-currencies: Decentralized or Centralized?
Today crypto-currencies have become a global phenomenon known to most people. This revolutionary technology has the ability to transform the current payment systems that are considered slow, error-prone and expensive relative to performance in other high-tech industries. The crypto-currency market is currently valued at a massive $19 billion! The significance of this form of digital cash can be understood by the hyperinflation scenario in Venezuela, which has caused thousands of people to use bitcoin as a way to pay for everyday expenses and even medical treatment. Having realized this, the financial incumbents have been making rapid progress in order to integrate modern digital payments systems in their infrastructure.
Understanding the Difference
There are numerous cyber-currencies out there already. Only if that wasn’t enough, the crypto space seems to be expanding every day. However, almost all of these currencies can be divided into two categories, decentralized & centralized. Now centralization might sound contradictory to the very essence of digital money, but not when we have state-sponsored currencies coming into the fray! With the backing of banks, financial incumbents, as well as local & national governments, centralized currencies have become a reality.
Both decentralized and centralized crypto-currencies are forms of virtual/electronic money that completely rely on the technology behind them. They both do away with the problems of double-spending and reversals, and are built on the foundation of a publically viewable, distributed ledger. Nevertheless, there exist some notable differences between them, which can be understood from the table below:-
|Who is the issuer?
||No centralized issuer
||Banks, Financial Institutions, or Governments
||Has its own monetary value
||Usually relies on the existing fiat currency
||Anyone and Everyone
||Only the customers of the parent organization
||Depends on the parent organization – could be local/state/national
||There will be fluctuations in exchange rate vis-à-vis base fiat currency
||No fluctuations in exchange rate
Who’s doing What
Most of the decentralized crypto market is dominated by Bitcoin, followed by Ether and Ripple. Then there’s Litecoin, Dash, Monero, to name a few. This list goes on. While every other attempt to create a digital cash system has not really attracted a significant mass of users, Bitcoin has managed to leave a lasting impact. The first, the most popular digital currency is not going away anytime soon.
This uprising of digital money was bound to have an effect on the financial incumbents of our society. Having initially been skeptical about it, both central and private banking institutions are now embracing the technology. This necessarily does not mean that banks are in favor of bitcoin. To overcome the risks associated with decentralized crypto-currencies, financial institutions have pioneered their own cyber currencies.
Some headline initiatives include CitiBank’s Citicoin, the Utility Settlement Coin (USC), and the Japanese MUFG Coin.
What’s even more impressive is the participation of governmental organizations in this crypto-revolution. Ecuador was one of the first nations to use state-sponsored digital currencies. This has paved way for various other nations such as Mexico, Russia and even United States, who are now deeply involved in building their own centralized digital currencies.
Decentralized vs Centralized
Security (Cyber threats)
For a crypto-currency to be realistically successful, it has to deliver on its promise of security. A decentralized currency such as bitcoin appears to have the edge here. With the whole system fragmented without a central authority, the chances of cyber hacks lower down. Centralized systems on the contrary are more prone to cyber-attacks. Having said that, even decentralization alone cannot guarantee cyber security. Bitcoin exchanges, in the past, have had major security breaches. Amongst the most notable ones, is the Silk Road 2.0, where $2.7 million worth of bitcoins were stolen from Silk Road 2.0‘s escrow account!
Centralization would mean that a bank or a central authority can regulate the distributed ledger. This however, would also mean that these ledgers will only be editable by regulated financial institutions. But this solves a very important issue with decentralized systems. With an entity looking after all the transactions, the accountability of every transaction can be established. If one is able to trace their transactions in case of frauds and counterfeits, both Anti Money Laundering (AML) and Know Your Customer (KYC) concerns be taken care of. Unfortunately, this salient feature of centralized systems will not be part of a decentralized setting.
The process of adding transactions onto the ledger, popularly known as mining, is the backbone of the whole crypto process. In case of decentralized currencies such as bitcoin, mining is done by ledger processors (miners), individuals who use mathematical algorithms to ensure transactions are recorded safely. The individual miners however can organize themselves into larger groups known as pools. When a pool obtains majority (51%) of a decentralized network’s mining power, it could enable massive double spending and will have the ability to prevent transaction confirmations, among other potentially atrocious acts. Ghash.io, one of the largest pools of individual bitcoin miners on the network, has twice come dangerously close to obtaining 51% of the bitcoin network’s hashing power.
Billed as the “Future of Money’, the adoption of digital currencies seems inevitable. They provide an incredibly exciting opportunity for today’s payments ecosystem. Decentralization seems to be the key here. Although historically, decentralization has a tendency to be incredibly inefficient compared to centralized solutions. So how much decentralization do we need? What level of distribution will result in the best of both worlds? The challenge is to maintain an adequate level of network distribution, which can ensure a secure and reliable crypto-system.