Centralized vs Decentralized: What’s the difference?

One of the most fundamental ways to understand blockchain technology is this: the blockchain is a force of decentralization. Prior to blockchain, the world had oriented around the logic of centralization—central governments, central banks—blockchain reinvents these systems in a radical way. Where power and authority concentrate, blockchain disperses it to the masses. In the battle between centralized vs decentralized ways of organizing society, blockchain technology will play a decisive role.

Ultimately, blockchain is giving the world a choice between centralized vs decentralized systems. The infinite possibilities of decentralization have begun to emerge and are already affecting us here and now.

Today, blockchain technology has the ability to completely alter the way we do everything. Truly, that’s no exaggeration. Anything that deals with data, information, any kind of transaction at all has the potential to link up with blockchain, a decentralized, public database controlled by no central authority or power.

What is Decentralization and Why Does it Matter?

So what does it mean for all of this information and all of these transactions to be “decentralized”? How is it different from a “centralized” way of recording and storing this information?

Let’s start with a basic definition of what blockchain is: a distributed, shared, encrypted database. Because of its open and public nature—anyone has access to it—it cannot be reversed, corrupted, altered, or destroyed. The rapid development of cryptography and decentralized computer networks have made this historic innovation possible.

Historic, because of what blockchain makes unnecessary: a central authority. Blockchain’s database spread out over countless computer nodes. It is public and unchangeable and is already all the authority anyone needs. Because the authority is shared, it belongs to no one and everyone; it belongs to blockchain and that’s why decentralization matters.

If people can transfer a unique bit of digital property, data, or code to anyone else safely, securely, and in an unalterable way, they can create currencies that don’t need the authority or backing of any central government. They can create self-enforcing digital contracts that eschew human mediation or marketplaces free of any regulation. They can communicate more securely, control assets just like digital property, and even issue financial securities.

The possibility of decentralization ushered in by blockchain tools and technologies, enables anyone to reach a consensus on the occurrence of a transaction or an event without any controlling authority. This means a significant shift in the balance of power across every sector of society, from communications to business, politics, and law.

In short, the disruptive force of decentralization is what’s causing all the fervor and volatility around blockchain and cryptocurrency.

The Basic Differences Between Centralized vs Decentralized Blockchains

By definition, a blockchain is a decentralized database or ledger. The work that maintains blockchain is distributed and shared among each node or “peer” in the network. And that means data doesn’t have to pass through any central server or hub.

But while technologically a decentralized system, there’s more to maintaining a blockchain than simply processing code. In it’s purest form, decentralization would mean that no peer or actor in the system would have more authority or power than any other. Yet the reality on the ground is quite different than this egalitarian vision.

Blockchains are supposed to work according to rules enforced by consensus, where anyone can participate and anyone can check that the rules are being followed. This is one of the major differences between centralized vs decentralized systems. In centralized systems, most people who participate have to trust that a small number of individuals or entities are following the rules. Or at least, they have to trust the people who say they’ve checked to make sure those in control are following the rules. Decentralized systems, however, shift power away from a small minority and eliminate the need for trust. Instead, anyone can check the ledger or contribute computational power to reproducing it.

In practice, however, most blockchains don’t achieve full decentralization and absolute transparency. Research has shown that in reality, only a handful of individuals contribute to setting and enforcing a blockchain’s rules. Underlying many cryptocurrencies, in other words, is a governance structure that is inherently centralized.

But many cryptocurrencies, including the major coins like Bitcoin and Ethereum, try to address the pull toward centralization. To do so, they open-source their code so anyone can examine it. In this way, anyone can propose improvements to the cryptocurrency protocol and contribute to decisions.

Decentralized Blockchains

Still, there are centralized vs decentralized blockchains. And in different contexts, each can have their advantages and disadvantages.

Decentralized blockchains are undeniably the most secure. This is due to their peer-to-peer, distributed nature. A blockchain is an ordered sequence of information—blocks—linked chronologically with the preceding blocks. The links between blocks go all the way back to the very first link in the chain.

If anyone had access to the entirety of blockchain, they’d be able to alter it, destroying the authority of the database and making it impossible to verify transactions. But decentralized blockchains don’t have this vulnerability, because the data doesn’t pass through or rely on a single or central point. To hack a decentralized blockchain, a hacker would need to access every single node in the blockchain and make a change at each one simultaneously. And it’s just not economically viable to obtain and direct that much computing power at once.

Blockchains and Centralized Systems

Centralized blockchains are hybrid concepts that blend a centralized governance structure with a decentralized network. Like decentralized blockchains, these systems distribute information over a shared P2P network with every node sharing and securing the ledger. They also require consensus rules (i.e. proof-of-work) to verify a single, indisputable version of blockchain.

Where centralized blockchains differ, however, is in the number of nodes in the network that can make changes to and enforce the consensus rules and software protocols. One of the largest decentralized public blockchains in the world, for example, is Bitcoin. Anyone can access its ledger and share computing power to execute its proof-of-work protocol.

Private or centralized blockchains, by contrast, sharply restrict who can make changes to the ledger and the protocols. But that makes them ideal for private organizations like corporations. In this way, companies can take advantage of the many benefits of a decentralized database for storing and sharing internal records and enforcing contracts.

The trade-off, however, is security. With fewer nodes responsible for making and implementing changes to blockchain, hacks require fewer resources. Furthermore, fewer nodes mean verifying the authenticity of blockchain’s records is more difficult.

Centralized vs Decentralized Cryptocurrency

One of the most powerful, groundbreaking and popular instances of decentralized blockchain technology is cryptocurrency. In fact, decentralization is the reason cryptocurrency can carry value without the backing of a central bank or government. Instead, the price of cryptocurrencies like Bitcoin and Ethereum relates to the differential value of a single transaction against every single other preceding transaction recorded in the chain. And making that determination requires mind-bogglingly huge computational resources.

Nevertheless, cryptocurrencies aren’t the fully decentralized systems many people think they are. Because fiat currency is involved in many crypto transactions, or currency backed by a central government, like the dollar, some degree of centralization is inevitable. And this brings us to one of the major arguments in the centralized vs decentralized debate. When it comes to cryptocurrency, what combination of decentralization and centralization is ideal?

Many Top Cryptocurrencies Are Centralized

While decentralization is absolutely the aim of cryptocurrency, many of the top cryptocurrency ecosystems are still fairly centralized. And creating a decentralized ecosystem for crypto continues to be a significant challenge for software developers.

So in the current moment, the reality is that cryptocurrencies are centralized in two major ways. First, “mining pools” create centralization. Remember all those computing resources needed to add to, verify, authenticate and reproduce blockchain on a P2P network? In many cases, that work—called “mining”—isn’t equally distributed across all the nodes in the network. Instead, “mining pools” of powerful, coordinated computers dedicated to executing the crypto protocol can exert a centralized control over the entire network. Mining pools are the forces behind “51 percent” attacks.

Second, there’s the less complex issue of the reliance on centralized platforms and service providers. It’s a myth that all of these platforms and service providers are by their nature decentralized. They’re not. And right now, there’s a serious trade-off between the “user-friendly” ecosystem of centralized platforms and service providers and the complexity for most users of decentralized solutions. But centralization undeniably hinders the potential of blockchain and cryptocurrency.

Decentralized Cryptocurrencies Are On The Rise

Big changes, however, are in the works. And the cryptocurrencies that survive today’s volatile environment will likely be those that can execute a fully decentralized model. No wonder, then, that 2018 has seen the birth of several cryptocurrencies proclaiming themselves to be the “first” or “truly” decentralized coin. And then you have the coin vs token debate; But are any really decentralized?

For a digital currency to actually be a decentralized currency, it must meet two criteria. It has to be immune to censorship and any other kind of tampering from project leaders. Many coin platforms do not meet these criteria. They adjust wallet balances, control nodes and in many ways behave just like the centralized institutions they intended to replace.

Still, popular cryptocurrencies are working toward a future decentralization model. It’s not an all or nothing affair, either. Many coins blend the two models. Therefore, it’s possible to measure how centralized vs decentralized a cryptocurrency is in two ways: the ledger itself and the platform leadership.

And this leads us to another crucial point. Cryptocurrencies and the exchanges on which people trade them are two different things. And for people interested in making speculative investments in crypto, choosing the right exchange for your investment needs and philosophy is paramount.

Centralized vs Decentralized Exchanges

Decentralized exchanges are on the rise, and for good reason. According to Reuters, an estimated $4 billion worth of cryptocurrencies vanished off of exchanges between 2011 and 2017. That kind of theft wouldn’t be possible on a decentralized exchange.

In other words, a decentralized exchange, or DEx, is a much safer exchange to buy and sell cryptocurrency. But why?

Normally, a crypto exchange works like this. A customer wires money to the bank account of the exchange. The customer then waits until the platform credits those funds to their account with the exchange. Then, using that account balance, the customer buys and sells crypto coins. But throughout the entire process, the exchange controls the customer’s funds.

The exchange is responsible, therefore, for keeping those funds secure. Of course, trusting the exchange with your deposits opens you up to several vulnerabilities, and you have to trust that the exchange isn’t open to a hack or doing something suspicious with your money.

On a truly decentralized exchange, however, customers don’t have to trust anyone with their funds. Instead, blockchain verifies the entire trading operation and buyers and sellers work directly with one another. Customers keep their own funds in their own digital wallets and trade them on the decentralized exchange.

Finally, centralized vs decentralized cryptocurrency exchanges isn’t an all-or-nothing scenario. Again, most currently operating models are hybrid. Different decentralized exchanges take different approaches. But in various ways, they can all act as relays for transactions that end up on popular blockchains. This crypto world calls this “on-chain” settlement. DEx customers keep control of their own funds until a trade is verified, and then they move them out onto a blockchain.

Trading Between Fiat Currency and Cryptocurrency Requires Centralized Exchanges

Any DEx, or decentralized exchange, has one key disadvantage to centralized exchanges. On a DEx, customers can only trade between different cryptocurrencies. Trades between crypto and fiat currencies like the Euro or the U.S. Dollar, for example, can’t happen on a DEx.

For now, customers need centralized vs decentralized exchanges to do fiat to cryptocurrency transactions. This is in order for trading to remain compliant with know-your-customer (KYC) and other regulations. But centralized exchanges like Coinbase, Kraken, and Binance are so because they put their own company’s representatives in control.

Centralized exchanges generate revenue from fees since they control all the entry and exit points to blockchain. Truly decentralized exchanges, however, work quite differently. In this case, a distributed blockchain routes orders and information through a peer-to-peer protocol. This spreads the issue of “trust” across hundreds of independent nodes, rather than one central authority.

Summing Up: The Key Differences Between Centralized vs Decentralized Blockchains

In its current form, the world of crypto is a hybrid world in the middle of some groundbreaking and disruptive transitions. Today, centralized and decentralized models co-exist, always seeking out new ways to link up with and interact with each other. But the trend and undeniably the future of cryptocurrency and blockchain is moving swiftly toward decentralization.

And the reason for that is simple. Decentralization provides better security against bad actors. It widely distributes control and decision-making power. Ultimately, it makes blockchain technology and the products that leverage it more stable and viable.

At the same time, there’s powerful incentive to centralize many aspects of blockchain operations, from mining to governance. Indeed, one of the most crucial blockchain transactions, converting from fiat to cryptocurrency, still requires a centralized exchange. But that doesn’t mean “centralization” isn’t a dirty word in the crypto world.