Decentralization is at the heart of Cardano

For the IOG team, the high decentralization of the Cardano protocol is both a top priority and a technological challenge that they are enthusiastically exploring. Decentralization is a key feature that brings disruption to current financial and social services. Without insistence on basic principles and innovation, the decentralized revolution makes no sense. In the article, we will show you why we think so.

TLDR:

  • The very same reasons that led to the loss of trust in current centralized services or authorities prevent us from trusting blockchain with a poor decentralization.
  • Private or poorly decentralized blockchains leave a huge space for minorities to control the majority. Cardano will be an independent intermediary that will always prefer the voice of the majority.
  • People should see the use of Cardano as a direct investment in an infrastructure that is owned by the users themselves. It is an investment in the protection of the basic principles of decentralization and thus the rights and freedom of users.
  • Nothing could be better than an infrastructure that is taken care of by all users who have skin in the game. This only applies to decentralized infrastructure. In the case of centralized services, the minority benefits, but the majority has skin in the game.

What blockchains we don’t need

The parameters of different blockchain projects vary. Imagine a blockchain named X, which is maintained by 20 super-fast nodes owned by a single entity. These 20 nodes are responsible for the production of blocks in the network and no one else has permission to join. The X network has high scalability and does not need second layers. All operations, including DeFi services, are very user-friendly.

How secure is blockchain X? Let’s say it can be similar to that of conventional centralized services. Protected assets will be safe until someone manages to break the protection of the nodes or until the owner abuses his position. We believe you could find similar blockchain projects on your own.

Do you think a government could adopt blockchain X and build its financial infrastructure on top of it? Could a new global bank be built on blockchain X? Could a company use this blockchain for its services?

Decentralized networks bring disruption mainly due to changes at the trust level. There is a close relationship between the characteristics of technology and the potential for trust enhancement at the social level. The world faces problems that are directly linked to the loss of trust. People are losing trust in banks, companies, institutions, authorities, and even governments. Decentralization can help solve these problems. However, if the blockchain is not decentralized enough, it loses the potential to solve these problems.

How can you trust the government that it can’t tamper with the data on the blockchain if the government can make a deal with the owner of the blockchain? The inability to make such an agreement is what changes the rules of the game at the trust level.

We don’t need blockchain X if we need to trust a single entity that holds direct control over key nodes in the network. The owner of network X is a single point of failure. The risk of failure is very high. The very same reasons that led to the loss of trust in current centralized services or authorities prevent us from trusting blockchain X.

We don’t necessarily need to get rid of all authorities and centralized services. At the same time, we don’t need another third party. In fact, we need to increase the mutual trust between us and our counterparts, whoever they may be. At this level, technology can help to improve relationships. We need to increase the credibility of the current authorities and services. Alternatively, we can create alternative decentralized services.

A blockchain network without a high degree of decentralization does not bring any qualitative change. There is no significant difference between blockchain X and a company server. Decentralization is about the distribution of decision-making power. Decentralization is about cutting out the middlemen and putting more trust directly into the technology. Decentralization needs to be defended and its growth needs to be pursued. Individuals cannot have a strong position in the network. If they gain it, all important characteristics are lost.

Imagine if a global company decided to use blockchain X and issue its own shares on it. The company and all shareholders would have to trust the owner of blockchain X. What if a government decided to issue a national currency on this blockchain? Should the government and all citizens trust a single person or a company? Absolutely not. The liability would be too high for one entity that could become an easy target. A decentralized network will not leave an attacker an easy target. The risk is thus ideally distributed among all network owners. If there is no easy target, the risk of abuse of power is significantly lower.

Blockchains without a high degree of decentralization are just toys that take advantage of the scalability problems of current projects. They bet on user experience and marketing. It is possible to quickly deliver attractive services and it works. However, this is just a misuse of hype and an attempt to take over the business from the current established companies or authorities. A DeFi service without decentralization is just another financial service competing with existing banks. In the long run, however, these projects will lose their meaning of existence. Technological progress and innovation will allow Cardano and a few other networks to improve scalability and maintain high decentralization. It is more than likely that adoption will reflect the quality of decentralization.

The current problems are related to the abuse of power and the ease of attacking a centralized entity. If we can decentralize control over infrastructure, we can solve many problems hopefully forever.

Why do we need public blockchain networks?

Imagine a bank running blockchain X. In that case, it’s essentially a private blockchain. The bank can increase fees, censor transactions, restrict access to services, prevent the spending of assets, change contract terms, or even stop the service. In addition, the bank gets all the fees for the services provided. If one party can arbitrarily change the rules without the consent of the other party, sooner or later it will do so. The unequal status of the participants is to blame. It doesn’t matter that a bank may have millions of customers. The management of a bank that has a minority position may make decisions that harm the majority.

Only decentralization can solve the problem of the unequal status of participants. Let’s go through all the points individually.

In a decentralized network, the bank cannot decide to increase service fees. Fees are set at the Cardano protocol level. Only the team is able to implement a change at the protocol level and will only do so if a majority of the network participants agree to it. Cardano distributes decision-making power among all ADA coin holders. Thus, all stakeholders could vote on the change. It is hard to imagine a minority being able to push through a change that would be disadvantageous to the majority.

Is it possible that a bank could own such a large number of ADA coins that it would push the change through? Theoretically possible, but unlikely in practice. Moreover, the network collects the fees, not the bank. The network would pay higher rewards to all stakeholders. If the network became expensive for users to use, they might go to a competitor. Competitive pressure among blockchain networks will not allow users to make irrational decisions. It is therefore in the interest of all users, including the bank, to keep fees low.

Pool operators operate a Cardano node and can influence the selection of transactions within a block that they can create. It is technically possible to censor transactions based on, for example, blockchain addresses. However, one pool operator cannot influence the behavior of another pool operator. The public network prevents transaction censorship by allowing each interested party to operate its own pool. Pools select transactions for the block and follow protocol rules. A pool violating the rules would be considered dishonest by the community. Stakers would stop supporting such a pool and delegate ADA coins to another honest pool.

A decentralized bank can influence its own smart contracts, but it cannot influence the behavior of other services running on the decentralized infrastructure. People who understand the point of decentralization are unlikely to trust a bank that censors transactions. Thus, the bank is incentivized to honor the rules of the Cardano infrastructure. Moreover, in an open-source world, it is relatively easy to create a competing service that will suit the majority.

From the bank’s point of view, trying to prevent access to a service is very similar to censoring transactions. Anyone is free to choose to use the Cardano network and does not need the permission of a third party or provide KYC information to do so. Anyone who installs a Cardano wallet can start using the network. Users expect all services to honor the principles of decentralization and anyone going against the rules will be considered an untrusted entity.

There may be relevant cases where it makes sense to restrict service. For example, on the basis of age or nationality. With the increasing integration of blockchain services with the physical world, it is conceivable that DeFi will make use of real user identities. This will make it possible to leverage the legal system. For a DeFi service to make a loan that accepts US real estate as collateral, it only makes sense for it to operate where the US legal system can reach. However, this access restriction is tied to the nature of the service and is understandable.

A decentralized infrastructure can ensure that users are always able to spend their coins and tokens. Furthermore, the terms of a contract, such as a loan, cannot be changed by either party. Anyone who has coins or tokens in their own wallet can spend them at any time and no third party can prevent this. If the coins are locked in a smart contract, the terms of possession and release will be clearly defined. It is difficult if not impossible to stop the global network maintained by thousands of people around the world. All transactions will be settled and deployed smart contracts will be executed as expected. Even entities with very powerful positions can do nothing about it.

We can imagine a hybrid bank whose officer locally assesses the risks associated with a real estate loan where the real estate serves as collateral for the loan. It is possible to create a digital contract and tokenize the property. With each individual repayment, the new owner of the property can receive a portion of the token. Once they have paid off the last installment, they get the whole token. Local authorities can monitor the repayment process in a completely transparent way. The bank could not change the terms of the contract. Each installment would be completely transparent and neither party could cheat.

A decentralized infrastructure can ensure transparency and prevent fraud attempts. A borrower cannot claim to have sent a repayment without the transaction being traceable in the blockchain. Similarly, a lender cannot claim that an installment has not arrived if the lender has sent it. Note that Cardano can provide trust between two parties who do not trust each other. Moreover, the blockchain ensures that both parties are on equal footing and the bank is no better off. It is very easy to audit transactions and contracts on the blockchain. It will be easy for the legal system to judge whose side the truth is on.

The principle difference between blockchain X and Cardano is the level of decentralization. Blockchain X leaves a huge space for minorities to control the majority. Cardano brings the opposite. Cardano will be an independent intermediary that will always prefer the voice of the majority. The challenge for the next decades will be to bring this abstract concept to concrete cases.

We are at a stage where centralized institutions have to deal with the possibilities of decentralized technologies. The initial resistance and mistrust are overcome. New laws and regulations are now being defined to allow closer integration of decentralized technologies with financial and social systems.

The emergence of decentralized banks today need not be doubted. The question is when we will see them in practice. There will be a lot of competition between banks, but also between those who want to compete with traditional institutions. The incentive to succeed will be strong.

The original mission of blockchain technology, i.e. to bank the unbanked, but also to unbank the banked, will be realized. Both groups, today’s banked, who are not satisfied with traditional services, but also the unbanked, people from the developing world who do not have access to banking services, will switch to decentralized services. Both groups are happy to do this because it will be advantageous for them in many ways.

Will blockchain adoption be driven by the quality of decentralization?

Will the quality of decentralization of individual networks really be what determines adoption? This is a complex question. Currently, we can observe that blockchain X can very easily compete with more decentralized blockchain networks because it is more user-friendly. People may prefer user comfort over the quality of decentralization. This is a perfectly understandable behavior and completely in line with how we use technology today. Speed, price, and quality of service are more valued than a difficult-to-understand feature like decentralization.

Let’s show this with a practical example. You hold $1000 in your digital wallet and want to send it abroad. Would you rather use a centralized service that delivers the transaction in 1 second and you pay $0.01, or a decentralized service that delivers the transaction in 10 minutes for $3?

Assuming the use was similarly simple, most people on the planet would choose the faster and cheaper option. Decentralization is not free and there will always be a price to pay. It seems that a centralized service will always be preferred.

Technological advances can increase the quality and at the same time reduce the cost of decentralized services. Running a centralized service will also never be free, so costs may be similar over time. The fundamental difference is that in the case of a centralized service, the service owner gets all the fees. The owner can keep most of the profit for itself and only put a part into innovation. The owner can raise the fees at any time if he is too greedy and confident in his strong market position. In addition, he may start to abuse his position and misuse users’ data. He can censor transactions at the request of the authorities or provide better services only to selected customers. A centralized service will always be prone to abuse of power.

In the case of a decentralized network like Cardano, the whole ecosystem can benefit from collected fees, including the users themselves. People should see the use of a decentralized service as a direct investment in an infrastructure that is owned by the users themselves. Moreover, in an infrastructure that will continue to evolve according to the wishes of the majority. It is an investment in the protection of the basic principles of decentralization and thus the rights and freedom of users.

Changing the perception of the differences between centralized and decentralized infrastructure is very important. However, it is only possible if the quality of service is similar. Users must not feel that they have to pay too much for decentralization.

Centralized services can work well until they are new, competition is high and the world is stable. Once any service gains dominance, it is unhealthy for the ecosystem as a whole and the service can degrade. If there is any instability at the government level, authorities may demand restrictions at the level of financial or social services. The banking system does not innovate because innovation is expensive and because a small group of people thinks the status quo is sustainable forever. Over time, disruptive technology will always emerge to change the existing order. A decentralized ecosystem that is economically and socially motivated to innovate may be much more easily sustainable in the long term and resilient to external pressures. Users’ rights, wealth, and freedom will be better protected.

People will only use and thus essentially subsidize the existence of decentralized infrastructure if they understand the importance and have access to useful services. Furthermore, they must be confident that they can collectively change the infrastructure according to the wishes of the majority. In other words, they can sustain a high level of decentralization in the long term. Decentralization is like democracy, if people don’t care about it and stop demanding it, they may lose it. People need to understand that caring about the quality of technology is similar to caring about democracy. If the current institutions, banks, authorities, and governments start using decentralized technology, and this is quite likely, technology will be one of the guardians of freedom, rights, fairness, transparency, and democracy.

People are not used to worrying about the quality of service at the level of technology. We are used to using a service and will only leave it if it no longer suits us, or if significantly better competition comes along. It’s similar to choosing a political party. The community should spread awareness and explain to people the importance of decentralization.

Decisive power in all current public blockchain networks is distributed based on the ownership of an expensive resource. For PoW networks it is electricity, for PoS networks like Cardano, it is ADA coins. The difficulty of controlling a significant share of the resource prevents individuals from gaining dominance.

In the future, ADA coins may not be the only expensive resource needed to gain decision-making power. As such, the system must prevent decision-making power from being bought with money or the accumulation in the hands of a few. This is a very difficult task, as the world naturally tends towards centralization. Maintaining a high degree of decentralization will thus be a never-ending process. Even those who do not own ADA coins or find it economically unviable to acquire and operate an ASIC miner should be able to gain their share of power. In theory, the primary decision-makers should be the users of the network, not those who can buy an expensive resource with money.

A different economic model and a different distribution of power are what distinguish a centralized system from a decentralized one. The base layer of the new system must be decentralized. Only above this layer can more centralized systems emerge. This is happening today and second layers are being built, which will always be less secure and decentralized, but cheaper and faster. However, people must always be able to rely on the decentralization of the first layer.

The underlying monetary policy of ADA coins will always be controlled by the Cardano network. Similarly, the first layer of the Cardano ecosystem will control the issuance of tokens and the deployment of smart contracts. The second layer will deliver the necessary speed and cheaper transactions. Only fees paid at the first layer can keep all public networks secure and decentralized in the long term. Second layers must not siphon off all revenues from service fees. If the need for the most decentralized and secure layer disappears and people stop paying for its services, we will go back to centralization.

If you encounter an ecosystem that has no or very low fees, you are likely to find a problem with the quality of decentralization. If the ecosystem has no revenue, it cannot have expenses. No one has an economic incentive to provide quality services to the network and behave fairly. It is not economically possible to drive an entity that behaves dishonestly out of the system.

Sooner or later it will become clear that only a decentralized infrastructure can solve the problems we face today. While centralized blockchain X may be popular for a long time, it will likely fail in the long run. The reason for failure will be the greed of the owner, who will prefer his own profit at the expense of costly innovation or delivering the improvements that users want. It is easier to attack centralized networks and break their protection. There may be hacks that will be difficult to prevent in the future unless resources are spent on increased protection or major infrastructure improvements.

Nothing could be better than an infrastructure that is taken care of by all users who have skin in the game. This only applies to decentralized infrastructure. In the case of centralized services, the minority benefits, but the majority has skin in the game. If some unfortunate event happens, usually only the majority will suffer.

Cardano is owned by literally everyone who holds ADA coins. All of these people may be users of the network at the same time and care about protecting ADA coins because it represents their property. Cardano can tokenize stocks and other assets. All companies that take advantage of tokenization will care about the quality protection of all tokenized assets. They will want to have some of the decision-making power and therefore will need to acquire ADA coins. Banks that will use smart contracts for their new decentralized services will want the same. One day, states will have an interest in holding part of the decision-making power. Everyone will have a vested interest in keeping the ecosystem decentralized. Once we reach this stage, we can declare that decentralization has succeeded. However, it will be a very long journey.

Conclusion

Decentralization really matters. Do not underestimate its importance in the long term. Decentralization will allow us to redefine very fundamental things such as freedom, the right to privacy, the right to equality, ensuring transparent processes, weakening the possibilities of corruption, etc. Decentralization, i.e. the distribution of power, is what can change the rules of the game and fix trust issues. Many people still don’t understand the importance of technology that we can rely on 100% when it comes to trust. We use trust every day in many of our financial and social interactions. Often we are not even aware of the abuse, or we think that if it doesn’t bother the majority, it must not bother us either. Trust operates primarily on a social level but can be significantly enhanced by technology. It is up to us how and where we use Cardano’s infrastructure.

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Good article! :grinning:

It’s a great read Jaromír, as always. Thank you for these articles!