Centralization Risk in Crypto: How Decentralized Is Crypto?

The crypto industry has a love hate
relationship with centralization. We need centralization,
but we don't like it. Everything should be as decentralized As possible, but we also love fast
transactions and low fees. 2022, highlighted
the risk of centralization of capital With the collapse of three
AC and also FTX. But there are other centralization
risks out there, And you don't have to dig deep
to find them, Even in the most popular cryptocurrencies. Hey there, my name is Trevor With CMC, and today we'll be discussing
decentralized Nation and crypto And we'll be showing you which areas are
not as decentralized as they claim to be. Let's get started. What is centralization in crypto? Well, centralization In crypto comes from centralized points
in the tech stack. Anytime there is a choke point in
the infrastructure, centralization occurs. To name only a few examples. There are only a handful of Internet
service providers to use. Miners are concentrated
due to economies of scale and hash power, Meaning it's easier for bigger mining
firms to be profitable. Nodes can have centralized clients
or rely on centralized node hosting. Centralization
can also lead to censorship. And here censorship actually refers to the
exclusion of transactions or addresses. We can distinguish between strong
censorship and weak censorship. Strong censorship is the exclusion
of transactions from a block, And it happens on the protocol level
when miners don't process a transaction From a certain address. One example would be the tornado cash
sanctions, the Office of Foreign Assets Control, or OFAC sanctioned Tornado Cash
and several Associated Ethereum addresses
in August of 2022, Leading to relay operators
to filter specific transactions. And weak censorship can happen
at the protocol or infrastructure level. An example is DeFi
front ends or infrastructure providers,

Like Infura of restricting the flow
of transactions through their nodes. Of course, this happened with Infura
a few months Ago, sparking a discussion
about the decentralization of Ethereum. So the conclusion Is that more centralization opens
the way for more potential censorship. But more centralization can come in
many shapes and sizes. So let's talk about the different types
of centralization risks. A study about blockchain decentralization
by blockchain security company Trail of Bits points out
different vectors of centralization risks. So we have governance. So how many entities are needed to disrupt
the system than we have consensus? How many entities control
the hashing or validation power? Then we have motivational. So how are participants
incentivized to act correctly? And then we have topological. So can a few nodes be disrupted
impacting the entire network? And then we have networks. So are nodes dispersed
geographically and across Internet service providers
or ISP and software? Does the blockchain
depend on any special software? Some of these have been well known topics
for discussion for Bitcoin, Ethereum And other chains. So for example, while consensus and
governance at centralization are similar, You can argue that Ethereum is exposed
to an added risk vector through Vitalik. If someone disrupted Vitalik,
it will throw Ethereum into turmoil Regardless of how many entities control
validation power. In a way, this happened to Solana
when FTX, one of the biggest backers, Went under and in similar fashion
topological centralization can harm Scaling solutions and alternative
layer one chains. They depend on cross-chain bridges
which can be exploited and proverbially Sever the link to more liquid ecosystems. And then when we're talking
about the examples of this, We have the $190 million hack of Nomad,
and then we have the hack of Binance’s Bridge, the $625
million hack of Ronin Bridge.

And with that in mind, What kind of centralization risks
to the big ecosystems face? So let's talk about decentralization
risk in Ethereum. Ethereum has a Fair bit of centralization
risk take consensus and chirality. At the time of this video, Lido
in the top three centralized exchanges. So Binance, Coinbase and Kraken hold
the majority of these staked ETH, while Lido technically only aggregates
the delegated seeking power, It is assigned the concentration of voting
power in the hands of a few entities Can lead to cartelization. MEV can even amplify this going forward. Speaking of MEV, this has become
another point of discussion for Ethereum. In simple terms, MEV refers to the profit
miners can make by prioritizing Some transactions over others. So this process of front running
has led to the rise of MEV boost Relay companies, and these are companies
providing tools That help everyone to capture
a slice of extra profit from MEV.. So what's the problem? Validators that use these tools outsource
the decision Over what transactions go into a block
to the MEV boost three layers. And these companies want to be compliant
with, say, a sanctions regime That can exclude certain blocks. That would be censorship and censorship,
which comes from centralization. So the share is currently declining,
but the centralization risk is there. Then there are centralized
choke points validator clients. And that note hosting diversity Most of ethereum's nodes
depend on a one execution client or Geth. Amazon Web hosting services hosts
the majority of nodes, so Two companies provide a majority of nodes
with consensus clients. While these are not imminent
or even critical risk factors, They go to show that Even a nominally decentralized chain
like Ethereum is not that decentralized, And you can have many nodes
which are widely distributed Geographically
and still have centralization bottlenecks.

And Gary Gensler
doesn't even consider Ethereum validators To be that decentralized, which is why
the SEC argues that Ether is a security Ethereum address this with an addition
to its roadmap called the scourge. So the community is aware
of these potential problematic issues And is looking to resolve them. So let's talk about decentralization
risk in Bitcoin. Well, Bitcoin's Community prides itself on Bitcoin
being the most decentralized Blockchain, but there are also
centralization risks in Bitcoin. The obvious one is the concentration
of hash power in the proverbial hands Of a few mining entities. So Antpool,
which is at 30.63%, and the Foundry USA 19.77%,
controlling majority of the hashrate At the time of this video
and a third pool enough to pool at 14.26% And you have a comfortable majority
and a fourth in binance's pool At 11.5% and 75% of the hash
rate is owned by four mining pools. This is not necessarily bad
or an immediate risk. Bitcoin's security model aligns
miners interests with that of the network As a whole. However, not being a risk today does
not mean it cannot become a risk ever. Nakamoto coefficient measures
how many entities are necessary To disrupt a blockchain system
and for Bitcoin it's currently Only at two, since only two mining pools
would need to be disrupted or over. The trail of bid study
found that 60% of Bitcoin traffic Traverses only three ISP's Bitcoin. ASICs production is highly centralized
with a few players Like Bitmain in a micro bit
dominating the market. Since Bitcoin's value as a function
of the kinetic energy that it converts via ASICs centralization
isn't actually going to occur. The geographic distribution of Bitcoin
mining power follows a similar pattern. 50% of the mining power in January of 2022
were located in the U.S. So 37% or China at 21%,
according to the Cambridge Institute For Alternative Finance Frequency, Whose community would like to see
it become the next world reserve currency.

Bitcoin is not all that much decentralized
than fiat currencies. So let's talk about centralization risk. In other layer one chains. Other Blockchains like BnB Chain
and Solana have often face The wrath of hard core crypto supporters
who accuse them of being too centralized. Instance, some have pointed out
that BnB chain has only 21 validators over BNB chain. Developers have also stressed
that decentralization is a process And not an end state
that BnB claims to already have reached. Solana has had to battle With repeated outages over the last year
due to its hardware hungry blockchain. And this has led to crypto Twitter
saying that Solana has open hours And a support desk
that will address issues when needed. And while it is true
that Solana is heavily influenced And also controlled by the Solana
Foundation, in other regards, It is also more decentralized than chains
like Ethereum or Bitcoin, for example. Solana's Nakamoto coefficient of 27
is much higher than that of its biggest Rivals. Solana also requires
no minimum stake to be a validator through Ethereum works around this requirement
with liquid staking derivatives. It introduces the very centralization
many fear node hosting Providers are similarly decentralized,
as with Ethereum. On the other hand, hardware requirement
is famously expensive, Which has contributed to the very outages
that keep plaguing the blockchain. Now let's talk about the
centralization risk in DeFi. So this guide Wouldn't be complete without a section
on centralization risks in DeFi. So one of the primary risks
associated with DeFi is the potential For a single entity to gain control
over a large portion of the network. Be it the majority control
of the governance power or being able To unilaterally change
the smart contracts power a protocol. DeFi is far less equipped to deal
with these risks than crypto folks like To admit.

The Wormhole hack in February of
2022 is a prime example of this. A hacker was able to steal 120,000 wealth
from a wormhole, a cross-chain bridge And the hacker was able to do this
because the project had a vulnerability That allowed them
to gain control of the funds. But this story doesn't end there. The wormhole hacker attempted to escape
with the funds by moving them Through various protocols
over in February of 2023 JUMP crypto. So the fund that initially plugged
the liquidity hole caused by the hack Was able to recover the funds. But this required a bit of centralized
help. JUMP Crypto
was able to obtain a court order From the High Court of England
and also whales which directed Oasis Protocol to take all necessary steps
to retrieve the assets. And by necessary steps
we mean changing the multisig To retroactively strip
the hackers of their funds. Was this an example of how centralization
can be abused or used in DeFi? Only through the intervention of a
centralized entity was the hacker stopped? Not very decentralized, is it? Centralization
risks in blockchains are real. Hosting providers And Internet service providers are common
bottlenecks for almost all blockchains. The concentration of capital
and or hardware inevitably leads To centralization. But it's also important to keep in mind
that centralization in itself isn't bad As long as stakeholders in blockchain
ecosystems work towards developing And improving the chain, centralization
can even lead to efficiency gains. Crypto supporters just need to be mindful
of how to mitigate the side effects Of centralization.

Coinbase
OUR TAKE

Coinbase is a popular cryptocurrency exchange. It makes it easy to buy, sell, and exchange cryptocurrencies like Bitcoin. Coinbase also has a brokerage service that makes it easy to buy Bitcoin as easily as buying stocks through an online broker. However, Coinbase can be expensive due to the fees it charges and its poor customer service.

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