Centralization in Cryptocurrencies: Will the future of crypto payments defy the average users?
The centralized mining process is what truly separates the peer-to-peer digital cash system from other forms of online payment. Instead of having a centralized third party that processes transactions, crypto coins use several dynamic, potentially-anonymous entities to move money around the network.
Initially conceived as peer-to-peer (P2P) electronic cash, cryptocurrencies have ideal features for retail payments. These permissionless networks enable independent verification of assets and unparalleled settlement assurance. Since validating transactions is the primary cost in generating US$1.9 trillion of revenue within the global payments market, blockchains will inevitably become mainstream technologies. But how this incredible utility manifests in the real world (e.g., buying clothes and groceries) will likely echo the adoption of the internet itself, and this means many centralized components.
Degrees of Centralization in Cryptocurrencies
There are varying degrees of centralization in all cryptocurrency protocols themselves. In general, tribal arguments center around various interpretations of the Nakamoto coefficient, token distributions, and external centralized dependencies. For instance, hardware/software requirements often severely limit average users from participating in the network consensus, resulting in centralized mining.
From an ownership perspective, many projects have tokens concentrated with insiders and private buyers. Even Satoshi Nakamoto, the inventor of the Bitcoin protocol, still controls up to one million bitcoins, methodically mined for 12 months to a myriad of addresses. Custodial services have been a critical driver of mainstream adoption, with Coinbase alone now holding customer assets worth 11% of the entire crypto market.
Considering crypto assets owned by hedge funds, venture capital, corporates, governments, and traders, it’s not surprising that more than half of all bitcoin is estimated to be maintained by virtual asset service providers (VASPs). Even custodial services hold at least 61% of staked ether for the upcoming Eth 2 merge.
Potential protocol centralization aside, it’s generally impossible to interact with blockchain assets without centralized services. Critics often lament the Ethereum ecosystem’s dependence on Infura, but that only scratches the surface when considering your web browser, operating system, hardware wallet, and even your internet service provider are all typically trusted participants in a cryptocurrency transaction. Users typically trust website and Transport Layer Security (TLS) certificates (BGP spoofing was recently used to steal crypto) for Web 3 interactions, and rarely inspect open-source wallet downloads.
Decentralized Crypto Payments
Beyond idealism and technology, people inevitably use products that make their lives easier. People are predominantly going to use custodial wallets for retail payments. These products are safer, cheaper, and more straightforward for an average person. People don’t care how payments work; they just want them to work. And they certainly are not comfortable with the possibility of permanently losing assets by forgetting a password or misplacing a seed phrase.
The hard reality is that we’ve never had truly full-stack decentralized payments in the first place. In the future, the significant majority of crypto payments will involve custodial products and multiple centralized components. However, using crypto in its many flavors will minimize payment costs, increase optionality and provide more equitable economic access around the world. The more freedom of choice individuals have, the more inclusive money becomes.