On The Importance of Decentralization

On the 11th of November 2022 FTX, one of the biggest global crypto exchanges, filed for bankruptcy. Its founder and CEO Sam Bankman-Fried resigned after it had been made public that its trading subsidiary, Alameda Research, was being lent billions in customer funds from the exchange. At the time of writing this, the reported shortfall is estimated at around $8 Billion. Days before the official bankruptcy announcement, people were reporting issues with withdrawals, mainly that they were not going through. Essentially, their money was gone.

It is hard to estimate the magnitude of this black swan incident and the ensuing cascading effect it will have on the crypto market — but we can all agree that a significant amount of trust in the community has been lost. Trust that took years of hard work to earn and build upon.

However, it is not trust that should be a foundational pillar of cryptocurrencies, but trustlessness.

Trustlessness removes the middle man. Looking back at the core principles of Bitcoin, it was engineered to give the power back to the people by enabling peer-to-peer transactions through universal electronic cash written in code. Such transactions are cryptographically secure without the need to trust another third party. An antidote to the traditional financial system, if you will, where participants have to rely on banks as a central authority. Because in doing so, participants have to assume that all participants are not only rational actors, but would also act according to the rule of law and not in their own self interest. Well, after the 2008 Lehman Brothers crash, we all know how accurate those assumptions are..

Why is it then, that we find ourselves repeating the same TradFi patterns in crypto, wherein we entrust our funds on an exchange, ultimately relinquishing safety and control over them, and blindly trusting that all partners on the other end act in accordance to selfless rationale. Has the 2014 Mt. Gox hack, in which the exchange lost over 740,000 BTC of customer funds, not ultimately taught us the self-custody mantra: not your keys, not your coins?

The case for self-custody has never been stronger. Self-custodial wallets are permissionless storage vaults for your cryptocurrency, which solely the owner has control over. They consist of a public key and a seed phrase, the latter permitting you, and only you, to access the funds. They come in hardware, paper form or as apps, best suited to individual requirements. One could argue that they are the easiest and safest form of storing and transporting wealth.

Your entire net worth can be on a sleekly designed ledger ready to be deployed at your own convenience. Now imagine your portfolio value in cash or gold; much harder to discreetly transport or safely store. In light of this, of course, it goes without saying that protecting your seed phrase is paramount. Lose it and it’s lights out — the access to your funds forever lost.

Back to the CEX debacle. As the name suggests, just because a centralized exchange is offering trading of decentralized cryptocurrencies, does not mean that the exchange itself is decentralized. By participating in trading on the platform, your funds are entrusted onto their wallet. ​​Letting the exchange manage the key for your wallet means whatever assets you keep in it are not truly yours. This leaves you vulnerable to security breaches of their infrastructure or malicious insider activity. We’ve seen this happen plenty of times. Besides, there are more barriers to entry like national restrictions and KYC requirements, all of which are not a problem on a DEX.

Trades on DEXs are matched by an automated market maker, through liquidity pools managed by smart contract, or algorithmically, by matching buyers and sellers. To participate all you need is to connect your self-custodial wallet to the exchange application. You still retain full control over your funds and can enter and exit on your own volition.

A whole industry built around this trustlessness ideal has blossomed in recent years. DeFi offers more ‘banking’ services like lending, borrowing and staking, all without a middle man. Just like on a DEX, DeFi applications give you autonomy and maximal freedom for your finances as all transactions are validated by code and not a governing entity. Anyone can participate and nobody can be censored. You see why it’s either real decentralization or nothing?

And what’s more, community building around the principle of the trustless blockchain is thriving. DAOs (Decentralized Autonomous Organizations) run autonomously by laws encoded via smart contract. Participation is accessible to anyone if they agree to the rules and values of the ecosystem. The financial resources are accessible to the entire organization, but only allocated based on the majority’s decision. These decisions are made non-hierarchically and geared towards the best interest of the organization.

Further solidifying the case for decentralized governance is the DAO’s censorship resistance. True decentralized blockchain architecture does not allow for rewriting or blacklisting of smart contracts and so, no third party can oppose or block a decision made by the organization. Let’s look at this through the real-life examples in the DeSci (decentralized science) field. Collectives of like-minded people join in DAOs to encourage medical research of specific issues, while researchers can list their projects and discoveries to receive funding from the community and connect with patients directly. As long as a majority has decided to allocate funds for the research of a specific topic, no outside forces can stop the scientific exploration. Such as PsyDAO successfully supporting psychedelic experimentation, as much as certain strict anti-drug governments would like to see it prohibited.

On a purely anecdotal note, there is a reason why so many crypto OGs, people who have been in the industry since the very beginning, are usually the loudest voices for decentralization. It is an industry championed for its transparency, and we must all, like them, stand against practices that are misleadingly opaque.