Centralization is dangerous
People have bad habits because they use traditional banking. Therefore, they do not need to own their money and entrust it to banks. People believe that when they need money they can use it through credit cards or internet banking. In most cases, this works well. The problem is that people apply the same pattern of behavior to cryptocurrencies. They trust centralized exchanges to own the coins if they have them in their account. People assume that the legal system will protect their cryptocurrency wealth in a similar way that it would protect them in the case of fiat money. There are several problems with this thinking.
Centralization offers people convenient and easy-to-use services. However, this is probably the only advantage. Everything else tends to be disadvantageous for users. Centralized services represent a single point of failure. Remember when Facebook stopped working for a few hours? People basically couldn’t communicate with their environment. Exactly the same thing can happen with your money. You don’t have to have it available when you need it. Many exchanges may not be as well protected as banks. Hackers can attack them and steal cryptocurrencies. If this happens, the exchange will probably go out of business, but you may never see your cryptocurrency. In the past, we’ve seen cases where the exchange owner himself has stolen cryptocurrencies and disappeared. Let’s not forget that regulations are still not completely friendly to cryptocurrencies in all countries. There could be a black scenario where cryptocurrencies are seized by the government. It is common for an exchange to unexpectedly announce maintenance and not allow you to send coins from the exchange. Or they charge fees that are more expensive than the current ones on the blockchain. Losing user data, misusing it, or even selling it on purpose is also not uncommon, and we’ve seen this with the aforementioned Facebook.
In addition to these technical problems, there is also an ideological problem. Cryptocurrencies are here to rid us of these centralized centers of power. If we are serious about cryptocurrency adoption and paradigm shift, we must first and foremost change our established patterns of behavior. People need to educate themselves, install their own cryptocurrency wallets, and actually own cryptocurrencies by holding private keys. Simply put, anyone who does not have coins on their hardware wallet is not a cryptocurrency user but a speculator.
People must learn to own and use their wealth without relying on middlemen. Decentralized networks allow you to send coins and tokens anywhere in the world. Cardano will soon allow you to own not only coins and tokens but also your identity with all the associated data. It will even allow you to trade, take out loans, insurance, and use other financial services. All in a completely decentralized way. You won’t be able to take advantage of any of this unless you learn to own coins.
The decentralization of the Cardano network is based on the distribution of ADA coins among users. Whoever owns an ADA coin also owns a proportional part of the Cardano network. Coin ownership is thus quite crucial. A portion of the coins will always be on centralized exchanges because people want to speculate with them. That is what is counted on. People who want to hold coins for the long term should withdraw their coins from the exchanges to their own wallets. The important thing to say is that you can stake ADA coins from your own wallet and you don’t need the exchanges to do that at all.
Stake from your own wallet is always the most advantageous
Cardano arguably has the best staking capabilities among the competition. Cardano staking does not lock coins for any time period. This gives you complete freedom to decide how to use and spend them. Do you want to lock coins in the DeFi service or buy something with them? You can do that at any time. Centralized exchanges often don’t offer you this option and require you to lock coins. The Cardano protocol does not require this. Exchanges do. As we mentioned, exchanges can be hacked. We believe you can protect your ADA coins better than exchanges. Cardano distributes rewards to all stakeholders every 5 days. Exchanges can do this over a longer period of time. In addition, Cardano does not charge any fees. The business model of the exchanges has to work somehow. Exchanges are always profit-oriented and will want to be paid somehow for the services they provide. If they offer you a higher interest rate than Cardano’s protocol, be interested in how it works in the background and if the model is sustainable in the long term. Cardano has a unique model that does not use slashing. This means that delegators will never lose coins due to pool operator misconduct. The Cardano protocol protects stakeholders as much as possible, so it makes no sense to expose yourself to danger through centralized exchanges.
In the Cardano ecosystem, there is not even a limit to the number of coins you have to own. People often use exchanges for staking just because some protocol forces them to own a certain amount of native coins. People who hold small amounts of coins, therefore, need to pool somewhere, and exchanges are happy to take advantage of this need. This is not the case in the Cardano network. All you need is a small amount of ADA coins and you can participate in staking. There is no need to find other people with small amounts of coins and pool the coins together to get the necessary amount for staking. A small amount of ADA coins can be delegated directly from your wallet to the selected pool. You don’t need to trust middlemen or anyone else in your area.
What’s best for you is also best for decentralizing the Cardano network. We mentioned the basic cryptocurrency lesson in the introduction. Not your keys, not your coins. You only hold the keys if you have the coins in your own wallet. If you have coins on the exchange, the exchange holds the keys. You only hold the passwords to log into the exchange, at best 2FA authentication. Many people have lost their cryptocurrencies just because they didn’t secure their access to the exchange well. This is another attack vector that is completely unnecessary in a world of decentralization. The Cardano network will become more decentralized the more users realize this and actively support it. The team has managed to beautifully align the needs of the network with the mission of the entire crypto industry.
What does it mean to hold ADA?
Owning ADA coins is different than owning BTC coins. Leaving BTC coins on an exchange does not directly reduce the decentralization of the network. In the case of Cardano, the centralized exchanges are essentially intermediary owners of the network. From the perspective of the legal system, the owners of the ADA coins are the people that purchased them. From the perspective of being able to use the coins for staking, for example, to choose the pool to which the coins will be delegated or to vote in Catalyst, the centralized exchanges hold those rights.
Of course, you have to take into account the misuse of coins for a 51% attack. Centralization is always dangerous in terms of abuse of power. On the other hand, large exchanges have a vested financial interest in maintaining a profitable business. For example, if 10 centralized exchanges held say 15% of the coins used for staking, this would not pose a significant threat. 15% of the coins is insufficient for an attack, and it is safe to assume that a larger number of exchanges would not work together in terms of an attack. You could even say that 15% of the coins are well protected by teams that know how to do their jobs very well. It is unlikely that hackers would be able to hack 10 exchanges at the same time. The coins on the exchanges are kept in cold storage, so they are well protected. While it is always better to have multiple independent entities holding a given amount of coins rather than one large one, this is not necessarily as bad as many people think. With increasing adoption and awareness, it can be assumed that people will eventually transfer the coins from the exchanges into their wallets. If someone manages to hack an exchange, it can scare people and speed up the process.
Let us ask ourselves an almost philosophical question. Who actually owns the blockchain network? No one, because we are in a decentralized world? If no one owned it, someone would appropriate the network. If everyone collectively owned the network, we would have to ask what specific rights that give us. In the software world, there will always be someone who decides to modify the source code. At this point, decentralization can only work to a limited extent. Cardano gives you a voice through the ownership of coins. ADA coin owners can make decisions about the future development of the ecosystem and, in time, the protocol itself. People will thus be able to decide what modifications to the protocol will take place. The team will thus be fulfilling the contract of the majority of owners.
However, the protocol cannot be said to be owned by the team through the source code. The distributed network code itself is not worth anything. What has value are the people who run the client and are actively involved in running the network. What is valuable to the user is the ability to create, maintain, transmit, and otherwise use digital value or establish trust between participants. It is critically important for the network to be able to produce new blocks. Thus, the network could be said to be owned by all those involved in the process. In the Cardano ecosystem, the network is owned by the pool operators and delegators. ADA coins provide critical decision rights about who will operate the pool. If you have these decision rights, we can say that you are the owners or operators. Coins are a means of control over the network.
If we ask a similar question in the case of PoW networks, we get a slightly different answer. The means of control in PoW networks is electricity. ASIC miner operators can decide to which pool they delegate their computing power. Of course, they will choose a pool that behaves fairly and runs a version of the client that satisfies the power provider. Note that coins are not a means of control anyway, but only a means of reward.
Financial reward is very important as it is a strong incentive to behave honestly. In PoS networks, coins are a means of control but also a means of reward. If you participate in staking, you earn regular rewards. As a coin owner, you want to appreciate your wealth. You have a direct incentive to see that the protocol evolves, that blocks produce honest pools, and that decentralization is maximized.
In PoW networks, control is more about business than building an ecosystem with democratic principles. Of course, PoW miners also want the protocol to do well and develop. However, miners can only take into account their selfish interests and these may not be in line with the coin holders, i.e. the users of the network. What is unique about the Cardano network is that all users of the network can simultaneously be owners of the network if they want to. They can even profit from the success of the network through regular rewards. PoS allows the infrastructure to be decentralized at a very high level and pool operators and all delegators can participate.
If you own ADA coins, you are actively supporting the creation of a decentralized ecosystem that can be used by other people on the planet. Even those who don’t own ADA coins will be able to send stable coins, NFTs, or other tokens over the network. People should realize that holding coins on exchanges prevents the full development of the decentralization ideal.
Trusted and untrusted delegation of power
In any decentralized ecosystem, there is the possibility to delegate decision-making power. This possibility is either directly supported by the protocol from the original design, or arises organically somehow. What does it actually mean to delegate decision-making power? In any network, there are a limited number of entities that produce blocks. It doesn’t matter if they are called pools or validators. What matters is that these entities must satisfy some protocol conditions and must have a certain size of a given resource. It doesn’t matter if they are coins in the case of PoS or energy in the case of PoW. Cardano has used the concept of pools from the very beginning. Bitcoin came to this organically over time and Satoshi doesn’t mention them in the white paper. Pools can decide whether to produce a block, what transactions to include in it, what block to continue on in case of a fork, and so on. Block producers make decisions that cannot be made by those who delegate power to these pools through coins or energy. You could say that delegators can only control the work of pools.
The delegation of decision-making power, or if you prefer, the delegation of control, is a very important process in terms of decentralization. We can divide this activity into two categories:
- A trusted delegation is one in which the choice of the delegator cannot be influenced or changed by a third party. This means that the delegator itself directly decides which pool it delegates coins or energy to. If there is any problem with a pool, the delegator can immediately change his choice. This weakens the rogue pool and strengthens another pool that is behaving fairly.
- An untrusted delegation is a delegation in which the owners of the resources use the services of third parties. This means that the resource owners do not have direct control over their choice. They may express their wishes, but the third party is one that carries out the will of the delegator and may or may not comply. If there is a sudden problem the delegators do not have full control over the delegation and cannot react quickly by delegating to another pool if necessary. Third parties may misuse the provided resource for an attack, the resource may be stolen, or the resource may somehow be prevented from being used.
Clearly, the ecosystem should support the existence of trusted delegation as much as possible. Untrustworthy delegation is a threat to decentralization. Let’s show examples.
Staking through a centralized exchange is a typical example of untrusted delegation. People entrust coins to the exchange and the exchange stacks the coins for them. Exchanges set up their own pools and use users’ coins to do so. The exchange thus holds a lot of power in the network, but the skin in the game is still held by the owners of the coins, not the exchange itself. Even if a centralized exchange has an economic incentive to behave fairly, and we can imagine that some trouble with lawyers might result from an abuse of power, prevention is always the best defense against abuse of power.
PoW networks suffer from the same problem. People are not always able to get a good price for power and are forced to run their mining through third parties. Large third parties always have an advantage against small miners as they can negotiate better prices for energy as large buyers, also when buying ASIC equipment, and even smaller fees from pools. Cloud mining is therefore relatively widespread. Genesis Mining claims on its website that up to 2 million customers use its services. People pay for the hash rate through their bank account, but the cloud mining companies are the ones who decide what to do with the hash rate or whether to abuse this power.
In the case of PoW mining, people often do not have the option to use trusted delegation. This means that power is centralized in the hands of third parties. In the case of Cardano, however, there is nothing stopping people from delegating from their own wallets. It costs nothing to delegate coins, and it’s just the same expensive anywhere in the world. There is no rational reason for people to leave coins on exchanges. People just need to understand the basic rules of staking and delegation to do without exchanges and untrusted delegation entirely.
Sooner or later, strong players will dominate every ecosystem. The protocol must be well prepared for this eventuality and ideally support greater decentralization, even at the cost of major changes at the first layer. The Binance exchange has roughly a 10% share of power at the block producer level in both the Cardano ecosystem and Bitcoin. This is hard for the community to resist and it would be naive to somehow prohibit it. In the case of Bitcoin, the Binance exchange is likely to have its own hash rate, as what miner would delegate power to a pool of a centralized exchange? Many such people probably wouldn’t. In the case of the Cardano ecosystem, however, people can leave the exchange and run staking completely freely and independently of a third party. The Binance exchange certainly doesn’t own 10% of the ADA coins.
Let’s add that not every PoS network allows delegation of power to pools. If a certain high number of coins is needed for staking, exchanges or other more centralized solution is the only option for smaller holders. These networks can also slide towards untrusted delegation. Cardano has delegation built right into the protocol and you can literally delegate with a few coins. Thus, nothing stands in the way of decentralization.
It is all about trust
The concept of decentralization is built on the distribution of trust. Instead of centralized entities, people can trust a large group of independent entities. For end-users, this means they trust the network, not anyone in particular. As decentralization begins to be explored more in the media, the number of pools or delegators in given ecosystems will be compared. As adoption grows, the demand for more decentralization will grow. This is logical if decentralized networks will have higher financial and social relevance. Decentralization must grow over time not stagnate or even decline.
If there are strong actors with a lot of power in a decentralized ecosystem, this will be a problem. Because there will be increasing pressure on these entities and many people will want to somehow control them, abuse them, or perhaps destroy them. The point of decentralization is about maximizing the distribution of power because that is the only way a given network can survive.
The success of the networks will be directly dependent on the network effect and the people who choose to use the blockchain network. The quality of decentralization will definitely be an important parameter in the decision-making process. Although we believe that decentralization is not the most important attribute from the users’ perspective, it is still what differentiates Cardano or Bitcoin from centralized services. Let’s never forget that. Imagine if a network was in the hands of 3 large pools and 100 large delegators of power. How are you going to convince other people on the planet that the rules of the network won’t change? People need to be assured that the fundamental rules of the network will either never change, or only through a transparent majority decision. If people don’t have a vote, the decentralized network will end up just like a regular bank or a big IT company. Top management will make the decisions.
We can revisit our philosophical question about who actually owns the network. We said above that it’s largely about who controls the network at the consensus or source code level. For all users, the choice of the network will be an absolutely critical decision, as they will entrust their wealth to it. These users must have confidence that the network is either partially owned by themselves or, conversely, not owned by a few powerful players. If the network is abandoned by users, the network itself will lose its meaning. If the “in code we trust” narrative is to succeed, users must be convinced that the network is truly decentralized and not in the hands of a few powerful actors. In other words, if a user sends a transaction, they must have 100% confidence that the network will process the transaction without delay. Any other outcome may be an indication of centralization.
Decentralization is a moving target. Powerful actors will seek to dominate the network, whether for economic or other reasons. We have no historical experience of sustaining decentralization and we are only at the beginning. The Cardano protocol is designed to allow trusted delegation. That is, it allows you to delegate small amounts of ADA coins from your own wallet. This process is as simple and cheap as possible. You can delegate ADA coins from the Trezor and Ledger hardware wallet. There is no reason to leave coins on centralized exchanges. If you want to rely on exchanges, it is always better to split the coins across multiple exchanges so that they are not held by a single entity. However, you always risk losing your coins and there is a potential risk of misuse.
Third parties will always be happy to offer their services because they can profit from them. To profit, their economic model must be better than the decentralized network model itself. This is theoretically impossible without risking coins or misusing your data. Third parties will offer not only staking but also, for example, cheap sending of coins over centralized networks. Although it is user-friendly to pay with a crypto card in a store, be aware that this has its negatives in terms of the sustainability of the first-layer economic model. For the networks themselves, only those transactions that earn fees are useful. The fees are used to reward stakers or miners. Thus, teams must strive for technological advances that allow coins to be used in a completely decentralized way while achieving high user-friendliness. This is a big challenge and it won’t do without second layers. The first and second layers should thus be economically linked.
Cryptocurrencies are primarily there to change the existing order. If you stake in the exchanges, buy an HW wallet and send your ADA coins there. You’ll support the decentralization of the Cardano network and protect your coins much better at the same time.
Source: Do not stake ADA on exchanges