Why decentralization matter
It can be difficult to understand why decentralization is such a big breakthrough in comparison with traditional financial services. Centralized services and governments have been here for many centuries and people are used to trusting them despite many failures. The reasons for change might not be so obvious and appealing. People will not fully understand the advantages of decentralization if they do not understand the risk and disadvantages of centralization. It is the community task to explain why we should consider using the new technologies and make another step in the evolution of mankind.
Decentralized blockchain technologies can bring qualities that traditional centralized services cannot offer.
- It can ensure the unchangeability of some rules unless the majority of participants agree. There is no center of power and individuals cannot change anything without the mutual consensus of the majority. Thus, decision power is distributed. Now we are not talking about the network consensus (PoS) but about protocol rules. For example, the max supply of ADA coins cannot ever be changed without the consensus. Cardano will have secure smart contracts that will be another powerful tool for enforcing rules that cannot be changed without consensus. Once a community deploys a smart contract and starts using it then only the majority of participants can change the rules later. Notice that not only the rules are unchangeable but they are also automatically enforced by the protocol and smart contract engine.
- The immutability of history and ability to make an audit quickly and often with all relevant information. This ability prevents fraud and corruption. Data can be publicly available and everybody can check it. There is no way to hide or delete something in the ledger. Transparency and data availability are powerful tools in the hands of people. Many frauds are caused just because it is easy to mask it. However, full transparency is not always a good thing and some form of privacy must be introduced. Cardano will be able to offer that in the future via zero-knowledge technology. Transparency and privacy are not necessarily mutually exclusive features. It is needed to find the balance between them.
- Global availability of the same quality of service for all people around the world without restrictions and limitations. Centralized services are often available only locally. People in western countries can choose a commercial bank but people in developing countries do not have the same opportunity. Commercial banks do not rush to provide services in poor countries since it is not financially attractive. Blockchain is a global technology that will be available nearly everywhere. Thus, it is inherently inclusive and the conditions are the same everywhere. Cardano has a very low transaction fee and it will be like that in the future due to the well designed economic and incentive model.
- Guarantees of availability of the service. A decentralized network is basically unstoppable and there is no single point of failure. Centralized services are also relatively stable and outages are rare. However, commercial banks can bankrupt or a financial service can stop suddenly as we could see recently in the case of Wirecard. There might be technological or financial issues that could cause short term or long term outages. Cardano is a decentralized network that is maintained by distributed nodes. Even if one or a few of them stop working suddenly the rest of the nodes keep the network running.
- Decentralization can get rid of us middlemen. Middlemen are in many places and take money for services that might be executed faster, more securely, and cheaper by the network. Peer-to-Peer business can be cheaper than a traditional business with plenty of middlemen. For example, why should you pay more when sending money abroad? Cardano allows sending value globally within seconds regardless of borders.
Let’s now compare how transactions are processed by the traditional services and by Cardano.
How banks work from the point of customers
The current financial services are highly centralized. In every institution, there is a hierarchy of responsible people that have decision power. Every institution is an independent unit to some extent. Trust between institutions is based on their positions in the hierarchy, legal systems, and sets of conditions and rules defined by the responsible authorities. States basically guarantee that financial institutions will behave honestly and correctly. To ensure that, institutions are regularly audited by independent authorities that inspect their activities and their ledgers.
The current financial institutions use traditional databases to record transactions that happened between customers and partners. Imagine that Alice and Bob are customers of commercial bank X. Both Alice and Bob have an account that is managed and controlled by the bank. They have access to the account via a credit card allowing withdrawal from ATM and via internet banking allowing to make a payment. When Alice sends Bob $1000 then the bank checks the balance of Alice’s account and transfers the value to Bob’s account. Thus, the record in the database is changed. When Bob checks his account he can see that Alice sent him $1000. Notice that only the bank X is aware of the transaction between Alice and Bob and no other banks in the world do not know about it. In the case that Alice would be a customer of bank X and Bob would be a customer of bank Y then both banks would have to cooperate to transfer the value. There would be two independent databases in which a record needs to be changed. The transaction would be more complicated if each bank would be from a different state. Then it could take even days to transfer the value and the process is error-prone.
Banks require to know the identities of customers and can decide whether they want to serve them or not. Banks dictate the conditions, decide about fees, and know the financial details of customers. Moreover, banks have the decision power to refuse the transaction or ask customers for the context of transactions. Banks might report suspicious transactions to authorities and can even freeze accounts.
It must be said that nowadays people generally trust the current financial system. However, the system is fragile in many aspects and we could see many frauds or critical failures quite often. Why? The reason is the centralization of the decision power in the hands of many institutions that often have different interests. The current financial system consists of many entities like governments, central banks, commercial banks, private companies, and other institutions. Nearly every state in the world has its own central bank with monetary policy that reflects the current financial situation. The financial situation depends on the government of a given state. You can find many commercial banks in every state that are controlled by the central bank.
During the last decades, globalization has come to the point where the monetary policy or political situation of one state can influence your wealth despite the fact that you live on the other side of the world. You can be wrong if you think that you do not need to care about high inflation, poor political situation, or printing money in other countries. If you trust the current financial system you basically trust your government and central bank, your commercial bank, to authorities responsible for auditing financial institutions, and to many other entities. Moreover, due to globalization, your wealth is dependent on other countries. Thus, you should believe that the monetary and political situation in all countries in the whole world will be fine.
From a technology point of view, there are many database systems all around the world. These centralized and private databases are managed by financial entities and not all of them act honestly and fairly. Corruption, fraud, and misuse of power occur quite often. It is easy to misuse decision power since it is relatively easy to manipulate data in these databases. It can also be very inefficient to update data in databases in cases when it is necessary to update more of them for example for abroad transactions. A transaction can travel from bank to bank when it finally settles and every database in every bank must be updated.
People often care only about transferring money or interest rate when they need a loan. They interact only with commercial banks. The legal system of democratic states ensures that all troubles can be solved to the customer’s satisfaction. What is not often seen is the fact that not all people in the world have access to a bank account. Not all people in the world live in a democratic state and the majority of people cannot influence monetary policy. Many people do not know how to protect their wealth and do not realize risks related to the instability of the current world. People should start to ask whether the current system deserves our trust and whether the decision power is well distributed. We should also care about the fragility of the system and find a better solution that would be global, censorship-resistant, open, inclusive, available everywhere, and for everybody.
Let’s explain how blockchain works
Let’s explain the differences between traditional centralized services and Cardano. The main difference is that you are always responsible for your wealth when you use Cardano. You cannot ask anybody whether you can create an account and you cannot provide Know-Your-Customer (KYC) information. You just download and install Daedalus or Yoroi wallet and you can start using the network and transact with anybody in the world.
There is only a single Cardano blockchain that is maintained by distributed nodes. All honest nodes in the network maintain the same ledger with all transactions. The key innovation that allows decentralized networks to work is a unique incentive model that is based on game theory. The incentive model economically motivates node owners to act honestly. Until the majority of the participants behave honestly the data in the blockchain can be considered as secure and trusted. The advantage is that everybody can become a validator and it is not necessary to provide personal data to anybody. Cardano is an open network.
When Alice sends ADA coins to Bob then every transaction is verified by all full-nodes in the network. Alice needs to provide cryptographic proof that she wishes to spend ADA coins and the majority needs to endorse the transaction. You can imagine that as an analogy to a check that is signed by all banks.
Cardano uses PoS network consensus for keeping the single version of the truth in the blockchain. Imagine the scenario where Alice sends 1000 ADA coins to Bob and then Bob sends 1000 ADA to Charlie. Alice, Bob, and Charlie could verify both transactions and confirm that they are valid. Besides them, there are also other nodes that verified both transactions. Let’s call them Dan, Eve, Frank, and Grace. All participants are witnesses of the history and know what is the current state of the blockchain.
Now imagine that Alice and Bob decide to take 1000 ADA coins back from Charlie and create an alternative chain where there will be only the first transaction between Alice and Bob. The second transaction between Bob and Charlie will not be there. Alice and Bob have no chance to enforce their faulty alternative chain since there are more witnesses of the reality. Charlie, Dan, Eve, Frank, and Grace know about the second transaction between Bob and Charlie. They have already endorsed it and have in their version of blockchain. Moreover, Alice and Bob are not able to provide valid cryptographic proofs for blocks that have been appended to the block where the second transaction. Once the transactions have been added into a block and the block has a few confirmations then it is not possible to rewrite the history. Alice, Bob, and Charlie know each other but they do not know Dan, Eve, Frank, Grace, and many other participants in the network. There are plenty of anonymous and independent people that maintain the blockchain and are motivated to act honestly.
Every single block in the blockchain can be audited by anybody. Alice and Bob were not able to commit fraud and take ADA coins back from Charlie. Moreover, they are not able to delete or mask the transaction between Bob and Charlie. If it is needed everybody can easily verify that Charlie has the 1000 ADA coins.
Charlie can send ADA coins to Eve and it does not matter whether Eve is in the same city or in the other part of the world. The transaction fee does not change and Eve will receive the coins within a few seconds. There will be only a single immutable record about the transaction in the blockchain. No extra middleman is needed for abroad transactions. There is always the same network processing all transactions.
Decentralization brings another big advantage and it is the censorship-resistance meaning that it is not possible to prevent transactions to be processed. The PoS network works in a way that in each turn one randomly selected node creates a block and the rest validate it. In the next run, roles are switched. Thus, one block is created by Dan, the next one by Grace and the next one by Alice and so on. If Alice decides to censor all transactions sent by Charlie for any reason then it does not matter since Dan will process it in the next run. All transactions are propagated from node to node and there is a high probability that all valid transactions will be processed sooner or later. The higher number of pools is in the network the higher is the level of resistance to censorship.
All nodes use the same software so it can be said that they follow the same rules. If, for example, Dan wanted to follow a different set of rules then the network would ignore his rules. It could happen that Dan’s block would not be accepted by the network and Dan would not get a reward. Nodes are motivated to follow the rules that are accepted by the majority. Individuals have no power in the network and again, the higher is the level of decentralization the better.
Challenges for blockchain
Public blockchain technology is not ready for the mainstream yet. Described advantages have a few drawbacks. With higher adoption, there will be more transactions that must be stored in the blockchain. However, the size of the blockchain cannot grow dramatically since it would be very expensive and prohibitive in the future to maintain the full node. Propagation of transactions and blocks all around the world is also quite difficult due to the network limitations. Thus, the network might not manage to process all transactions in the time since only a limited number of them can be processed within a block. It is not possible to settle transactions within a second or so when using blockchain since block time will always be a few seconds and every added block will need a certain number of confirmations.
Luckily, Cardano has a solution for that. It is a second layer called Hydra. Many transactions can be processed off-chain faster and without a need to store the whole history. Still, we need more features to keep blockchain viable in the long term.
The concept of decentralization has definitely many positive properties that are superior to traditional centralized services. It does not mean that people will come and start using it. The process can take some time and we need more innovations that will be attractive. Education is a very important part of the adoption. Cardano Virtual Summit, the Shelley edition, attracted over 10 000 people. Let’s hope it will be 100 000 people next year. To make it happen, everybody should spread the word and explain how Cardano can change the world.