Since the inception of bitcoin and blockchain technology, the concept of decentralization has been the pinnacle goal. Once an amalgamation of different theories and mechanisms floating around the deepest and darkest web forums, the DeFi sector has morphed to become (subjectively) the next big thing to happen to financial services.
While controversial, especially given this year’s track record of supposedly “DeFi” companies being brought to their knees, the idea of true decentralization has taken hold. Now some say a decentralized economy could and should become a reality.
Before you roll your eyes and put this down to the dreams of a crypto crazy with their head in the clouds, I invite you to reserve judgment — significant steps are being made, which may make all the difference.
The development of DeFi and the concept of decentralization
Out of the depths of the 2008 financial crisis, bitcoin was born. Exasperated at the economy’s dependence on financial services, the mythical “Satoshi Nakamoto” published a nine-page whitepaper outlining a system for peer-to-peer transactions, sidestepping commercial intermediaries.
Discounting the mathematical equations and coding language, the concept was simple. “What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party,” reads the introduction.
A few years later, DeFi emerged, catapulted into the limelight by ethereum. The eth blockchain, conceived by Vitalik Buterin, allowed the development of several different use cases. From there, innovation has kept coming.
The original bitcoin concept of decentralization still forms the basis of pure DeFi, namely, the rejection of centralized entities as the core facilitators of processes.
Many recent failures in the DeFi sector have been made within centralized businesses offering “DeFi services,” using the term somewhat disingenuously.
This in itself is a problematic concept to uphold. Even now, people are pulling ethereum’s decentralization into question, and Aave, a previous posterchild of decentralization, has faced criticism (the announcement below sparked a thread of disillusioned centralization rumors).
Commentators continue to uphold the potential of pure decentralization to avoid issues seen in global economies. DAOs are seen as fundamental to this development going forward.
Web3’s development getting in the way of decentralization
“They are actually using clients, browsers, and servers and just blindly trusting the server. So they’re using a proxy to get to the ethereum blockchain.”
“On the blockchain, there’s all of this great cooperation by unknown parties that can prove things without prior arrangements or a trusted third party. That’s wonderful. But if you’re browsing this proxy farm through a server and trusting it not to lie, misorder, or tamper, that’s Web2.”
He referenced an essay published by Moxie Marlinspike, founder of messaging app, Signal. The post presented the current Web3 as a form of Web2 with centralized platforms, trying to get the decentralization of Web1- “Web2 but with even less privacy.” This brings apparent drawbacks and security concerns.
He cited that a primary issue stems from a reason behind the development of Web2, people don’t want to manage their servers. For this reason, intermediaries, in the form of platforms, have been brought into the Web3 space.
“People are used to the convenience of Google. That’s good,” said Eich. “But the decentralization is bad. The tracking they do is bad. And if we can decentralize, it will mean a stronger browser, which Google does not want to have. They don’t want you to have blocks and protection from privacy threats and then give you the Web3 tools, the cryptographic protocols. But that’s what we need.”
“I think it’s time to get strong cryptography and smart contracts, or at least verification, into the browser.”
Centralized entities may create security Issues.
The existence of centralized platforms also could present vulnerabilities in terms of security.
“There are the centralized actors in the way between people having direct relationships; it’s much more likely you’ll get a compromise there,” said Dean Tribble, CEO of Agoric. “You know, some bug in Chrome is used to exploit everybody’s Wallet. So, for everybody that makes a transaction that day, an extra transaction is put in to steal their assets. That’s a problem.”
“That’s because they’ve got this centralized software optimized for speed and upgrade by a centralized institution. They don’t go through the same level of (coded) audits, they go through a different set of audits, but they don’t get the same kind of audits that crypto things would”
“All attackers have to do is find one opening, and then they get into the security up. If the gateway where everyone is going through is controlled by someone now, suddenly, someone can censor a region, and people can’t get through to my decentralized services.”
In place of the Web2 “trust the server” approach, truly decentralized Web3 is built on the premise of trusting code.
“With smart contracts, one of the main values is they can enforce actual terms. And you can tell that that is going to happen,” said Tribble. “The thing that blockchain brought to the world of smart contracts is high integrity execution, where machines running in multiple jurisdictions and multiple administrative zones, no one human government or organization can compromise the execution of your smart contract. This means I can rely on that. I can trust that it will do what it says.”
In brief, the approach to conducting processes without trusted parties relies on a network of coded smart contracts automated to react to specific parameters. The idea is that the lack of involvement of a single entity or organization in the authorization of processes mitigates the possibility of tampering to fulfill individual gain or control. Validation is left to a network of entities (node operators), thus distributing power.
“The world I want to be in is where everything that can be made into a smart contract will operate the way I expect to, with no human compromise,” he continued. “It will be made that way in a decentralized fashion so that we’re living in a hybrid integrity world, and then all the places where we have to rely on humans, we can go ahead and focus our energies there to make sure they’re doing the right thing and that they are trusted.”
This way of working also theoretically dilutes the points of weakness. Information on a decentralized network is duplicated and distributed to every entity (node), meaning every node is a verification point. An attack or bug in one node can be identified as a security concern by using the rest of the network to validate. As long as the attack isn’t affecting the majority of the nodes in the network, the breach in security and integrity of the code can be identified.
The existence of centralized players in the DeFi makeup could inject singular points of weakness that can then be exploited.
As it stands, 30% of ethereum staking is conducted using three centralized platforms, Binance, Coinbase, and Kraken. While the staking itself is a “decentralized” action, its concentration into these platforms adds an element of “Web2 trust the server”.
“You end up with a backbone of decentralized stuff that is for experts, and some number of retail front ends that are absorbing risk in some revenue, regulated fashion and getting paid for it by non-experts,” said Tribble.
“You’re using Coinbase, Robin Hood, or FTX, or one of these things, and they’re absorbing some risk. They’re being clever about it, explaining it, or they have the responsibility to cover it. But they’re clear that if there’s a bug over there, we’ll only cover 50%- 60%, or you can pay for this insurance to be covered if some technical problem happens.”
Now the mention of trusting an entity such as FTX echoes with the connotations of disappearing wealth and absolute chaos — a far cry from risk absorption.
Regulation – yes – but with care
For some, the only way forward for a decentralized economy is regulation. While perhaps counterintuitive (could jurisdictional policing REALLY be the answer to something which operates without borders?), it could solve many crypto “wild west” issues stemming from the “DeFi” platforms and organizations many users are interacting with.
Regulation surrounding DeFi was, at best, murky, but in light of the recent events with FTX, many believe it could be set back even further. Adding to the wave after wave of seemingly stable entities crumbling almost overnight, it may have set already wary regulators back on defense.
Senator Warren’s take seems to be upheld by the White House, with Press Secretary Karine Jean-Pierre stating this week, “The most recent news further underscores these concerns and highlights why prudent regulation of cryptocurrencies is indeed needed.”
While regulation is welcomed by much of the crypto community, experts are calling for care when addressing DeFi.
“Any of these regulatory things need not be heavy-handed to enable innovation to flourish,” said Tribble.
“There’ll be work to do, and the world is a different place. Pretending that 100-year-old laws still make sense and especially make sense on-chain, unchanged, is naive. So some of this should require tuning and new treatments as we figure out how to make all of this work and leverage the advantages across the board.”
The desire for innovation’s balance with regulatory constraints is a familiar cry across the fintech sector. In DeFi and creating a decentralized economy, freedom of innovation could be critical.
Aside from regulation, another challenge that could be constraining the Web3 world’s decentralized innovation is the difficulty of the coding language.
“A downside right now to get good decentralized technology out there is that there aren’t enough developers who know how to do it well,” said Tribble. “Ethereum is programmed in a unique language for ethereum that’s now spreading, but an estimated 6,000 programmers worldwide could build real apps.”
He explained that despite millions of use cases and developers building for Web3, most of them would have to involve one of these programmers to create a secure dApp on the ethereum blockchain.
The small pool of developers using the language specific to ethereum (Solidity) could create a centralizing effect. Tribble explained that the programming language creates barriers for developers to access their apps, and the existence of these intermediaries could compromise the security and integrity of smart contracts.
“There’s still a long way to go to get developers educated and get a lot of our software infrastructure back from being so deeply centralized in these Web2 institutions and building the Web3 version.”
“The more cooperation you start with, the more cooperative your world is. And that’s a safer world, a more secure world, a world in which people have more freedom of action.”
“To really have this stuff spread to all the use cases…you need to empower all these developers.”
“We wanted to build more infrastructure to make more smart contracts,” said Tribble. “The cool thing about smart contracts..is that it enables this new class of business, but it’s a class of business that enables strangers to cooperate.”
A decentralized economy that could start small
Tribble explained that this development has the potential to open out Web3 to smaller, more niche groups.
“We look at the economy, and people look at the big industries, but most of the economy is what you buy from your local stores or your connected parties,” he continued.
He gave the example of NFTs and their popularity with sports fans, giving them a new way to engage and participate despite the low monetary value of the NFTs themselves.
“It’s valuable. It affects people’s lives. And that’s just scratching the surface of all the different use cases people can use for decentralized stuff. We already know the centralized versions of these things have many different problems.”
Tribble explained that centralizing power in one person or organization increases the possibility of tweaking processes for individual gain. In addition, it could limit the number of use cases if the problem is “too small” for larger institutions to care about.
“What about my high school game and my church choir? Those people want the same service and more, and they could increase their local experience…Suppose you can empower developers around the world to build this stuff. In that case, some enterprising high school student in college will just go build it for an organization they care about that solves their problem, and someone else will pick it up and use it for their organization.”
“You’ve got something that can grow from the grassroots in a way that no one’s in a position to prevent or to break or to subvert to steal all the data of all the people engaging with it.”
But is it viable?
The news of multiple giants in the “DeFi” space falling could have put the idea of a decentralized economy on the back foot, despite the lack of correlation. Large-scale trust in the sector and its ability to keep to its decentralized promise is low.
However, developments are still being made to uphold that ideal.
“There’s a science fiction author, Theodore Sturgeon, that had Sturgeon’s law, which is that 90% of everything is crap,” said Tribble. “That was true of the internet, and every time there was a dotcom burst. And that happened a couple of times.”
“From the outside, 90% of everything being crap looks much like 100% of everything being crap, but that 10% is really important. There’s a 10% in crypto that is enormously important.”
“Zero-knowledge, consensus technologies, and formal methods, those have all been substantially advanced by each wave of crypto and substantially leveraged to produce new real value and change the game in really important ways and largely towards decentralization.”
While the industry still has its drawbacks, this inching toward the decentralized ideal could make all the difference.
Isabelle is a journalist for Fintech Nexus News and leads the Fintech Coffee Break podcast.
Isabelle's interest in fintech comes from a yearning to understand society's rapid digitalization and its potential, a topic she has often addressed during her academic pursuits and journalistic career.