The Drawbacks of Centralization
USDT and USDC, the largest stablecoins by market cap, are both US dollar-based and centralized. This article explores the drawbacks of centralization.
Centralization describes the concentration of management and decision-making power with a central authority. This means that there is one governing authority that ultimately makes all decisions. In the case of cryptocurrencies, this would apply to popular cryptocurrencies like XRP, which is controlled by Ripple. Other examples would be USDT and USDC, which are controlled by Tether and Circle, respectively.
There are several problems with centralized cryptocurrencies. First, a centralized system means that there is a single point of failure. This makes the entire system vulnerable to a single hack. Naturally, security measures are taken by centralized cryptocurrency projects, but large hacks that affect entire ecosystems are not unheard of. One popular example of this is hacked cryptocurrency exchanges. These hacks occur more often than is generally assumed. For example, in May 2024, the Japanese exchange DMM crypto was hacked. This hack resulted in a loss of 300 million dollars’ worth of Bitcoin (1).
However, being inherently more vulnerable to hacks is not the only disadvantage of centralization. The potential lack of transparency is another big factor. In a centralized system, the central authority has control over the operations and decisions. Without proper oversight and transparency, this can lead to misuse of power like embezzlement, manipulation of data, or insider trading. Users are forced to trust that the central authority is acting in their best interest, which is not always the case.
Another significant disadvantage is the concentration of power. In theory, a centralized cryptocurrency could be entirely controlled by that one central authority, undermining the principle of financial freedom. This also means that the controlling authority is easier for governments and regulatory bodies to identify and target, which can lead to strict regulations or sanctions against the central entity.
But the central entity is not the only target for potential new regulations – so are the token holders themselves. When power is centralized, decision makers can impose policies or taxes on the community. This is not likely to happen, but the mere existence of this threat is enough to discourage centralization.
A centralized architecture also raises privacy concerns regarding user data. This data can be collected, stored, and potentially misused or leaked. Not a single month seems to go by without a significant data leak. Even well-protected systems have fallen victim to hacks that led to severe data leaks. Naturally, this impacts the company’s image as well. A decentralized system on the other hand simply does not have any data to steal in the first place.
A prominent example of a centralized institution in the crypto space would be Binance. A successful Binance hack would not only exploit user data, but also their funds. As the largest cryptocurrency exchange with 11 million visits a month (2), Binance is a significant target for hackers.
The problems associated with centralization can significantly impact the trust the community has in the system.
This article made it clear that centralization creates distrust, which is why decentralization is not only to be desired, but even needed. The Frankencoin is decentralized, but how effectively does it solve the problems of centralization? This is what we are going to discuss in the next article.
Sources: