If you're just learning about cryptocurrency one word you’re going to hear a lot about is decentralisation. So what exactly is decentralisation, why is it such a big deal in relation to money and how does cryptocurrency achieve it?
The simple definition of decentralisation is:
the transfer of control of an activity or organisation to several local offices or authorities rather than one single one.
We could expand this further into an example, where a company changes from having one central office that makes all key decisions - which are simply pushed out to smaller local offices that implement them - to a network of offices with no natural headquarters, where each local office has a similar level of influence on decisions.
But what we are talking about is money, so how is money centralised, why is that a concern and how does decentralised money function?
The modern system of money creation is centralised because each nation state decides what money is legally accepted within its borders. That is what the term, legal tender means.
You might be thinking that there isn’t much wrong with that set-up, and even if there is, it doesn’t impact you. But governments also control the money supply - when and how much money is created and distributed - which does impact you, whether you realise it or not.
As highlighted in our separate article looking at what money printing really means, you can boil down the problems that a rapidly expanding money supply creates:
If the level of production of goods remains the same, but the supply of money chasing those goods is steadily increasing, then prices will go up.
In short, the purchasing power of the money that you’ve worked so hard to earn is eroded by inflation caused by government’s creating more money out of thin air.
Right now in Venezuela people have no confidence in their money because it’s value declines by massive amounts every single day - that scenario is called hyperinflation.
So centralised money is money controlled and created by the state alone. There are no limits on money creation, other than those the government chooses to employ, it isn’t backed by anything, and creating more is a simple exercise of changing numbers of a centralised ledger (again, read this article to fill in the detail and how money is created). It is simply built on trust - your trust in the government.
Yes, most people can vote out their government, but the same power just shifts to the next lot, and short-term decision making, dictated by fixed-term parliaments, actually makes the problem worse.
This arrangement, what is described as fiat money, has effectively been in place since 1970 - up to then money was backed by gold - so surely there would have been more opposition if it was such a big problem?
The problems of centralised money are a bit like the problems of global warming. The changes are incremental, and everyone assumes that it is something to worry about down the line, so in both cases the can is kicked down the road. With fiat money, that means solving problems by short-term money printing, creating more debt to somehow be paid off tomorrow.
For an idea of what those problems are, take a look at the website which is creatively named wtfhappenedin1971 or the US Debt Clock. The 2008 financial crisis elevated those problems to the next level, as did the current Covid Pandemic.
So what is decentralised money and why is it considered the solution?
So far we’ve established that centralisation in relation to money is a problem because:
Any solution must therefore address those problems. Bitcoin was the first cryptocurrency created in 2008, so let’s focus on that for answers.
First off Bitcoin has no one in change, no central office, no headquarters, no CEO. It was created by someone or group of people - referred to as Satoshi Nakamoto - but understanding that a central authority would undermine what they were trying to achieve, they disappeared in 2011 and haven’t been seen again.
So if there is no one in charge, how does it work? There is a set of rules - called the Bitcoin Protocol - written in computer code which runs across a huge network of computers managing Bitcoin, where everyone has to agree to any changes. Those rules state that there will only ever be 21 million Bitcoin and the rate at which they are created is also fixed. This gives it a known level of inflation, declining to zero when the total supply is reached.
The same rules ensure that a required amount of effort - electricity - is used to allow the creation of new bitcoin. Electricity costs money, so bitcoin turns energy into money.
This also counters problem 4 of centralised money - it isn't backed by anything - because bitcoin is backed by a network of computers all committing electricity to maintain it.
Now those answers simplify the process of how bitcoin works, you can fill in the gaps in our Knowledge Base, but they set some fundamental parameters around what decentralisation means.
Some consider it a binary idea; money is either centralised or it’s Bitcoin, but the cryptocurrencies that followed claim to be decentralised but are really hybrids because they cannot concretely answer all those points. Satoshi Nakamoto prioritised decentralisation over speed of transaction; newer blockchains flip those priorities, with decentralisation sacrificed for speed.
Bitcoin is unique in not having a creator exerting some influence. Many other coins - known as alt coins - don’t have fixed supply. Some have small networks managing them, providing minimal security and many take a different approach to putting something of value behind the creation of new money other than electricity, which isn’t great for the environment.
So you might think of decentralisation as an ideal, or a spectrum, and when you hear it mentioned in relation to a cryptocurrency, be able to think about where on that spectrum they sit and what that means about the value they offer given how important the ideal of true decentralisation is.