The Curious Case of Centralized Cryptocurrencies: How Do They Work?

The Curious Case of Centralized Cryptocurrencies: How Do They Work?

Like politicians backtracking on their promises, many people are confused by the concept of centralized cryptocurrencies. Weren’t they built for the exact opposite purpose – for decentralization? It’s confusing.

Just under a decade after the launch of Bitcoin, we’re now faced with the concept of cryptocurrencies being managed (and potentially controlled) by a single organization or institution.

If you’re a crypto purist, the idea might irk you. Why would we want to violate the founding principles of blockchains and cryptocurrencies as outlined by father of it all, Bitcoin’s creator, Nakamoto Satoshi?

Let’s dig a bit deeper.

Looking Into the Decentralized vs. Centralized Debate

Without going into the dictionary definitions, we can define these two concepts by their connotation.

Decentralization comes off as the white knight, the angel of light that will liberate mankind from the financial clutches that banks and financial institutions hold over us.

Centralization comes off as the bad guy wearing the black hat, the villain, the force that’s responsible for troubles such as devalued currencies and inflation.

While it’s true that centralized currencies are subject to manipulation by the authorities, that doesn’t mean that it’s an evil presence altogether. And keep in mind that decentralization has its disadvantages.

Looking At Centralization Through a Different Lens

First off, centralization may not actually be as cut and dry as we think it is (and the same can probably be said for decentralization). In reality, centralization exists on a spectrum, and in the world of cryptocurrency, all coins have varying levels of either status.

Bitcoin.com published a piece to explain this concept. They ranked the world’s top cryptocurrencies in terms of decentralization and noted some interesting observations.

Bitcoin itself was the most decentralized cryptocurrency in terms of its ledger and its leadership, scoring 9/10 and 10/10 respectively. But even though it is the hardest coin to manipulate, Bitcoin’s mining pool is largely concentrated in China.

As much as 70% of Bitcoin’s hashing power comes from the country. This is one aspect where Bitcoin shows a slight leaning towards centralization, but new mining farms in Europe and North America may change this.

Ethereum’s decentralization score was very interesting. The article gave Ethereum’s decentralized ledger an 8/10 but its leadership, a measly 3/10. Why? It noted that the coin and its platform largely depends on its creator, Vitalik Buterin, and his level of involvement going forward.

With just these two examples, you can see that centralization vs decentralization isn’t a black or white concept. More importantly, even the most decentralized currencies show some traits of centralization at times.

But of course, there are currencies now that have shifted more towards the centralization side of the spectrum.

Examples Of Real-Life Centralized Currencies

The most controversial and glaring example of a centralized currency is Ripple (XRP). It’s one of the most criticized by cryptocurrency enthusiasts as well. Referring back to the Bitcoin.com article, Ripple received a decentralized score of 2/10 for its ledger and 1/10 for its leadership (ouch!).

There are no surprises there since it was created by the Ripple Lab company, giving them full ownership over how the coin develops. One of the first indicators of Ripple’s centralization appeared when investors were having their accounts frozen back in 2014.

For example, one of Ripple’s co-founders, Jed McCaleb, tried to sell billions of XRP after leaving the company, but his account was quickly frozen. The ability to freeze one’s accounts is a classic trait of centralized ownership.

Here’s the other factor: All 100 billion XRP coins were created by Ripple Labs themselves, and the currency doesn’t even run on a blockchain. No one can mine a Ripple coin. The absence of an open source platform means that the company owns the coin, and can carry out changes to the currency however they see fit. No outside developer has a say.

Now Ripple isn’t the only centralized cryptocurrency. Several others including Stellar (XLM) (a fork of Ripple), Monero (SMR), NEO (NEO) and tangle-based newcomer, IOTA, all stray far away from decentralized status.

Centralized Cryptocurrency – Is It the Dark Side?

Earlier we mentioned that Ripple gets its fair share of flack from critics. The reason for this is because its creators label the coin as decentralized when it’s clearly a centralized currency that they created and fully control. Crypto enthusiasts and investors likely felt cheated and deceived when the reports of account freezing first emerged.

However, there are many people who still invest in Ripple because it has some practical use for cross-border payments which in part comes from its lightning fast transaction speeds (clocking in at four seconds). There are also several companies partnered with Ripple, making it a somewhat attractive investment.

From the reactions of investors and enthusiasts alike, what we’ve gleaned is that centralization itself is not the enemy. However, a centralized cryptocurrency disguised as a decentralized one will frustrate those who learn that a company actually controls a coin they want to buy or end up buying.

No Cryptocurrency Is 100% Uncontrolled

Ultimately, what you need to keep in mind as a cryptocurrency investor is that there are few coins that truly standalone as “unmanaged” platforms. They all exist on a spectrum. As we mentioned earlier, even certain aspects of Bitcoin seem to be influenced more so by certain people in certain locations.

What we can say is that you shouldn’t let the label decide whether you should buy a coin or not. What matters is the inherent value you see in it based on its applications and functionality, traits that don’t depend on a currency’s level of decentralization or centralization.

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