Summary: One characteristic that makes blockchains a technical innovation is their ability to be decentralized and secure, meaning that no single entity or group of entities controls the network and its functions. However, as larger entities get involved in the space and exert significant influence, this critical component of blockchain’s value proposition could come under attack. ...
One characteristic that makes blockchains a technical innovation is their ability to be decentralized and secure, meaning that no single entity or group of entities controls the network and its functions. However, as larger entities get involved in the space and exert significant influence, this critical component of blockchain’s value proposition could come under attack. Let’s look at how these blockchains achieve decentralization, how entities could attempt to exert disproportionate control, and what built-in mechanisms prevent this.
The basic definition of a blockchain is a distributed ledger technology. Around the world, there are tens of thousands, and in some cases hundreds of thousands, of validators who each store a copy of the blockchain and its record of transactions and come to a consensus about the state of the blockchain at specified time intervals, known as blocks. This decentralization is how blockchains allow for digital assets to be wholly owned in a way that was not previously possible. Since a large majority of validators, who are incentivized through transaction fees, agree about the state of the chain and what each user holds, there is no way for any one party to steal, duplicate, or otherwise revoke a user’s ownership rights, whether that be of a cryptocurrency or NFT. Additionally, the blocks agreed upon by validators are cryptographically attached to previous blocks, creating a chain of ownership dating back to a chain’s inception, hence the word “blockchain.”
Bitcoin and Ethereum are the two largest distributed ledgers by a wide margin, with 14,000 and 500,000 validators, respectively. Bitcoin’s validators achieve consensus through a consensus mechanism known as proof of work, where powerful computers mine Bitcoin and validate transactions by solving very difficult cryptographic puzzles. The measure of how powerful a given computer is is its hash rate, and the overall hash rate of the network is typically seen as a measurement of how secure the entire network is. This is because an attacker would require 51% of the entire Bitcoin blockchain hash rate to exert control over the network, allowing them to censor new transactions or create fraudulent transfers. For Bitcoin, this would require an unprecedented amount of hardware that would be nearly impossible for one malicious actor to acquire.
Ethereum, on the other hand, uses a consensus mechanism called proof of stake. Instead of relying on energy-inefficient hardware, Ethereum validators use the Ethereum cryptocurrency as collateral to validate transactions. Each validator is required to stake 32 ETH, and if they act honestly, they are rewarded with transaction fees and rewards from the network. However, if they act maliciously against the majority, a portion of their staked ETH is taken from them and removed from the overall Ethereum supply. Executing a 51% attack on a proof of stake blockchain requires that an attacker controls 51% of the staked cryptocurrency. At current Ethereum prices, this would amount to $12.6 billion ETH. Though this number may seem low for a massive bank or corporation, there is an apparent liquidity issue: attempting to buy 8% of the total ETH supply would skyrocket the price and may not even be possible.
In theory, both blockchains seem to have perfect protection against manipulation and 51% attacks, thanks to their consensus mechanisms. However, both have a critical vulnerability: mining and staking pools. Since only one validator gets the transaction fee rewards for any given block, users have begun pooling their resources and splitting the reward to give themselves a more stable and predictable income. The Nakamoto coefficient, named after anonymous Bitcoin creator Satoshi Nakamoto, is a measure of blockchain decentralization that measures how many entities would need to collude to control over 51% of the hash rate, or the staked coins on a proof of stake chain. Bitcoin’s coefficient is two and Ethereum’s is five. Though these numbers may seem threatening at first, they come solely from pools and not actual control of hardware or coins, and at the first threat of centralization users would leave their pools and join others.
If the top entities decide to collude and conduct a 51% attack with pooled resources, one final failsafe of blockchains is forking. At the moment of attack, honest actors could choose to ignore the malicious chain and continue running the main chain without manipulation and continue as usual. These two chains, each with the same history up until the point of attack, could run independently. Since decentralization is such an essential tenet of blockchains, most of the ecosystem would likely support the honest chain.
With carefully designed fail-safes, incentive mechanisms, and distribution in place, Bitcoin and Ethereum can safely be considered sufficiently decentralized and resistant to individual control. The decentralization of blockchains gives them their value and is protected at all costs. Without distribution, a blockchain is no different than a centralized database like a bank or website, and there is no way to truly own your digital assets.
By Lincoln Murr