2022 went down in history as one of the most horrible years for the cryptocurrency industry. According to Chainalysis, 2022 stands out as one of the worst years on record that witnessed funds being stolen through exploits and hacks. The Ronin hack — an attack engineered by a North Korean-linked Lazarus Group in March where over 650 million USD worth of ETH and USDC was stolen — is particularly notable.
Before the Ronin attack, hackers had drained the Wormhole bridge funds worth over 320 million USD in February. The list of crypto hacks that occurred in 2022 is all but endless. For example, Nomad bridge lost over 190 million USD, and Beanstalk Farms was exploited for nearly 182 million USD. Even Binance’s BNB bridge was exploited, losing over 100 million USD.
To make matters worse, the year ended with an implosion characterized by the spectacular collapse of the FTX cryptocurrency exchange, where more than 8 billion USD of the platform’s customer funds were lost. These hacks and scandals will continue sending shockwaves throughout the cryptocurrency sector.
So, what is next for the industry?
The future of the cryptocurrency industry hinges on a crucial, and yet-to-be-resolved question about the role of decentralization in blockchain networks. While it is evident that blockchain networks will shape our future, it is also apparent that they need to be fully decentralized for them to achieve their full global potential.
The desire for truly decentralized blockchain networks springs from a fundamental desire for antifragility. For some, a truly decentralized network would eliminate the need for distrustful authorities. For others, it is about creating better and more resilient protocols for storing human wealth.
In this post, we take a detailed look at decentralization in current blockchain systems, their weaknesses, and how Analog intends to address these weaknesses.
The drift toward centralization
Blockchains are conceived to work by decentralizing data storage. Rather than storing data on centralized entities like corporate servers, blockchains act as immutable ledgers, copying each new record on many interconnected nodes. Financial data, digital art, and gaming data can all be validated and stored on a shared, transparent, and immutable ledger.
Despite these core principles, there is a weak link in the vision of most decentralized ledger technologies (DLTs). To help us understand these issues, a little background is necessary. Decentralization is only one cog of the three blockchain trilemma “features” that a perfect DLT needs to provide besides scalability and security.
A blockchain project can only provide two of these three essential features at any given time. As such, platform builders and decentralized applications (DApp) developers must make inevitable tradeoffs regarding decentralization, scalability, and security based on the project’s vision and ambition.
While decentralization is the backbone of any blockchain-based project, it can also slow down the network. For example, in proof-of-work (PoW)-powered chains, transaction speeds can drop significantly if more users join the network and start participating as miners. This flaw can be seen with the Bitcoin network, which only achieves a paltry seven transactions per second (tps).
Consequently, most platforms are willing to make this tradeoff of enhanced throughput and functionality at the expense of decentralization. For example, rather than requiring any user to participate as a miner and solve complex cryptographic algorithms that use substantial computing power, proof-of-stake (PoS)-based chains determine the validator status based on their staked coins in the network.
Although PoS-based chains are more scalable than PoW-powered networks, they tend to favor only those validators that stake the largest portion of their coins in the network. This means that a large portion of staked coins that secure PoS-based networks sit with centralized entities. For example, there were 14 million ETH staked on Ethereum when the platform switched from PoW to PoS in September 2022.
At the time, Lido Finance, and top centralized exchanges, such as Coinbase, Binance, and Kraken, controlled more than 60% of the 14 million ETH. This means centralized entities have more chances of adding blocks to Ethereum and can decide to censor transactions they do not like on the network.
Other blockchain networks, such as EOS, have gone much further toward the centralization paradigm to provide more scalability and functionality by allowing only a few validators to secure the network. In the Cosmos network, the top 10 validators control more than 46.3% of the staked ATOM tokens.
The centralization problem in PoS-based chains is compounded even further by the rise of infrastructure providers like Bison Trails and cryptocurrency exchanges (e.g., Coinbase, Huobi, and collapsed FTX). These platforms typically operate the same infrastructure for multiple blockchain projects, potentially increasing the risks of coordinated downtimes.
It is not surprising that developers and users have gravitated toward these platforms. After all, improved functionality and throughput are components developers and users would appreciate in a blockchain project, while the decentralization benefits appear amorphous.
Why does decentralization matter in a protocol?
To help us understand why decentralization matters, let us take a look at challenges associated with Web2 platforms that are largely centralized. Virtually all Web2 platforms follow the same predictable growth cycle. At the inception stage, they do everything they can to onboard users and other third-party complements, including developers, media, and businesses. This allows them to make their services more valuable since their systems need to leverage multi-sided network effects.
As these platforms recruit more users and their network effects grow, their power and control over users and third parties steadily increase. When they hit their growth targets, their relationships with network stakeholders change from positive-sum to zero-sum. Under such an environment, the only way to continue growing is to extract user data and compete with rivals over profits and audiences.
This can be seen from the competition wars that arose from [Microsoft versus Netscape](https://businessmodelanalyst.com/multisided-platform-business-model/#:~:text=As the name states%2C it,or cross-sided network effects.)), Facebook versus Zynga, and Google versus Yelp. While operating systems (OSs) like Android and iOS have behaved well, they still take 30% tax from developers and reject some applications for apparently arbitrary reasons. As such, the relationship between Web2 platforms and third parties is a kind of bait-and-switch one.
Over time, the best developers become wary of developing on top of these platforms. In addition, users are compelled to give up privacy and control of their data. These platforms have also become vulnerable to security hacks in recent times.
Blockchain networks promise a different kind of future. Unlike Web2 platforms, blockchain networks are built on the internet and use consensus algorithms to maintain and update the ledger’s state. Blockchain networks also incentivize validators and miners, and other network participants with tokens. Some platforms like Ethereum are general programable ecosystems that allow developers to build virtually any application for any purpose.
In a sense, you could compare blockchain networks with early internet protocols — or Web1 — that were largely conceived as open-source systems by working groups or non-profit organizations. However, unlike the early internet protocols that lacked incentivization mechanisms, blockchain networks provide economic incentives to DApp developers, node operators, and other network participants in the form of tokens.
Blockchain networks are also much more resilient and robust. For example, they can keep the state and perform an arbitrary transformation on that state, something that early internet protocols could not do.
They are also much more technically robust. For example, they can keep the state and compute arbitrary transformations on that state, something Web1 protocols could never do. Unlike Web2 platforms that use the bait-and-switch approach, blockchain networks can leverage multiple mechanisms to ensure they remain neutral as they grow.
One such mechanism is using an open-source code to serve as a contract between the network and its participants. They can also allow network participants to voice their concerns via decentralized governance structures, such as decentralized autonomous organizations (DAO). Most importantly, network participants can easily exit these networks by selling their tokens or, in extreme cases, forking the network.
However, despite these compelling value propositions for blockchain networks, current ‘decentralized’ protocols suffer from flaws that keep them from seriously challenging Web2 platforms. Decentralization is one such flaw.
The collapse of FTX illustrates this point. For years, many have questioned why people would use decentralized finance (DeFi) when centralized exchanges (CEXs) are often cheaper and faster. The FTX fiasco has now flipped this question: why would you trust your funds to an intermediary if you don’t have to?
Public advocates of CEXs, such as Binance’s CZ or even FTX’s Sam Bankman-Fried a.k.a. SBF, have long believed that responsible cryptocurrency regulation is the solution to the sector’s challenges. However, these demands are misplaced if the FTX scandal is anything to go by. This is because the critical element of CEX is that there is always a third party — either an operator of the order book or an intermediary such as a brokerage — that takes custody of users’ money.
While this provides certainty that each party will always settle when the exchange matches the order, there is no assurance that the trade will be concluded if buyers or sellers renege, rendering these platforms unreliable and useless.
Even if FTX operated on a U.S. stock exchange rather than as a cryptocurrency exchange, regulators would have required users’ money to be held in custody by outside entities and orders routed through a brokerage firm. This would have made it illegal for a bad actor working for the custodian to misappropriate users’ funds. While preventing such practices is the paramount objective of any regulator, it doesn’t mean that the regulations will always achieve the desired goal.
DeFi platforms like decentralized exchanges (DEXs), by contrast, require no intermediary due to blockchain-powered smart contracts. They attract liquidity providers that deposit tokenized assets into a smart contract, allowing traders to swap them at a price determined via an automated market maker (AMM) formula. Because smart contracts are blockchain-enabled and publicly visible, these platforms can easily be audited.
This is why despite sell-offs, DEXs, such as Uniswap and SushiSwap, and other DeFi platforms have been functioning smoothly, allowing users to exit their cryptocurrency positions and, if they prefer to capitalize on low prices, to buy in. While users might have seen their portfolios decrease in dollar value over time due to the prevailing cryptocurrency macro environment, they have never lost access to their assets.
Analog network: the sunrise of decentralized Web3 data and omnichain interoperability
As the cryptocurrency sector continues to grow, it has become more evident that the future is multi-chain. The Analog network would not have been conceived without the realization that in a multi-chain world, access to Web3 data needs to be a public good and not a siloed privilege.
Making this goal a reality demands a clear departure from centralized and siloed practices that have recently taken hold of the cryptocurrency industry. The end game for the Analog network is to build a vibrant and decentralized Web3 future, empowering users and DApp developers with any blockchain data via a pluggable and intuitive Timegraph API.
As a fully decentralized and permissionless blockchain ecosystem powered by the proof-of-time (PoT) consensus protocol, the network validates all the event data transactions that emanate from external chains. All the transactions — including cross-chain event data transactions — are fully verifiable, transparent, and function in a completely trustless environment.
We also intend to build a generic cross-chain event data transfer (XCEDT) protocol that DApp developers can leverage to pass messages, which can be blockchain data or value, between any two heterogeneous chains connected to the Analog network. Through XCEDT, DApp developers can build novel cross-chain applications, such as cross-chain DEXs, yield aggregators, and universal wallets, by simply implementing a few functions within existing smart contracts.
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