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What is actually ... decentralization in DLT?

19 March 2024

In this series "What is actually ...?", Oliver Völkel explains various terms and concepts relating to blockchain and distributed ledger technology (DLT). This article is dedicated to a fundamental concept, namely decentralization in DLT.

1. The importance of decentralization in public blockchains

Anyone who deals with public blockchains such as Bitcoin or Ethereum is quickly confronted with explanations that all sound roughly similar: For example, there is talk of a decentrally managed database or a decentrally managed account book, a decentralized digital register or a distributed ledger in general. The decentralized nature of the technology is emphasized over and over like a mantra.

Public, in this context, means that anyone can decide to actively participate in the respective DLT network by operating the corresponding hardware and software. The prime example of a public blockchain is Bitcoin. Another example is Ethereum. The counterpart to public blockchains are private DLT networks, sometimes also called permissioned blockchains. In contrast to the public blockchain, participation in private or permissioned blockchains is not open to everyone. Instead, a person or a group of people must actively agree.

While other database systems can be changed at any point in the data structure, blockchains are not as flexible. As discussed in the thought experiment in this series' article What is actually ... a public blockchain?, past entries cannot be changed without destroying the integrity of the data structure. Changes can therefore only be made in new data records that are added to the existing data structure. Such data records are also called blocks. Over time, a chain of such blocks is strung together: the blockchain is created. This technical aspect in itself has nothing to do with decentralization. A central data collection can also be organized in this way, for example when it comes to private blockchains. However, the block-by-block stringing together of new data records is relevant because this type of data management is what makes decentralized administration possible in the first place. But what actually makes Bitcoin, Ethereum and comparable public blockchains decentralized?

For the following description, a distinction must be made between two groups of people who appear in public blockchain networks: on the one hand, the people who operate the DLT network (miners or validators) and, on the other, the people who use it.

2. Decentralization in the relationship between miners and validators

Miners and validators perform the task of adding new data records to the blockchain. Decentralization initially means that no central body is responsible for adding new data records to the blockchain, but that this task is performed by different people. Immediately the question arises as to how to determine which person should make an addition. It cannot be a central authority, otherwise it would not be a decentralized system. So, decentralization also means that no central authority determines which person adds a new data record to the blockchain. A mechanism is therefore required on the basis of which agreement can be reached among the miners or validators as to which person will add a new block to the blockchain.

The problem is familiar in the real world: Imagine, for example, a group of children playing Monopoly. How are the children supposed to decide who starts? Finding a solution is not difficult, even for the youngest: the children could agree to roll dice in turn. Whoever rolls the highest number takes the first turn. In this example, the decision as to who gets to start the game is decentralized: No central authority decides, such as the children's mother, but ultimately chance. Of course, this only works because the children have previously agreed on a mechanism for decentralized agreement on who starts the game.

It's the same with decentralized DLT, where the question is which miner or validator adds a block to the blockchain. It is not as obvious as in the Monopoly case how agreement is to be reached between people who are not in the same room and therefore have only limited control over the process. Various technological solutions exist to solve this problem.

The Bitcoin blockchain relies on the so-called proof of work mechanism, which in simple terms involves solving a complex mathematical problem. The first person to find a valid solution is allowed—based on convention—to generate the next block of transaction data. To draw an analogy with the Monopoly example: The children could agree that the first person to succeed in correctly multiplying hours by minutes based on the current time will start.

The Ethereum blockchain relies on the so-called proof of stake mechanism, in which only those can participate who are willing to confirm their compliance with a set of predetermined rules by staking Ether. To decide who is allowed to create a block next (in very simplified terms), a number of validators first generate a common random number, on the basis of which, among other things, the next person is determined from a list of validators who is allowed to create the block; also, it determines which validators jointly create the next random number. To draw another analogy with the Monopoly example: Each child writes a number from 1 to 5 on a piece of paper. All children reveal their paper slips at the same time. The child whose turn it was last adds up the numbers and counts in turn to determine who goes next.

Decentralization in the relationship between miners or validators therefore means that no central authority adds new data records to the blockchain and that no central authority determines who takes on this task. This is achieved by agreeing on a mechanism that allows a decentralized consensus to be reached on the selection of the responsible person. Such a mechanism is therefore also called a consensus mechanism.

3. Decentralization in the relationship between users, miners and validators

So far, users of the technology have been excluded from the picture. Users are those people who wish to carry out a transaction or change the status of a blockchain in some other way. To do this, a user first creates a transaction request. In simple terms, this is an electronically signed message that describes, for example, which amounts of a certain virtual currency should be transferred from which sender addresses to which recipient addresses, or how to interact with the blockchain in another way, for example by calling up a function of a smart contract. The user also specifies a certain amount to be paid to the miner or validator who has confirmed their transaction request in a block. This amount is also known as the transaction fee. In this way, transaction requests can be prioritized. If there are more transaction requests in the DLT network than can be confirmed with a single block, there is an incentive for miners and validators to confirm those transaction requests that provide for a higher transaction fee.

Once the user has created a transaction request, he or she sends it to one or more miners or validators. However, they do not keep the transaction request to themselves, but pass it on to others, who in turn proceed in the same way. Within a short period of time, a user's transaction request spreads throughout the entire DLT network. Virtually all miners or validators worldwide are aware of the transaction request within a very short time and take it into account, provided the economic incentive of the transaction fee is sufficiently high.

Decentralization in the relationship between users and miners or validators thus describes the fact that a transaction request is not only handled centrally by one person, but in principle in parallel by all miners and validators in the DLT network. It is also important to note that the person who transmits a transaction request to the DLT network does not care who ultimately confirms the transaction in a block. All that matters to the user is that their transaction is included in a block. The same applies to the transaction fee: the user is ultimately indifferent to which miner or validator receives it. The only thing that counts to him or her is the result of recording the transaction request in a block.

Oliver Völkel

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