There is a set of fundamental trade-offs at the heart of decentralized blockchains. There is this potential for disruption, for the development of trustless and censorship-resistant decentralized applications et al, but that remains a pipe dream for the foreseeable future as these blockchains are limited in their ability to scale up. We are pretty much in the stagnation zone where the three core properties of a decentralized blockchains – scalability, decentralization and consensus – are in a constant state of battle with each other.
As public blockchains require every node to record a transaction to achieve consensus, such a blockchain is only as fast as the slowest node. Centralized databases address this situation by ensuring that all nodes have sufficient computing power to process a transaction quickly because they exert full control over all the nodes. Given the decentralized nature of public blockchains, each node is run independently and the onus is upon the node operator to upgrade the nodes regularly. As the blockchain becomes bigger and bigger, the cost of running a node increases, leading to a centralization of nodes. Bitcoin and Ethereum hit their upper limits on transaction throughput in 2017 and this resulted in higher transaction costs, which led to concerns about their ability to achieve mainstream adoption.
While we firmly believe that scalability will be a problem that will eventually be solved, the tradeoff between scalability, decentralization and consensus varies from blockchain to blockchain depending on their primary use case. For example, micropayment focused blockchains such as Steem that have to process thousands of transactions per day achieve faster consensus by using DPoS consensus mechanism that is more centralized. On the other hand, Bitcoin, which requires a sovereign-grade protection for it to be resistant to a large-state attack compromises on scalability to achieve true decentralization. This explains the Bitcoin Core’s recalcitrance when faced with the prospect/opportunity of increasing the block size in 2017; Such an increase would leave the network more centralized due to the significant increase in the cost of operating a node.
Second layer and off-chain solutions such as Lightning Network achieve scalability by compromising on consensus, without affecting the security of the base layer.
Ethereum’s proposed scaling solutions – PoS, Sharding, Raiden Network – are all focused on improving the scalability of the blockchain at the expense of decentralization or consensus. Transition to PoS results in greater scalability but results in a more centralized network of nodes as the minimum deposit to operate a node is 1000 ETH. Sharding involves breaking down the overall state of the blockchain into individual shards where only nodes in a particular shard need to validate a transaction and multiple transactions can be verified in parallel as the load on the nodes are reduced. However, achieving consensus through Sharding is a challenging task as it requires trust between the nodes. In addition, most emerging ‘distributed app’ blockchains that purportedly are building a ‘better Ethereum’ in terms of scalability are more centralized than Ethereum, whether it be NEO or Cardano or something else. The future of these blockchains is very much dependent on their ability to reach the ‘Goldilocks zone’ between scalability, decentralization and consensus.
In the near future, as with all seemingly intractable problems, there will emerge a new technological development, or a new way to approach this problem, which will help us break out of this zero-sum scenario between these three attributes and leads to a win-win-win solution.
What we really liked this week was this Medium Post that nicely summarized the current approaches to the fledgeling field of crypto asset valuations.
What we do not like are the Chinese whispers. Stay braced for some temporary turbulence emanating from the Eastern front and spreading rapidly across the crypto markets.
P.S. – we also did not like this puerile piece on the blockchain from a couple of (ostensibly) very smart people. There are so many holes in this one, it is probably worthy of another long post in itself. To counter Nouriel Roubini’s characteristically bearish views, we present to you some perspective from Nassem Taleb.
Cryptocurrency of the Week
Litecoin is a peer-to-peer Internet currency that enables instant, near-zero cost payments to anyone in the world, much similar to Bitcoin. It was created by Charles Lee in 2011 to complement bitcoin as the currency for P2P transactions. Litecoin addresses the shortcomings on the bitcoin blockchain such as concentrated mining pools, slower transaction processing rates, and higher transaction fees. Unlike Bitcoin, which uses SHA-256 encryption algorithm that led to concentrated mining pools through the creation of Application Specific Integrated Circuits (ASICs), Litecoin uses a scrypt algorithm, which is memory consuming and prevented ASICs from being developed yet. Most of the litecoin is mined through GPUs, which are widely available, resulting in a decentralized mining community. A new block is added every 2.5 minutes on the Litecoin blockchain, versus 10 minutes on the Bitcoin blockchain, making transactions speedier and 4 times faster than on the Bitcoin blockchain. Litecoin’s price went up by almost 700% earlier this years after the miners agreed to activate SegWit on its blockchain and US-based Coinbase decided to enable LTC trading on its exchange.
Faster transactions compared to bitcoin: Faster transaction capabilities of litecoin as compared to bitcoin might be more appealing to vendors. Faster transactions on litecoin also reduce the risk of double spending attacks. For merchants who place more emphasis on transaction time than security, litecoin is the closest available currency to bitcoin. Litecoin network’s transaction speed was further expedited after SegWit was activated on the litecoin blockchain in May. In addition, litecoin’s community is more cohesive and offers more confidence to investors, especially due to the uncertainty over the future path of bitcoin given the split within the bitcoin community.
Ease of mining could attract significant miner interest: Bitcoin’s SHA-256 algorithm has grown more and more complex over the years, resulting in miners deploying sophisticated and expensive technology to extract relatively small amount of coins. This makes litecoin a preferred currency for novice miners to mine given the less complex nature of Litecoin mining. As more number of miners choose Litecoin over bitcoin, the network becomes more secure and scalable
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