• Citation: Walch, Angela. ‘Deconstructing 'Decentralization'; Exploring the Core Claim of Crypto Systems’ Oxford University Press, 2019
• Wiki topic: Decentralization

Overview

• In Part I, Walch outlines the two key senses of the word “decentralized” within this space: describing how power operates in blockchain systems; and describing the network of computers that comprise a permissionless blockchain.
• In Part II, Walch identifies and explores key themes within the commentary, such as the different domains where power is exercised in blockchain systems and the fluid nature of power concentration and diffusion in these systems.
• In Part III, Walch explores examples of events which reveal sites of concentrated power in permissionless blockchain systems.
• In Part IV, Walch explores why using the term “decentralized” in decision making (policy, legal etc) is problematic, paying particular attention to how use of the term can lead to flawed judgements about how accountability or liability of people within a blockchain system should work.
• Walch concludes that courts, regulators, and potential users of crypto assets should use other factors to inform their decisions about a blockchain.

Summary

Introduction

• In 2018, William Hinman, Director of the SEC’s Division of Corporation Finance, stated that “current offers and sales of Ether are not securities transactions”. He linked this conclusion to the “sufficiently decentralized” structure of the Ethereum network. While this is not binding law, it demonstrates how pervasive the belief that blockchains are ‘decentralized’ has become, and that a blockchain’s level of ‘decentralization’ is being used to draw conclusions about these systems.
• If this is the case, and ‘decentralized’ is transitioning from a marketing term for crypto assets to one of legal import, we must be clear about what we mean when we describe blockchain networks or systems as ‘decentralized’.
• We must decide whether ‘decentralized’ is a meaningful way to evaluate a blockchain system, and if so, we must be precise about what we mean by the term, and which portions of a complex blockchain system we are referring to.

I. Mainstream Discourse Around ‘Decentralized’ Permissionless Blockchains

What does 'decentralized' mean?

There are two different common usages for the term 'decentralized' within crypto: (1) To describe the peer‐to‐peer network of computers that comprise a permissionless blockchain; (2) To describe how power or agency works within permissionless blockchain systems. Coalescing of these meanings and the complexity of blockchain technology results in misunderstandings of how 'decentralized' blockchain technology actually is.

• The terms ‘decentralized’ and ‘decentralization’ are ubiquitous in the discourse around blockchain technologies and cryptoassets.
  • Academic work, discussions within the crypto space, businesses, governments, international organizations, legislation.
• It is rare to see clear explanations of ‘decentralized’ or ‘decentralization’ when the terms are used.
• The different ways ‘decentralized’ is used in mainstream blockchain discourse:
  • To describe the network of computers (often referred to as ‘nodes’) that comprise a permissionless blockchain, as these systems operate through peer‐to‐peer connections between computers, rather than on a central server. The record generated by the system is stored on many computers within the network, rather than just on one.
  • To describe how power or agency works within permissionless blockchain systems. If there is not a single, central party keeping the record, that means that power is not held centrally, instead power is diffused throughout the blockchain.
• Both political (no one has any power, especially not the state) and physical (we have a lot of computers running, so you can’t easily knock the entire system out) meanings have melded in mainstream usage of the terms.
• Director Hinman’s June 2018 speech reflected these melded meanings of ‘decentralized’. His understanding of the ‘decentralized’ nature of bitcoin and ether led to his conclusion that the two are not securities.
• Walch argues that the SEC’s standard for “sufficiently decentralized” is extremely low, and argues that a deeper analysis of the concept is needed.

II. The Complex Nature of “Decentralization”

• Key themes identified by the author within commentary on “decentralization”:
  • No One Knows What “Decentralization” Means
    • Decentralization is often discussed as essential and a feature that differentiates crypto systems from others, yet its complexity is under-acknowledged and what it actually means is poorly understood.
    • Crypto systems are comprised of many different actors - developers, miners (or validators), and the nodes. the decentralization level of a crypto system as a whole was dependent upon each subsystem within it being decentralized as well.
    • Other sites of potential centralization: actors outside the system eg exchanges (have the power to choose whether or not to list a particular token for trading); token holders (in many crypto systems, ownership is concentrated in a very small number of people); number of software implementations of a blockchain system’s protocol, particularly if there is a dominant one.
    • It is not helpful to describe a blockchain system as decentralized unless one is specific about how he is measuring the level of decentralization in each domain of the system.
    • However, it’s difficult to quantify decentralization. Possible to count numbers of computer nodes within a system, and potentially determine how ownership of the nodes is distributed. Meanwhile, the governance of the software development process is just as relevant to how decentralized a system is, but is much more difficult to quantify or measure, as it deals with the behavior of individuals and often unwritten norms.
  • Satoshi Didn’t Invent Decentralization
    • Decentralization is fundamentally about diffusing power by distributing it away from a central point of control – sharing that power among many.
    • The idea of decentralization is a foundational principle of many institutional governance structures: the federalist system; the checks and balances inherent in the three branches of the US government; the principle of subsidiarity in the European Union that pushes power away from the center.
    • Decentralization is often about disruption or revolution – breaking up existing power structures, with hopes of spreading power around. The decentralization mantra around blockchains follows in that vein, including the discussions about “being your own bank” or “owning your digital identity” or creating money not issued by a central bank.
  • Decentralized Does Not Equal Distributed
    • According to the Cambridge Centre for Alternative Finance’s Distributed Ledger Technology Systems: A Conceptual Framework (the “CCAF Report”), “decentralized” is used to indicate that the nodes operating in a system are controlled by different parties, rather than by the same entity.
    • The CCAF Report states that “distributed” is used to indicate that “storage or computation…is divided into parts and occurs across multiple servers or nodes (‘parallelised’), but “may still rely on a central coordinator to act as an authoritative source of records.”
  • Decentralization Exists on a Spectrum
    • The CCAF Report: decentralization “is not a simple binary property,” as “the degree of centralization reflects the accumulation of interacting decisions and tradeoffs at various layers.
  • Decentralization is Dynamic rather than Static
    • The CCAF Report: the “power dynamics” within a blockchain system “can be fluid and evolve over time, which further complicates the task of forming a definitive assessment of the system.”
    • So many factors affect how decentralized a blockchain system is, so a change to any of those factors can shift the blockchain on the decentralization spectrum.
  • Decentralization is Aspirational, Not Actual
    • ‘Decentralization’ in blockchain systems is not something that has been achieved yet.
    • Some initiatives are open about their current, highly concentrated power structures, noting that they need centralized decision‐making and highly coordinated actions to build the system, and then expect it to become decentralized.
  • Decentralization Can Be Used to Hide Power or Enable Rule‐Breaking
    • Decentralization enables groups of people to obscure power and escape consequences for breaking rules.
  • Calls to Action
    • The status quo usage of the terms “decentralized” and “decentralization” is deemed untenable by many commentators, and there are a variety of calls to action in the literature: deeper study of the term; frameworks for better understanding or measuring the decentralization of crypto systems; doing away with the terms altogether in discussing crypto systems.

III. Examples of Concentrations of Power in Permissionless Blockchain Systems

• Emergency rescues of Bitcoin by small groups of developers in 2018 when a critical software bug was discovered and March 2013 when the blockchain suffered an unintended hard fork.
• Invite‐only meetings held by key software developers of Ethereum in 2018.
• The actions key developers of Ethereum took during the July 2016 hard fork in response to the DAO hack.
• Pockets of power:
  • Core developers:
    • Only a small number of developers (known as core developers) within a blockchain system have commit keys that enable them to make changes to the code repository. Every line of code reflects a policy choice about the blockchain system as a whole (e.g., how expensive should it be to participate in the system?) and technical choices about how to best reflect the policy mandate in code.
  • Mining pools:
    • In proof‐of‐work systems like Bitcoin and (currently) Ethereum, whoever controls more than 50% of the hashing power of the network effectively controls the validation process, and is able to block transactions from being entered onto the blockchain or even alter old entries on the blockchain (sometimes referred to as a block ‘reorg’).
    • A series of 51% attacks on many permissionless blockchains, including the January 2019 51% attack on Ethereum Classic, demonstrate the power dominant miners wield over these networks.

IV. Using ‘Decentralized’ to Make Legal Decisions about Blockchains

Is crypto 'decentralized'?

There are sites of concentrated power in permissionless blockchain systems: core developers and mining pools. Usage of the term differs making its meaning uncertain. Decentralization is dynamic. 'Decentralization' is therefore ill-suited to be used as a legal standard.

• The implications for law of making decisions about permissionless blockchains based on their level of decentralization are significant.
• Decentralization’s uncertain meaning makes it ill‐suited for a legal standard.
  • As discussed in Part II, no one is sure what it means for a blockchain system to be decentralized.
  • We could come up with complicated formulas to measure the ‘level of decentralization’ of a permissionless blockchain system. Issues with this:
    • While some aspects of a permissionless blockchain system are easily quantifiable, the roles of software developers, miners, and even nodes in governance are complex and poorly understood, so these actors who strongly influence the success or failure of a blockchain system remain unremarked.
    • Could fall prey to the observational bias sometimes referred to as the “streetlight effect” – i.e., paying attention only to matters that have been illuminated, and not ones remaining in the dark.
    • “Gresham’s Law of Measurement”: “Easy‐to‐calculate quantitative metrics tend to crowd out more relevant but difficult‐to measure assessments.”¹
• Decentralization’s dynamic nature complicates its use as a legal standard.
  • If a system’s level of decentralization were relevant to a legal status, there would have to be periodic evaluations of the decentralization level of the relevant blockchain system to measure it. Issues:
    • Can something cease to be a security that has already been one? How? What are the rules for trading it? How is secondary market trading of the token managed when the token can fluctuate between security and non‐security?
    • If the measurement and determination of a decentralization level is done periodically to mark the moment when a particular legal status is achieved, then participants in blockchain systems (nodes, miners, developers) may game the standard by taking actions to move along the decentralization spectrum. If the prize is large (as non‐security status would be), then anything gameable (including a level of decentralization) will be gamed.
• If actual decentralization is now just a dream, wait till it comes true.
  • Part II noted the largely aspirational nature of ‘decentralization’ in permissionless blockchains. If this is the case, it is premature to use ‘decentralization’ as a way to make legal decisions. The law must deal with present‐day realities rather than hopes or dreams.
• Decentralization veils.
  • As outlined above, though they are called ‘decentralized’, there are many parts of blockchain systems that are exceedingly centralized. Thus, the meaning commonly conveyed by the word ‘decentralized’ does not match the reality of these systems, with the consequence that misleading, inaccurate information about how power works in a given blockchain system is being conveyed every time someone describes the system as decentralized. This includes regulators, policy makers, and anyone else making decisions about these systems.
  • Misuse of the term ‘decentralized’ can lead to flawed judgements about how accountability or liability of people within a blockchain system should work, effectively providing a liability shield similar to that of limited liability entities.
    • If one believes that no particular people are doing things of consequence, and power is diffuse, then there is effectively no human agency within the system to hold accountable for anything. Law has no reason to reach into such a system, as there is no relevant human behavior to direct.
  • Misuse can also lead to perceptions that the tokens of a given system are more fixed and less subject to change than they are, potentially impacting any financial product tied to that token as well as other infrastructure built on or related to the blockchain system.
    • Legal and risk determinations about tokens like Bitcoin and Ethereum have generally been based on the view that the tokens themselves have fixed characteristics. Eg The Commodity Futures Trading Commission has deemed bitcoins to be commodities.
    • This view of tokens as having fixed characteristics underpins decisions to integrate tokens like Bitcoin and Ethereum into the mainstream financial system, whether as collateral for loans or investments by retail and institutional investors.
    • When blockchain systems like Bitcoin or Ethereum serve as infrastructure to applications built atop them, and their tokens are integrated into the financial operations of our societies, sudden changes to the infrastructure (tied to the exercise of centralized, unaccountable power), can be destabilizing to everything that rests on the infrastructure.
    • If our understandings of the power dynamics within a system were accurate, we would expect fluidity in the characteristics of a token, and therefore factor that fluidity into our risk assessments, our views of the value and potential use cases of the technology, and critically, our legal and regulatory decisions.

Conclusion

• Making decisions based on an unsubstantiated conclusion that a given blockchain is ‘decentralized’ is highly problematic. Courts, regulators, and even potential users of crypto assets should use other factors to inform their decisions about a blockchain.

References

1. Sridhard Ramamoorti et al., The Gresham’s law of measurement and audit quality indicators: Implications for policy making and standard setting, 29 RESEARCH IN ACCOUNTING REG. 79, (2017).