Risks of Centralization in Crypto — Ripple and NEO
The crypto community often praises decentralization as one of blockchain’s strongest features. According to Ethereum creator Vitalik Buterin, “Blockchains are politically decentralized (no one controls them) and architecturally decentralized (no infrastructural central point of failure) but they are logically centralized (there is one commonly agreed state and the system behaves like a single computer).”
While Bitcoin and Ethereum are widely considered decentralized networks, their Proof of Work (PoW) consensus leaves questions in the overall strength of their decentralization. Ethereum is moving toward further decentralization by implementing Proof of Stake consensus (PoS) through its Casper project. However, developers are now creating newer consensus protocols that offer even more solutions to problems with network centralization.
As blockchain technology grows, we are beginning to see concrete examples of why decentralized networks offer more security and functionality than centralized networks. Centralization creates issues with both network control and functionality, and can have a negative impact on the value of the cryptocurrency itself.
Political Decentralization — Issues With Centralized Coin Control — Ripple
Lawsuit — R3 v. Ripple
In 2017, R3 sued Ripple in Delaware and New York for breach of contract. According to R3, Ripple violated its agreement with R3 to supply R3 with the option to purchase up to 5 billion XRP coins at a price of $0.0085 each ($42.5 mil total) at any time before the end of 2019. XRP coins are currently trading around $0.70. 5 billion XRP is now worth about $3.5 billion, an 82x increase in value from the contract price. Ripple responded to the lawsuit by convincing the Delaware court to dismiss the Delaware suit, and petitioned for the case to be heard in Ripple’s home state of California. However, a California court of appeals recently ruled that it would not hear the legal dispute. The final outcome will be decided by a New York court, where New York based company R3 will have a home court advantage. Ripple did file a counter-claim against R3 for entering the contract in bad faith and using the partnership to steal Ripple’s expertise in order to develop a competing product. It will be up to the New York court to resolve the claims between both parties.
Centralized Coin Management
Ripple maintaining centralized control over most of its coins and agreeing to sell them under contract could cause serious consequences for the value of XRP.
At launch, Ripple created a total of 100 billion XRP. 20 billion XRP were given to the founders, and the remaining 80 billion were transferred to Ripple Labs to “incentivize market maker activity to increase XRP liquidity and strengthen the overall health of XRP markets.” In 2017, Ripple decided to commit 55 billion XRP (89.17% of its remaining 61.68B XRP holdings) into escrow in order to remove uncertainty that Ripple may liquidate its entire holdings — a move that would over-supply the market with XRP and dramatically drive XRP price value down. Ripple placed the 55 billion XRP in escrow, allowing 1 billion XRP to unlock on the first of each month until 55 months pass. All unsold, unlocked XRP would be replaced back into escrow until month 55.
While Ripple’s decision to lock most of its coins in escrow increased transparency and calmed XRP holders, it left billions of XRP under Ripple’s control and allowed Ripple to sell up to 12 billion more XRP each year. The overall issue of Ripple’s centralized coin management is now at play in a lawsuit that could be dangerous for the value of XRP. If Ripple loses its suit to R3, the possibility arises that the court could order Ripple to allow R3 to exercise its option to purchase 5 billion XRP for cheap. R3 could then liquidate its 5 billion XRP instantly, causing an over-supply of XRP in the market and decreasing XRP price — the problem that XRP holders were initially concerned about. Another possibility is that Ripple could end up liable for damages to R3 for the value of the contract. The New York court would have to decide if Ripple would be liable for the XRP’s current value or past value. A third possibility is that Ripple escapes R3’s suit altogether.
While many cryptocurrencies are concentrated in a small group of wallets, the control and distribution mechanisms of the cryptocurrency is often decentralized to many individuals and entities. Ripple maintains centralized control over an overwhelming majority of coins, and its poor business decisions or legal liabilities could create a negative impact on the value of the coin. Even if Ripple wins its lawsuit against R3, Ripple may continue to enter into contracts and sell XRP, placing potential strains on the value of XRP for any missteps Ripple makes.
Architectural Decentralization — Issues With Centralized Infrastructure — NEO
NEO’s current centralized infrastructure is causing issues with the functionality of its network, also harming the value of the NEO coin. As mentioned above, a properly decentralized blockchain is protected from failing nodes by decentralizing infrastructural points of failure.
On March 4, NEO’s network froze completely because of a single failed node. The failed node caused all remaining nodes to wait indefinitely for a reaction from the failed node. NEO restarted the failed node, but it did not become part of the pending consensus immediately, requiring all nodes to restart through a “forced changeview.” The network failure caused a several hour delay before the network began working again. Currently, NEO’s consensus nodes are operated under NEO’s control, and not by the users themselves. NEO has a relatively small number of nodes compared to many other decentralized blockchains. In October, 2017, NEO was running only 13 nodes. It appears the number of NEO nodes has over doubled since then, but the centralization issues remain.
On March 10, NEO’s network had more problems with block generations occurring long times apart, and network transactions never arriving at their destinations. Funds took much longer to transfer between addresses than usual. Node synchronization issues appeared to partially cause NEO’s second round of network issues. While synchronization issues can be common for a blockchain, a decentralized architecture with a high number of nodes usually prevents synchronization issues from ever causing legitimate problems for the network.
NEO plans to further increase its amount of nodes, and will allow users to run their own nodes in the near future. However, NEO is currently a good example of why decentralization plays a fundamentally important role in blockchain infrastructure. At the end of February, one NEO was trading for over $140. Two weeks later, after encountering numerous network problems, one NEO is trading for about $72, and at about 64.5% of its Satoshi value from the end of February.