Emergent centralization due to economies of scale

Colin LeMahieu
Oct 30, 2018 · 2 min read
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A defining property of cryptocurrency which separates it from other monetary systems is the focus on being decentralized. This is needed as a mechanism to prevent someone from altering currency transactions. Therefore, these systems should be designed without inherent drivers pushing towards centralization.

When put into place, however, these systems have trended towards a small group of entities in opposition of the primary property of being decentralized. This difference between ideological goals and the reality of implementation is called emergent-centralization, and a contributing factor is the marginal cost of producing consensus.

Marginal cost is an economic term that describes the cost of producing one extra unit of a particular good. When applied to cryptocurrency this represents the cost expended by a consensus-producing actor to produce one additional unit of consensus on the network.

When producing a good has a decreasing marginal cost it benefits from economies of scale and thus encourages fewer producers and larger scale production which is in opposition to the goal of decentralization.

The principal examples we will look at are capital costs, operating cost and opportunity cost.

Capital Cost

Capital costs refer to payments made to purchase infrastructure used to produce consensus. These costs could be facilities or servers used to run nodes. If additional physical goods are required to be purchased to produce extra consensus, there is a marginal capital cost and economies of scale favor producers who can purchase or manufacture bulk quantities.

Operating Cost

Any inputs required for infrastructure to function, such as electricity, bandwidth, or staff, fall under operating costs. Consumption of these resources leads to a marginal operating cost. When consensus requires additional resources, economies of scale favor those who can find specialized access to cheaper electrical sources or can buy inputs at discounted industrial rates.

Opportunity Cost

If producing extra consensus requires the producer to give up something else, it has a marginal opportunity cost. When extra consensus requires collateral, economies of scale favor producers with access to substantial amounts of capital or those who can obtain leverage on their collateral, offsetting their costs.

Based on these factors: any system which aims to be decentralized must aim to minimize the advantage of economies of scale when producing extra consensus or it will suffer from emergent centralization as it grows.

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