Centralized Cryptocurrencies: Everything to Know

By  Beluga Research September 3, 2023

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Summary

  • The term "centralized" refers to a system in which control over transactions and operations is held by a central authority
  • Centralized cryptocurrencies operate under a single authority or organization
  • A centralized cryptocurrency can offer users efficiency and the ability to engage in transactions quickly
  • Centralization can lead to a number of concerns, including denial of access to certain populations, censorship and vulnerability to attacks

Overview

The term "centralized" refers to a system in which control over transactions and operations is held by a central authority. Centralization can lead to a number of concerns, including denial of access to certain populations, censorship and vulnerability to attacks.

A centralized cryptocurrency is usually able to respond to threats like manipulation in a quicker, more organized way than a decentralized cryptocurrency. Exchanges on which cryptocurrencies are bought, sold and traded can also be centralized. Coinbase is an example of this type of exchange.

A Brief History

Centralized cryptocurrencies have roots in the early days of digital currencies. The digital payment system called E-gold, which was developed in 1996, operated under a centralized model. It allowed users to open accounts and transfer digital gold units. E-gold shut down in 2009 due to regulatory concerns and issues related to money laundering.

New centralized authorities emerged after E-gold disappeared. One is Ripple, which was established in 2012. Ripple is a cryptocurrency and a payment protocol that enables quick, low-cost international transactions. Ripple has faced criticism for its centralized nature. This is because Ripple Labs, its parent company, holds the majority of the native coin, XRP tokens.

Centralized: Everything to Know

Control and Authority: In centralized cryptocurrencies, control and authority are concentrated in a central entity's hands. This entity makes decisions about the cryptocurrency's operation, governance and future development. Centralized control offers efficiency and fast decision-making. It raises concerns about censorship and potential abuse of power.

Transaction Validation: Centralized cryptocurrencies rely on a central authority to validate transactions. This authority acts as a trusted third party, verifying transaction authenticity and integrity. The concern is that centralization introduces a single point of failure and potential security vulnerabilities.

Governance and Consensus: Centralized cryptocurrencies have a clear governance structure. Decisions are made by a central authority or a group of stakeholders. This structure allows for faster decision-making and implementation of changes. It limits transparency and inclusivity.

Scalability and Efficiency: Centralized cryptocurrencies often offer greater scalability and efficiency than decentralized ones. With a centralized infrastructure, transactions can be processed quickly and at a higher throughput. This advantage makes centralized cryptocurrencies suitable for applications requiring fast and frequent transactions. Examples include payment systems and remittance services.

Trust and Security: Centralized cryptocurrencies rely on trust in the central authority to ensure fund and transaction security. Users must trust that the central entity will act in their best interests and protect their assets. This trust can be compromised if the central authority experiences security breaches, hacks or engages in fraudulent activities. Centralized systems also present a single point of failure. An attack or disruption on the central authority can have severe consequences for the entire cryptocurrency ecosystem.

Getting Started

  • Placing control and decision-making power in the hands of one entity or group. Centralization offers this entity the ability to govern what occurs with the cryptocurrency. The authority needs to exercise proper care in ensuring the security, fungibility and ease of access to the cryptocurrency.
  • Users used to decentralization may be frustrated with losing opportunities and access . Users may be frustrated by the limits that the central authority sets for the coin. The central authority can address this by implementing some of the measures that users request.
  • Partial centralization can be a solution. An entity or group can have a limited amount of authority over the cryptocurrency. They can use this authority to take certain measures to ensure the safety and fungibility of the cryptocurrency. For example, they could set up funds to compensate users in the event of a loss. The cost of having such a fund may be higher gas fees. The centralized administration for the cryptocurrency can use surveys and discussions on forums to gauge the level of interest and protection that users want.

Unique Aspects

  • A central authority controls the network. This authority is typically a company or organization that issues and manages the cryptocurrency. It makes decisions about the protocol, governance and direction of the cryptocurrency. Users of centralized cryptocurrencies must trust this central authority to act in their best interests.
  • The central authority processes and validates transactions. Alternatively, a select group of validators does this task. This allows for faster transaction processing compared to decentralized cryptocurrencies. It introduces a single point of failure and potential vulnerability.
  • Hierarchical structure. The central authority is at the top making key decisions. This enables efficient decision-making and implementation of updates or changes to the cryptocurrency's protocol. It means the central authority has the power to influence the cryptocurrency's direction. The central authority could also disregard the interests of all users.

Advantages

  • Efficiency: Centralized cryptocurrencies often have faster transaction speeds and lower fees than decentralized ones. This is due to the fact that centralized systems have streamlined decision-making processes and infrastructure.
  • Scalability: A centralized cryptocurrency can easily handle a larger number of users and transactions than decentralized ones. Centralized cryptocurrencies can implement upgrades and optimizations without the need for consensus among multiple participants.
  • Governance: Centralized cryptocurrencies usually have a governing body or authority. This entity can make decisions and implement changes quickly. The presence of a central authority allows for faster responses to security threats, regulatory requirements and technological advancements.
  • User Support: Many centralized cryptocurrencies often offer dedicated customer support. Their staff or infrastructure can promptly resolve issues and provide assistance. The customer support enhances user experience and provides a sense of security and reliability.
  • Accountability: Centralized systems provide a clear chain of accountability. All decisions and actions can be traced back to a central authority. Such transparency helps prevent fraudulent activities and ensures compliance with regulations.

Disadvantages

  • Single Point of Failure: Centralized cryptocurrencies are vulnerable to a single point of failure. If the central authority or infrastructure experiences a technical issue, attack or disruption, the entire system could be compromised.
  • Lack of Privacy: Many centralized cryptocurrencies require users to disclose personal information for regulatory compliance. This could compromise user privacy and expose individuals to data breaches and misuse of personal information.
  • Censorship and Control: The central authority of a cryptocurrency can control transactions and accounts. Such activity could lead to censorship and restrictions on certain transactions or individuals. This raises concerns about abuse of power and manipulation by the central authority.
  • Counterparty Risk: Centralized cryptocurrencies require trust in a central entity. Users must trust the central authority to act in their best interests and protect their funds. If this trust is compromised or the central authority engages in fraudulent activity, it will place users' assets at risk.
  • Lack of Decentralization Benefits: Centralized cryptocurrencies do not enjoy the benefits associated with decentralization. These include resistance to censorship, immutability and increased security through distributed consensus mechanisms.