Crypto-Confusion: What Does Decentralised Control Actually Mean?

Decentralisation is a central theme in cryptocurrency. Let's make sense of it.

This post is presented in partnership with NCX. You can kickstart your cryptocurrency portfolio with NCX. Find out more here.

There are a lot of buzzwords thrown around in the world of cryptocurrency, but there's one thing they all have in common: they're all pretty confusing and hard to grasp.

'Decentralised control', however, might be the hardest of the buzzwords to wrap your head around, despite being key to how cryptocurrency actually works.

In essence, it's the moving of control from a centralised being or body to multiple beings or bodies. Example: If you had a bunch of chocolate eggs and someone offered to hold them for you in their basket, congratulations, you've just entered a centralised system. If later, you decide you don't want to keep all those eggs in your new friend's basket so you take most of them out and distribute them across other baskets, you've just decentralised your egg collection.

Still, that's not enough to get on with! Let's break it down further.

Why is a cryptocurrency decentralised?

To understand that, we have to first understand how our current centralised systems operate.

Centralised systems, as the name suggests, operate under a central system. It's something many of us are used to due to most of the companies and organisations we interact with functioning under this model. Take banks, for instance. You deposit your savings into one company that promises to take care of your money and help you grow it. All transaction data is monitored by the bank and stored in their system under a digital (and sometimes physical) lock and key.

During turbulent times (like, say, the Global Financial Crisis), these centralised systems are at risk of failing the millions of people around the world who've entrusted them with all their money. It's for this reason some have argued that decentralisation is the obvious antidote.

Let's bring back that chocolate egg analogy for a second.

In a decentralised system, instead of you depositing all your chocolate into one basket (AKA bank account) for safekeeping, the risk and spread would be diversified (multiple baskets holding smaller amounts of your chocolate).

Okay, let's ditch the chocolate eggs analogy, because, in the real world, while a decentralised system for holding eggs might work just fine, it's not quite as simple in the monetary or banking department.

See, the first cryptocurrency, Bitcoin, was invented in 2009 to offer a solution to the fact that a decentralised monetary system wasn't really possible with previous technology. (And if you need a reminder how cryptocurrencies work, go here.)

With cryptocurrencies, transactions are stored across multiple networks around the globe. They use distributed ledger technology (DLT) to record information (like transactions), which is time-stamped and synchronised within the whole network of users, making it unfeasible to edit. In fact, you would need to simultaneously login to every network (provided their online) to hack the system, which, aside from being laborious, energy-draining and time-consuming, is also basically impossible.

It's not an easy concept to grasp so here's a simple video to explain it all with pretty colours.

But this is where the concept starts to get a bit fuzzy for most. While the idea of cryptocurrency is built on decentralisation, many of the exchanges that people use to trade and hold their coins are not.

Traditional exchanges are organised markets, like stock markets, where people can trade their share of a company or foreign currencies for another. Most cryptocurrency exchanges are centralised and work in much of the same way. This means there is a central organisation helping crypto owners to trade their coins (or shares of coins), withdraw national—AKA fiat—currencies ($, £, ¥ etc.) and just generally manage their digital crypto wallets. It also means that if you lose your cryptowallet, you won't lose all your cryptocurrencies, as some poor souls have.

We asked Daniel Garnsey from National Currency Exchange (NCX) why it can be beneficial to use a central exchange.

"Staying up to date on the latest security protocols is not something the typical end user has time to do," Garnsey tells us.

"A centralised exchange, like NCX, has a team in place to ensure that end user funds are protected by the latest security in the industry."

However, not everyone wants a third-party monitoring them, which is why some have turned to decentralised exchanges.

Okay, what makes an exchange decentralised?

Essentially, there are no third-parties in charge of decentralised exchanges (DEX). Someone will create the platform so that exchanges can be made, but unlike at a centralised exchange, traders are on their own.

They will need to find sellers or buyers, negotiate prices and execute the sale. DEX primarily work on a cryptocurrency to cryptocurrency basis with users utilising smart contracts (computer protocols, the most common is called 'atomic swap') to trade. For smart contracts to self-execute and trades to be made, both the seller and the buyer must commit to sending their payments. If only one honours the smart contract, the trade doesn't occur and they are automatically refunded.

It's also possible to exchange fiat currencies (like Australian dollars) for cryptocurrencies via DEX but these trades are extremely risky without the use of smart contracts.

While anonymity is guaranteed, DEX are often criticised for their lack of 'Know Your Customer' (KYC) guidelines, which are set in place in traditional structures to stamp out illegal actions (like money laundering) by users.

"A decentralised exchange has no local presence and, as such, isn't required to comply with local laws," Garnsey explains.

"NCX is an Australian registered company and is bound by the same laws that govern any other company under Australian law.

"[Centralised exchanges unlike DEX] are required to report on suspicious transactions in the same way a traditional bank does."

While centralised banking structures have been around for centuries, we're only in the first decade since Bitcoin was invented and opened the 'altcoin' floodgates.

Like the dot com boom before it, cryptocurrencies definitely have a future in our evolving world, but we're only just at the beginning. Definitely conduct your own research first and carefully consider what works best for you!

Register here now with NCX to receive special offers and more.

Header Image: iStock.com/alexsl