Decentralisation is a way of classifying how a system operates. In general, a system that is ‘decentralised’ operates through a series of rules that coordinate the contributions of individual components, or nodes. These nodes are self-organised, and interactions among nodes collectively achieve the system’s goal without the need for a central guiding or authoritative entity. As such, each node contributes to the purpose of the system and one node or component cannot operate the system independently.
Decentralisation does not imply a lack of order or structure simply because the network has no reliance on a central authority. In fact, decentralised networks are rules-based, highly organised, predictable systems. Protocols dictate how the network operates and how participants in consensus communicate and interact with one another, meaning that governance is embedded into the network design. In general, in a decentralised system, individual actions are consequential to the system in which they participate and participants are incentivised to act in a way that serves the collective good: maintaining a secure, trustworthy and rules-based system.
Building consensus around what decentralisation is – and is not – and how to determine whether a blockchain network is decentralised lays the groundwork for developing appropriate regulatory approaches. Yet given the varied and novel aspects of blockchain-based technology, a one-size-fits-all approach to determining decentralisation is neither appropriate nor practical. The blockchain industry is nascent and will continue to develop over time; many of the fundamental assumptions that hold now will become outdated, making an overly prescriptive definition outdated or irrelevant.
As a starting point, we recommend the development of a straightforward framework for evaluating a network’s degree of decentralisation, one that allows regulators the ability to evaluate specific attributes of a network and its underlying protocol. A broad framework that draws on high-level principles allows for adaptability and avoids a situation in which strict criteria developed today fail to capture future innovations.
To this end, we created a simplified framework that isolates two key dimensions of decentralisation: network architecture (whether there are single points of failure), and governance and decision-making (whether power is centralised) (Figure 1). We recognise that other dimensions exist beyond the two we have identified, and that nuance is lost in developing simplified evaluation criteria. However, a highly complex framework would be incompatible with easily administered policies and would be burdensome to apply in practice.
Figure 1. Key dimensions of decentralisation
Source: Stellar Development Foundation
Implications for regulators
With centralised systems, policy-makers are charged with assessing whether a central authority operates responsibly and transparently. Laws, regulations and rules condition the behaviour of central authorities and engender trust with system participants. But decentralisation allows for an alternative model of trust, one that does not depend on centralised authority. Decentralised systems are designed so that no single actor or affiliated group can exert undue influence or control over the system, and it is the protocol that conditions the behaviour of participants in the system. In a truly decentralised system, trust is shifted away from a centralised authority and to the system itself.
In decentralised systems, policy-makers must assess whether the underlying protocol eliminates the risks associated with centralised authority. Where decentralised systems do not eliminate or sufficiently mitigate risks associated with centralised authority, oversight and regulation should follow. For example, if there is a security vulnerability in a protocol that is exploited, how is that vulnerability addressed? If there is a risk of collusion among entities running nodes, how can that risk be alleviated? Regulation can solve these gaps in trust.
Ensuring consumer and investor protections, promoting market integrity and mitigating systemic risks remain key priorities for policy-makers, whether looking at centralised or decentralised systems. Yet decentralisation raises fundamental questions about the nature of regulation, and how that regulation is deployed most effectively. In confronting this unfamiliar territory, policy-makers will be challenged to rethink the very nature of oversight.
Lesley Chavkin is Head of Policy, and Alexander Wu is a Graduate Fellow at Stellar Development Foundation.
This article will be published in OMFIF’s Digital assets 2023 report, publishing 28 September. Register to attend the launch event here.