Why Is Centralization Hurting The Crypto Ecosystem? And Can Terra Fix It?

2021 was THE year for blockchain! From Bitcoin hitting its all-time high to the meteoric rise of meme coins, and whatnot!

From Elon Musk to your granny, everyone seems to be talking about crypto and blockchain only. Literally, everybody is rushing to have a piece of cake.

But, there’s another thing that’s rising, and it’s not good for cryptos at all.

The Rise Of Centralization

Centralization refers to a process where specific groups of people have the decision-making powers. The rest follow the directives coming from the top.

In the crypto space, this means the very essence of blockchain — decentralization is under attack.

In 2021, Binance, the world’s largest cryptocurrency exchange, announced its plan to move from a decentralized structure to a centralized one.

This comes after the Binance exchange received significant regulatory pressure from the U.K., Japan, Italy, Hong Kong, etc. as well as restrictions from banks from the U.K. banks and other countries.

While the intention of these regulations may have been wise, it is doing more harm than good.

Centralized Ecosystem Vs Decentralized Ecosystem

To a newbie, both centralized and decentralized ecosystems look the same. But the devil is in the details.

Centralized Ecosystems

Centralized ecosystems are like modern banks. It acts as an intermediary to execute transactions between a buyer and seller and even lets you store your cryptos in your account.

In such a system, a central authority is in control of the data as well as the functions of the said platform and the authority to make decisions lies within a small set of people.

In short, the centralized platform does store your data on their platform, whether you like it or not. They are also likely to hold private keys, which means they are 100% in control of your assets.

Decentralized Ecosystems

A decentralized ecosystem is like a counterpart of the centralized one, except for the complications. It doesn’t involve a third party or intermediary, making the system ‘trustless’.

In such a system, the authority to make decisions doesn't lie within closed doors, rather it is equally distributed among all the stakeholders.

Additionally, decentralized platforms do not store your data without your consent.

TLDR: The crucial difference between centralized and decentralized platforms is whether a third party is involved in the transaction.

Why Is Centralization Terrible? And How Can Terra Solve This?

Although there are a few pros of centralization, it is ultimately overshadowed by its cons due to extensive interference by the holding entity.

And it goes without saying that whenever a third party is involved, things always go haywire, as it is often with centralized platforms. Instead of working for the customer, these platforms have their own interests to serve, which often leads to disasters.

To counter this, decentralized protocols like Terra are coming up with their own solutions to beat them at their own game.

Terra is a next-generation, decentralized blockchain protocol that serves as its own banking ecosystem. Terra also supports smart contracts and run on multiple chains that gives it an upper hand against other centralized protocols.

On top of that, it also has configurable architecture characteristics that automatically changes the monetary supply, based on an algorithm, to absorb any volatility and keep the prices as stable as possible.

Here are the major drawbacks and limitations of the centralized system and how Terra can solve them:

Market Manipulation

Market manipulation or 'Pump and Dump' event refers to a situation when the trading volume increases above the average in a short time, resulting in a rapid decline or increase in the crypto's price.

Since individuals have access to vital, insider information in a centralized organization, they may take advantage of the same by manipulating the crypto by selling large volumes on the spot market.

This has recently happened with Binance, which was accused by US authorities of Insider Trading.

Activities like this can be tackled by Terra since its stablecoins are powered by an algorithm. Without getting into technical details, it simply maintains the supply of the coins by minting and swapping using its native coin — LUNA.

Volatility

Crypto and volatility go hand in hand, and it is often said that the crypto market thrives on speculation. Even though this happens everywhere in the crypto world, this is especially true for Altcoins, which often becomes a target of market manipulation.

As explained earlier, market manipulators pump and dump massive volumes on spot markets, which rapidly increases or decreases the price of the coin, and ultimately, burns the investors.

Terra fixed this using its stablecoins coins, including UST, and its native coin — LUNA.

For a more practical example, let's say the price of UST climbs above $1, Terra's algorithm would mint more UST using LUNA to increase the supply and reduce the price. If the price falls below $1, it would swap UST for LUNA to push the price back up.

Fees

Nobody enjoys paying fees. But centralized platforms, run by for-profit third-party organizations, usually have high fees for providing the services to their users. Although this varies from platform to platform, they ultimately have the authority to decide the fee, and sometimes, they take advantage of it.

Because why not? If they can earn more, why wouldn’t they?

Terra, on the other hand, comes as a relief since it charges a transaction fee ranging from 0.1% to 1%, capped at 1 TerraSDR, on every transaction.

Ownership

As mentioned above, one big disadvantage of centralized exchanges is the fact that it gains absolute ownership of your assets in the name of convenience and faster execution.

In reality, this very vulnerability is exploited by hackers and scammers, as it happened with the QuadrigaCX scandal, where the founder had the supposed access to their crypto wallet with around $200 million in it.

Later during the investigation, it was found out that no such wallet ever existed and the entire drama was orchestrated to hide other unauthorized transactions.

Terra, as a decentralized protocol, neither stores your personal details nor holds your private keys. A Terra user has full control of their assets.

Exit Scams

An exit scam is an unethical practice where founders, promoters, or the initial team vanish with investors’ money during or after an ICO or listing. In other cases, businesses simply realize it’s simply not working for them and run with the remaining funds without refunding the investors.

And since we are talking about exit scams, nothing can explain it better than the legendary BitConnect scandal.

BitConnect was known for its Ponzi scheme that guaranteed 1% ROI every day and was portrayed as the best alternative to Bitcoin. The hype was real, and it soon skyrocketed to an all-time high of $463 in 2017 from a mere $0.17 in 2016. That’s a massive growth of over 272252%!

However, BitConnect announced the shutdown of its exchange in 2018 and refunded its users in its native token BCC, and ran away with the actual holdings. The BCC tokens soon became worthless as everyone lost trust in the company. It was a lot of drama that eventually involved the SEC.

And millennials think the Dogecoin was a big ripoff.

This can never happen in Terra; the network itself is decentralized, and no one person or entity holds the ultimate authority to take such decisions.

Security Risks

As surprising (or maybe not) as it may sound, many exchanges do not have a sound security system, even though they take custody of millions of dollars of crypto assets.

The security concerns can be divided into many issues, but one way or another, most incidents resulting in crypto-asset loss are often the result of internal theft or cyber-attacks. Most exchanges do not even have a mechanism that prevents a high-level executive from accessing the funds or preventing cyber attacks.

In 2017, the South Korean exchange — Youbit lost more than $73 million after a series of hacks and was forced to shut down. Later in 2019, they rebranded themselves to Coinbin, but unfortunately due to lack of supervision, the former CEO allegedly had the access to the private keys and siphoned off all the funds. The company was once again shut down, still owing $30 million to its users.

The conclusion — they are not as secure as you think.

As highlighted above, Terra itself is decentralized and hence, there are no private keys that anyone can use. On the other hand, it runs on Tendermint, which is based on a Proof of Stake mechanism that can be configured for proof of work. Although it comes with its own pros and cons, it is open sourced and hence, if there's a security risk, it is out in the open.

They also happen to have a bug bounty program that rewards if critical issues are found.

Conclusion

Like them or hate them, but centralized exchanges are not going away anytime soon.

Even with the massive benefits of decentralized exchanges, their counterparts are here to stay for many reasons, but notably, because they are way faster and efficient when it comes to liquidity because of a large pool of users.

It is also the only place where you can exchange crypto for fiat currency. Unlike fiat-pegged stable coins, a decentralized platform can’t offer crypto-fiat exchanges since they do not have a place to store fiat currency.

And the fact that 99% of the digital currency is in fiat, it is likely that once in a while, you need a centralized point of exchange. This may change in the future, as crypto and DeFi are adopted widely.