How to tell if a crypto is legit
As the crypto markets endure turbulent times, highlighted by recent market collapses and high-profile incidents like the downfall of FTX, newcomers are still entering this volatile domain. While many are not novices in traditional investment, the unique complexities and risks inherent in cryptocurrencies are often new territory for them. With an overwhelming selection of over two million cryptocurrencies, it's a challenging task to discern which ones are trustworthy and safe for investment.
This situation raises a critical question: How does one evaluate an “altcoin,” or more broadly, the quality of a DeFi ecosystem, especially in such a fluctuating market?
Determining the legitimacy of a cryptocurrency isn't straightforward and varies based on individual preferences and risk tolerance. For some, the focus might be on low transaction fees, while others might prioritize high yields. However, it's essential to understand the trade-offs that come with these preferences. For instance, the importance of decentralization is often overlooked in the pursuit of lower fees or higher returns. Understanding these trade-offs is crucial, particularly in the light of recent events that have shaken the crypto world, reminding investors of the inherent risks and the need for careful evaluation.
Quick Takeaways:
It's a common misconception, but not all blockchains are inherently decentralized.
Decentralization plays a key role in preventing conflicts of interest and maintaining open access for everyone.
Straying away from decentralization contradicts the foundational principles of Bitcoin and the original intent behind cryptocurrencies.
When a large chunk of coins, sometimes nearly half, is handed out to insiders and investors before the public can get a hold of them, it can significantly undermine the decentralization effort.
Besides decentralization, there are other crucial factors to keep in mind while picking a cryptocurrency or DeFi platform, such as the process for proposing updates, transaction speed and associated costs.
Decentralization Demystified
There's a common misunderstanding among crypto newbies that all blockchains are by default decentralized. Some, upon realizing that's not the case, might downplay the importance of decentralization. But why is decentralization so crucial?
The Genesis of Decentralization
The concept traces back to the roots of Bitcoin, born in the aftermath of the 2008 financial crisis. Banks then had risked too much on unstable mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), leading to a bailout with taxpayer money. The Federal Reserve's intervention to soften the economic blow resulted in inflation and a devalued dollar.
Bitcoin emerged as a counter-system: a currency free from single-entity control or manipulation. Changes to Bitcoin can only happen if the majority of its users agree. This stands in stark contrast to a system like the Federal Reserve, which has substantial control over a global currency.
Beyond Economics - Decentralization as a Social Equalizer
Bitcoin's decentralized nature also opened up financial systems to the unbanked, particularly in regions with little structure oppressive regimes. In such regions, people may not have access to official state identification and therefore cannot access global banking networks. Current KYC (Know Your Customer) and AML (Anti-Money Laundering) regulations, despite their good intentions, often exacerbate inequality by locking billions out of basic economic structures.
The Trust Factor
Decentralization also reduces the need to trust a single entity, which becomes crucial considering the frequent data breaches and hacks in institutions like Visa, Mastercard and various banks. It gives control to the collective users rather than a central company, ensuring ethical handling of money and personal data.
The Risks of Central Control
Decentralization's importance is amplified in the context of private groups controlling unregulated digital assets. When entering the crypto markets, it's vital to invest in systems that aren't centrally controlled. Central control opens up risks of hacking, conflicts of interest and possible misuse of the currency for personal gain, defeating the very purpose of cryptocurrency’s initial intent.
In essence, when choosing a crypto investment, ensuring it embodies the true spirit of decentralization isn't just about following the ethos of cryptocurrency; it's about safeguarding your investment from potential risks and ethical conflicts inherent in centrally controlled systems.
Evaluating Decentralization in Cryptocurrencies:
Understanding the decentralization level of a blockchain platform isn't straightforward. The challenge lies in the diverse structures of different platforms, making it difficult to draw direct comparisons using uniform metrics.
However, it's still possible to gauge a platform's level of decentralization by examining certain common elements across blockchains. Let’s delve into how some of the top layer 1 cryptocurrencies stack up in terms of decentralization, looking at factors like network size, distribution, accessibility, initial coin distribution, as well as cost and speed.
Note: The following decentralization statistics are derived from relevant blockchain explorers and may not be precisely accurate.
Hashrates, Stake Pools and Validators
Decentralization measurement involves examining the mining hashrate of a network, along with its nodes, stake pools or validators.
Note: Mining and hashrate are associated with Proof-of-Work systems, while stake pools and validators pertain to Proof-of-Stake systems. Both utilize nodes. Hashrate indicates the total computational power of a Proof-of-Work cryptocurrency such as bitcoin.
It's essential to assess how these elements are distributed among different entities. Stake pools, validators and miners process new transaction groups, which are then verified by nodes against previous transactions on the ledger. If they align, the new transactions are added to the blockchain. Typically, multiple validators, stake pools or miners can link to a single node.
To determine a Proof-of-Work system's decentralization, you need to analyze the total hashrate produced by its miners and how it's divided among different groups.
In a Proof-of-Stake system, the focus shifts to the number of stake pools or validators, the portion of the circulating coin supply that is staked and whether the validators or stake pools are operated by the coin's founders or by public entities and individuals.
For Proof-of-Stake systems, a higher percentage of the coin staked to the network, as opposed to merely being held in wallets or traded, indicates greater network security.
