Ten years ago today I posted
Economies of Scale in Peer-to-Peer Networks . My fundamental insight was:
- The income to a participant in a P2P network of this kind should be linear in their contribution of resources to the network.
- The costs a participant incurs by contributing resources to the network will be less than linear in their resource contribution, because of the economies of scale.
- Thus the proportional profit margin a participant obtains will increase with increasing resource contribution.
- Thus the effects described in Brian Arthur's Increasing Returns and Path Dependence in the Economy will apply, and the network will be dominated by a few, perhaps just one, large participant.
In the name of blatant self-promotion, below the fold I look at how this insight has held up since.
Experience in the decade since has shown that this insight was correct.
The insight applies to Proof Of Work networks; for the entire decade Bitcoin mining has always been dominated by five or fewer mining pools. As I write this AntPool, ViaBTC and F2Pool have had more than 50% of the hashrate over the last week. Even within those pools, the vast expense of mining rigs, the data centers to put them in, and the power to feed them make economies of scale essential.
The insight applies to Proof Of Stake networks at two levels:
- Block production: over the last month almost half of all blocks have been produced by beaverbuild.
- Staking: Yueqi Yang noted that:
Coinbase Global Inc. is already the second-largest validator ... controlling about 14% of staked Ether. The top provider, Lido, controls 31.7% of the staked tokens,
That is 45.7% of the total staked controlled by the top two.
In addition all these networks lack software diversity. For example, as I write the top two Ethereum consensus clients have nearly 70% market share, and the top two execution clients have 82% market share.
Economies of scale and network effects mean that liquidity in cryptocurrencies is also highly concentrated. In
Decentralized Systems Aren't I wrote:
There have been many attempts to create alternatives to Bitcoin, but of the current total "market cap" of around $2.5T Bitcoin and Ethereum represent $1.75T or 70%. The top 10 "decentralized" coins represent $1.92T, or 77%, so you can see that the coin market is dominated by just two coins. Adding in the top 5 coins that don't even claim to be decentralized gets you to 87% of the total "market cap".
The fact that the coins ranked 3, 6 and 7 by "market cap" don't even claim to be decentralized shows that decentralization is irrelevant to cryptocurrency users. Numbers 3 and 7 are stablecoins with a combined "market cap" of $134B. The largest stablecoin that claims to be decentralized is DAI, ranked at 24 with a "market cap" of $5B.
| Protocol | Revenue | Market |
|---|
| | $M | Share % |
|---|
| Lido | 304 | 55.2 |
| Uniswap V3 | 55 | 10.0 |
| Maker DAO | 48 | 8.7 |
| AAVE V3 | 24 | 4.4 |
| Top 4 | | 78.2 |
| Venus | 18 | 3.3 |
| GMX | 14 | 2.5 |
| Rari Fuse | 14 | 2.5 |
| Rocket Pool | 14 | 2.5 |
| Pancake Swap AMM V3 | 13 | 2.4 |
| Compound V2 | 13 | 2.4 |
| Morpho Aave V2 | 10 | 1.8 |
| Goldfinch | 9 | 1.6 |
| Aura Finance | 8 | 1.5 |
| Yearn Finance | 7 | 1.3 |
| Stargate | 5 | 0.9 |
| Total | 551 | |
Similar effects apply to "Decentralized Finance". In
DeFi Is Becoming Less Competitive a Year After FTX’s Collapse Battered Crypto Muyao Shen wrote:
Based on the [Herfindahl-Hirschman Index], the most competition exists between decentralized finance exchanges, with the top four venues holding about 54% of total market share. Other categories including decentralized derivatives exchanges, DeFi lenders, and liquid staking, are much less competitive. For example, the top four liquid staking projects hold about 90% of total market share in that category,
Based on data on 180 days of revenue of DeFi projects from Shen's article, I compiled this table, showing that the top project, Lido, had 55% of the revenue, the top two had 2/3, and the top four projects had 78%.
Because these systems, if successful, cannot be decentralized, the cryptosphere doesn't care about the fact that they aren't. In
Deconstructing ‘Decentralization’: Exploring the Core Claim of Crypto Systems Prof. Angela Walch explains what the label "decentralized" is actually used for:
the common meaning of ‘decentralized’ as applied to blockchain systems functions as a veil that covers over and prevents many from seeing the actions of key actors within the system. Hence, Hinman’s (and others’) inability to see the small groups of people who wield concentrated power in operating the blockchain protocol. In essence, if it’s decentralized, well, no particular people are doing things of consequence.
Going further, if one believes that no particular people are doing things of consequence, and power is diffuse, then there is effectively no human agency within the system to hold accountable for anything.
In other words, it is a means for the system's insiders to evade responsibility for their actions.
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