Key Elements of Decentralization in Web3 Protocols

Decentralization is the core innovation of blockchain technology and one of the most prominent features of Web3 protocols. To more accurately assess and compare the degree of decentralization of various Web3 protocols, industry insiders, policymakers, and regulatory bodies need to develop a more unified and detailed understanding of decentralization. This not only helps in formulating regulatory policies that are more suited to the characteristics of decentralization and understanding how decentralization reduces risks, but also encourages Web3 developers to pursue decentralization and maximize the realization of the public interest of Web3.

We defined three types of Decentralization and proposed relevant elements for each type, applicable to tokenized blockchain protocols and tokenized smart contract protocols deployed on the blockchain. We also provided two tables, one for tokenized blockchain protocols and the other for tokenized smart contract protocols, which help to enumerate the components of Decentralization and provide more specific and standardized definitions.

When analyzing the degree of Decentralization of blockchain protocols or smart contract protocols, all circumstances related to the protocol must be taken into account. The factors we propose aim to provide a direction for this analysis.

The Importance of Decentralization

Web3 has opened a new era of the internet - the era of "reading, writing, and owning." The technology that supports Web3 has achieved "trustless computation," eliminating the reliance on centralized entities to browse the internet and databases. This enables us to develop more complex and advanced protocols that provide the functionalities of the modern internet while being truly owned by the users. For example, a decentralized social media protocol can support the building of multiple applications and distribute ownership and control of the protocol to a broad community of developers and users through token ownership.

Decentralization is a key feature of Web3 protocols, driving this paradigm shift. Decentralization will create a more democratized internet and achieve three important transformations: promoting competition, protecting freedom, and rewarding stakeholders.

First, Decentralization gives Web3 systems reliable neutrality, which is crucial for incentivizing developers to build applications within the ecosystem. At the same time, they also possess composability. Therefore, Web3 systems resemble public infrastructure rather than proprietary technology platforms. Unlike the closed software of Web2, Web3 protocols provide a distributed internet infrastructure where anyone can build and create internet businesses.

Secondly, Decentralization requires a broad distribution of control and participation rights in Web3 protocols, ensuring that the development and use of the network reflect the opinions of various stakeholders, not just the companies that created these protocols. By appropriately constructed protocols that promote Decentralization, the concentration of power in the hands of a few companies can be limited.

Third, decentralization allows for the design of systems that focus more on stakeholder capitalism—these systems aim to more equitably meet the interests of all participants, rather than just serving a specific subset of people. Web3 protocols and networks have become a diverse design space that can more fairly meet the interests of all stakeholders. Such decentralized protocols provide a more stable internet infrastructure, enabling a broader range of stakeholders to confidently build upon it.

Decentralization Types

We can view Decentralization from three different but interconnected perspectives: technology, economics, and law. All three perspectives are important, but there are often competing interests among them, which presents complex design challenges in maximizing overall Decentralization and utility.

Technology Decentralization (T)

Technical decentralization mainly involves the security and structural mechanisms of Web3 systems. Programmable blockchains and autonomous smart contract protocols can support technical decentralization by providing a self-governing, permissionless, trustless, and verifiable ecosystem, thereby enabling value transfer.

For blockchain protocols, technical Decentralization is a highly challenging issue that requires balancing multiple competing forces. However, for smart contract protocols, this type of Decentralization can be relatively quick and easy to achieve by making smart contracts immutable (i.e., no one can control or upgrade them).

Economic Decentralization (E)

Blockchain and smart contract protocols utilize their native tokens to unlock the potential for these open-source and Decentralization systems to have their own decentralized economy (i.e., autonomous free market economy), enabling more people to participate and benefit from these decentralized ecosystems.

Through careful design decisions, builders of Web3 systems can facilitate the formation of a Decentralization economy, exchanging and accumulating value from various sources (including information value, economic value, voting rights, etc.). If constructed correctly, a decentralized ecosystem can utilize token incentives to encourage participants to contribute value to the ecosystem and distribute value more fairly to the stakeholders of the system based on their contributions.

The continuous incentive balance among stakeholders (developers, contributors, and consumers) can drive more value contributions to the entire system, benefiting everyone. In other words, this is all the advantages brought by modern network effects, but without the drawbacks of centralized control and closed economies.

Legal Decentralization (L)

The decentralization of law depends on whether the decentralization of a system eliminates the risks that specific regulations aim to address.

For example, technically decentralized blockchains and smart contract protocols can eliminate the risks associated with trusted intermediaries. Therefore, such systems, when it comes to regulations regarding trusted intermediaries, technically decentralized also means that they are legally decentralized.

Decentralization in terms of technology and economy can also eliminate other risks, including those related to the tokens of Web3 systems and their potential value. This decentralization will eliminate the need to apply U.S. securities laws to token transactions, which could otherwise severely limit the widespread distribution of tokens.

According to SEC guidance, we can define legal decentralization as the potential risk of a Web3 system being able to eliminate significant information asymmetry, without relying on the critical management efforts of others to drive the success or failure of the enterprise. Once this threshold is reached, the system may be considered "sufficiently decentralized," and therefore, U.S. securities laws do not need to be applied to the tokens of that system.

Decentralization要素

In a Web3 system using local tokens, it is essential to comprehensively consider the three types of Decentralization: technical, economic, and legal. These types influence each other, and changing one may affect the other two.

For example, decentralization in the economy can drive the system towards legal decentralization by prioritizing decentralized ownership of stakeholders, value accumulation from decentralized sources, and distributing value to decentralized stakeholders. All these factors reduce the risk of information asymmetry and decrease reliance on individual management efforts.

On the contrary, if the value of a digital asset in a Web3 system depends on the ongoing management efforts of the original development team, then the decentralization of that system on the technical, economic, and legal levels may be at risk. For example, the departure of the management team could exert significant downward pressure on the price of the digital asset, making the system more susceptible to 51% attacks.

In light of this mutual influence, we will break down Decentralization into many factors that may affect it. These elements are categorized by type (technical, economic, and legal) and by category (computation, development, governance, value accumulation, as well as usage and accessibility).

Decentralization is an evaluation process that is not based on absolute standards, but rather on a series of circumstances that include all aspects of any Web3 system. The relative importance of factors will change depending on the Web3 system and the purposes of the evaluator. Additionally, the trade-offs between different types of decentralization may vary by project and individual.

I hope these tools can help Web3 participants contribute to building more decentralized projects, while enabling decision-makers and regulators to design regulatory frameworks that recognize the power of decentralization to mitigate and eliminate risks.