The Nakamoto Coefficient was created in 2017 by former Coinbase CTO Balaji Srinivasan. It measures the decentralization within a project and determines the minimum number of nodes needed to disrupt the blockchain network.
Decentralization is the cornerstone of blockchain technology. After the financial crisis of 2008, the pseudonymous creator of Bitcoin, Satoshi Nakamoto, decided to build an economic system that would work without central authorities, such as banks and governments. This is how Bitcoin was born: a network where users can transact without any middlemen, which is the main premise of decentralized blockchain technology.
However, as blockchains and cryptocurrencies progressed, large investors started building huge crypto stocks. Additionally, giant mining companies have entered the fray, leaving little to no room for individual miners. The result? A concentration of power in the hands of a few, which goes against the promise of decentralized blockchains.
Therefore, measuring the level of decentralization within the project is essential before putting your trust and money behind a blockchain and its corresponding cryptocurrency. This is where the Nakamoto coefficient can help. Follow along as we describe this decentralization measure and how it works.
What is the Nakamoto coefficient?
Judging by its name, one might think that it is a measure developed by Satoshi Nakamoto himself. However, this is not the case. The Nakamoto Coefficient was created in 2017 by former Coinbase CTO Balaji Srinivasan. It measures the decentralization within a project and determines the minimum number of nodes needed to disrupt the blockchain network.
A node is one of the computers that runs the blockchain software and is used to validate and store the complete transaction history on the network. More nodes means more decentralization. It also means that a malicious actor would have to control more nodes to gain majority in the system and tamper with transactions.
The importance of measuring decentralization
Decentralization, with all its inherent positive aspects, is not absolute. Blockchains can be decentralized and centralized to some extent. A blockchain like bitcoin focuses more on decentralization at the expense of scalability. On the other hand, blockchains like Solana are a bit more centralized to ensure scalability.
When you trust blockchains because of their decentralization and the inability of anyone to take full control, you need to know how decentralized a blockchain is, and then it becomes necessary to measure it.
Of course, there was never a barometer to measure decentralization until former Coinbase CTO Balaji Srinivasan developed the Nakamoto Coefficient.
How does the Nakamoto coefficient work?
The Nakamoto coefficient determines the number of nodes that must be compromised to affect the blockchain and prevent it from functioning properly. A higher Nakamoto measurement indicates a more decentralized network. This means that the network has a large number of nodes. Therefore, anyone looking to compromise the system would need to affect at least 51% of these nodes to prevent the blockchain from working properly.
How is the Nakamoto coefficient calculated?
To calculate the decentralization of a blockchain, Srinivasan derived a method combining the Gini coefficient and the Lorenz curve. These two socio-economic measures are used to determine inequality and non-uniformity within an economic population.
Srinivasan’s idea was to combine the Gini coefficient and the Lorenz curve and use the resulting method to study multiple subsystems of a blockchain to arrive at a number indicating decentralization. These subsystems include nodes, miners, clients, exchanges, developers and more.
Decentralization in Popular Cryptocurrencies
The highest Nakamoto coefficient on any given day goes to Bitcoin, which has a score of 7,349, signaling immense decentralization. A distant second is Avalanche, with 26 for all of its validators. We have Solana at 19, who is compromising on parts of her decentralization to increase scalability. Ethereum’s score is quite tricky as it is difficult to find the total of validators in its vast network.
The Nakamoto coefficient gives us a way to measure decentralization. With it, we have a way to analyze the risks associated with blockchains. It is also a guide for blockchain developers on what is needed to ensure decentralization. Measuring the Nakamoto coefficient is still a complicated process, unlike a formula where you only enter numbers. Yet this is what we have until a better alternative comes along.
First post: STI