Contributor: Hermez Network takes a deep dives into the pros and cons of decentralized payment networks.
What Is a Decentralized Payment Network?
A decentralized payment network refers to a system where users, customers and vendors can exchange money without having to trust any third party to keep the network secure and operational.
These networks are possible thanks to the globalization of access to the internet and are built using blockchains, which bring different degrees of decentralization, scalability and security.
Before the adoption of blockchain technology, the most decentralized payment network was cash payments. The parties involved in a cash exchange don’t need to trust anyone else to verify the transaction, as the balances of both parties rest in a physical note.
However, cash, as any physical currency, still relies on central banks and governments to maintain its legitimacy, and tackle threats like counterfeiting.
The inception of Bitcoin brought a revolution, as the cryptocurrency aims to emulate a peer-to-peer electronic cash system. In that sense, Bitcoin is a distributed payment network where every transaction is processed publicly and accessible by all nodes. That makes it less decentralized than cash, but is not centralized, as there is no central point of failure.
How Is a Decentralized Payment Network Different From a Centralized Payment Network?
A centralized payment network can be anything from a bank to a remittance company. Every bank has a private ledger filled with all the transactions made by its users. Each bank also keeps accounts open with all other banks and central banks to enable cross-bank transfers. For instance, when someone makes an international bank transfer, the two banks involved will credit and debit between their accounts.
Banks have traditionally offered a high degree of security compared to other options available, like keeping the money under the mattress.
However, with the rise of the internet came the rise of hacks and information leaks. If a malicious actor gains access to the bank’s central ledger, they could potentially manipulate the balances of all its customers, and maybe even other banks.Blockchains like Bitcoin and Ethereum take a totally different approach. They keep a public ledger that is continually recorded and verified by all the nodes on the network. However, the transaction records are immutable which helps to avoid fraudulent transactions.
This makes them a better option for transferring value in the digital age than banks.
What Are the Benefits of Decentralized Payments?
The main advantages of decentralized payment network over their centralized counterparts are:
1. Cheaper, more transparent, more reliable and less prone to hacks.Although blockchains like Ethereum are usually criticized for their high fees during periods of congestion, traditional bank transfers aren’t much cheaper.
Consider an international transfer from Germany to Brazil. Not only will the users have to pay for the transfer, typically a percentage of the total amount, but they also may need to pay a currency exchange rate from euros to reais. This makes Bitcoin or Ethereum a much more user-friendly option, eliminating any intermediaries from the transfer.
International transfers can also take days to settle. Before the value arrives to the recipient it passes through two or three institutions that normally take three-four business to finish the settlement.As discussed above, blockchains are less prone to hacks, compared to a centralized database.
2. Decentralized payment networks can help bring financial services to millions of people in developing nations. There are billions of people that don’t have access to the global financial system. They are typically referred to as the “unbanked population.” These people used to be excluded from accessing credit, sometimes due to a lack of identification, official documentation or simply geographically distant from a physical bank or credit union.But with the universalization of access to the internet through mobile devices, anyone with a phone can open a Bitcoin or Ethereum wallet and have instant access to money transfers or decentralized finance.
3. Decentralized payment networks give people control of their money.Following the previous point, another entry barrier for the unbanked is the high level of corruption, especially in some developing countries. A combination of weak nation-states, nepotism and lack of trust in the institutions has made it impossible for many citizens to be in control of their money. More importantly, some currencies around the world are collapsing, mostly due to mismanagement by corrupt elites that are solely focused on enriching themselves.Decentralized payment networks allow every user to choose in which currency they want to operate, and networks like Bitcoin and Ethereum are censorship-resistant.This means that nobody can stop another person from opening a wallet and operating with the network.
An example of a decentralized payment network is the Hermez Network, a Layer 2 solution built on top of the Ethereum blockchain. It’s open-source software, censorship-resistant and inherits the security of the Ethereum Layer 1. Hermez enables cheap transfers of money, helping scale Ethereum to serve as a global settlement layer.
Conclusion
The world is rapidly adopting decentralized technology. Governments, central banks and commercial banks are beginning to recognize that the internet and blockchain technologies are empowering people and making third parties increasingly irrelevant.
Soon we will be able to pay for anything from a cup of coffee or a bagel using decentralized payment networks without even realizing. Users won’t even need to have any knowledge of cryptocurrencies, blockchain or any underlying technology, in the same way, that everyone can send an email without knowing anything about POP3 protocols.
New innovations, such as Layer 2 solutions built on top of Ethereum (Hermez Network, zkSync, Optimism…) are actively being developed to scale blockchain technologies, and put them at the service of all of humanity.
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