The world of DeFi (decentralized finance) has a good deal of competition. Bitcoin is the world's first programmable money, but other projects sought to make it even easier to program blockchain assets. The first was Ethereum, whose goal was to give developers an easier way to create applications that ran atop a decentralized blockchain.
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This allowed people in search of loans or greater yields to circumnavigate banks and institutions that charged large fees and required proof of identification. Now, individuals can use DeFi to have a unit of account, means of trade, loans and more without the need or approval of a third party.
One of the largest competitors to rise out of the DeFi space is the Binance Smart Chain (BSC). But what is BSC and how does it work?
- Binance (BNB) is one of the worlds leading crypto exchanges.
- The Binance exchange launched the Binance Coin in 2017 as an ERC-20 token on the Ethereum blockchain. It was a utility token that allowed users of the exchange to pay less in fees if they used the token for transactions.
- Binance Coin was then moved to the Binance Smart Chain when it was released in September of 2020.
- The Binance Smart Chain is a smart contract-enabled blockchain network created with the goal of creating a decentralized financial (DeFi) ecosystem.
- The Binance Smart Chain operates using a Proof-of-Authority consensus mechanism.
- This system has 21 validators that all need to be approved by the Binance exchange, giving them full control.
- The founder of Binance, Changpeng Zhao, once called the Binance Smart Chain CeFi (centralized finance), or CeDeFi, in a since-deleted tweet.
- The centralization of the Binance Smart Chain goes against the typical ethos of the cryptocurrency space.
- Given the control that the Binance exchange has over the Binance Smart Chain, it's hard to distinguish assets issued on it from securities, including BNB.
What is Binance?
Binance is a cryptocurrency trading exchange founded by Changpeng Zhao. The company was initially based in China but relocated to the Cayman Islands after increased Chinese regulation threatened its business.
Binance quickly became one of, if not the largest crypto trading platforms in the world with its extensive list of trading pairs and relatively low fees compared to competitors.
What is Binance Coin?
In 2017 Binance launched its Binance Coin (BNB) as an ERC-20 token on Ethereum with an initial coin offering (ICO). The company offered 10% of the supply to angel investors, 40% of the supply to the founding team and the remaining supply to the public.
The coin is used as a utility token for the Binance exchange and allows users to pay for transactions and trading fees at a lower rate than they would be with other tokens.
Binance uses the process of token "burns," meaning they use the profit from token sales to repurchase more BNB and then burn (destroy) them.
The token then transitioned off of the Ethereum network to a new native chain in 2019. They were then moved again after the announcement of the Binance Smart Chain.
Binance Smart Chain
In September of 2020, Binance announced its new DeFi platform, BSC, which was later launched in April. Its purpose was to offer an alternative to Ethereum and other leading DeFi platforms.
Over time Ethereum grew past what its infrastructure could even handle, causing congestion, slow transactions and fees so high that sending anything under $100 was borderline impossible unless timed perfectly.
This led to the rise of other smart contract platforms like BSC, which rapidly grew as Etheruem couldn't provide a viable platform for those that couldn't afford the fees.
Today, BSC has $26 billion in total value locked in the various applications that run on the platform. But what is BSC and how does it compare to others like Ethereum?
Binance Smart Chain vs. Ethereum
Binance has made huge strides in catching up with Ethereum in terms of trading volume. They also both have extremely similar applications built on top of them like decentralized exchanges and lending and borrowing platforms. But they operate on two vastly different consensus mechanisms.
A consensus mechanism is a system that allows nodes (participants) in a distributed computer system (blockchain) to reach a "consensus" about the correct set of data (transactions). This is what gives blockchain networks their security and allows the participants to verify the authenticity of transactions without needing to trust each other.
Different blockchains have different ways of forming this consensus. Ethereum currently uses a mechanism known as Proof-of-Work (PoW), the original consensus mechanism used by Bitcoin. Binance, on the other hand, uses a method called Proof-of-Authority (PoA).
In PoA, the block creators are known as validators. These validators, of which there are only 21, are pre-approved and chosen by Binance, as explained by Binance's own website.
To be approved, they must confirm their real identities, invest money to prove long-term commitment and be equal to all other candidates, making PoA reputation-based by design.
In this model, Binance has absolute control over the blockchain. They decide who becomes a validator and they remove validators at their discretion. This requires the users must trust that Binance will behave in their best interest. Should Binance decide to alter any aspects of the chain or ecosystem, it has the power to do so.
The founder and CEO of Binance, Changpeng Zhao, famously said that BSC is like "CeDeFI," or centralized DeFi. The tweet where he made these comments has since been deleted, but according to BSC's founder, it is not a decentralized financial application ecosystem.
In the thread that stemmed from Zhao's tweet, he said that the benefits from such centralized control are that Binance itself can vet projects built on the system, but more than one project has already "rug pulled" investors.
Currently, Ethereum uses the same PoW mechanism that Bitcoin does. In this system, computers compete with one another to validate transactions. To win, the computer must solve complex mathematical puzzles.
Once they've won, the computer adds a new block of transactions to the blockchain. These computers are also known as miners and they are given Ethereum for completing a new block of transactions. This process is energy-intensive and helps to secure the network from bad actors.
This process is very energy-intensive and helps to secure the network. Enough miners geographically distributed makes for a decentralized network without a central authority, which is drastically different than how the BSC operates.
Ethereum is in the process of moving over to a new consensus model known as proof-of-stake (PoS) in an effort to reduce fees. In this model, consensus is reached by using an algorithm that chooses a node to win a block of transactions. When a node is chosen, it produces the next block of transactions in the chain. These nodes are generally referred to as stake pools.
These stake pools are chosen based on the "stake," or the number of coins it holds. In other words, the more coins a stake pool holds, the more likely it is to be chosen to produce a block and get rewards. To ensure that the wealthiest pools do not always win a degree of randomization and other criteria, like the amount of time coins have been staked, can factor into the selection process.
So, in PoS, miners are replaced with people who stake their coins. Individuals can "stake" or place their coins with various stake pools, just like miners joining a mining pool to earn more rewards. Unlike PoA, stake pools and nodes in the PoS model are not approved or chosen by any central authority, making it far more decentralized.
Is Binance Coin a Good Investment?
Evaulating crypto-assets for their quality as an investment opportunity can be a tough exercise. With something like Bitcoin or even Ethereum, it is easier to place value when analyzing their decentralization.
Bitcoin, for example, has a high quantity of geographically distributed nodes and miners and has survived over 11 years of ups and downs. With Bitcoin, you can know with a high degree of certainty that no sole company, government or individual has control. Instead, the collective of its users determines its future, meaning that a free and open market only determines its price.
While Ethereum has half as many nodes as Bitcoin does, it is still orders of magnitude more distributed than Binance Coin. This is due to its PoA model that gives the Binance exchange full control.
But why does this matter? Binance has lower fees than Ethereum and it's faster, right? Who cares if it is centralized?
Every individual's answer to these questions depends on their reason for investing in the first place. Do you wish to speculate on a cryptocurrency? Or are you interested in a decentralized ecosystem that solves real-world problems?
The problems that cryptocurrency, specifically Bitcoin, aims to solve are related to control and freedom, not just making money on speculation.
Who should control money and its supply? Should one company or government make the rules for the rest of us? Who decides who is allowed to get access to the financial system?
These are all serious questions that humanity has faced for nearly its whole existence. So far, the result of giving one single entity control over money has proven to be less than ideal. It causes currency debasement and inflation, disenfranchisement of certain communities who don't meet the made-up prerequisites and far more.
If you are interested in speculation and trying to make money, perhaps Binance Coin could be an opportunity as more and more leave Ethereum to search for cheaper transactions. If you are interested in building systems without central control, then an investment in Binance Coin would be ironic to that cause.
With the level of control the Binance exchange has in the PoA model, assets issued on it seem far closer to securities than anything else. It is unlike many other chains where nodes, miners, validators and stake pools are ungoverned by the chain's creators. With this structure, there could even be cause for regulatory concern.
To be fair, there is nothing wrong with making speculative investments. Cryptocurrency itself is widely considered speculative in general due to its reformative nature. That's why it can help to understand why cryptocurrency exists in the first place — to give economic empowerment and self-sovereignty to individuals and to remove the control from the hands of the few and give it back to the people, and Binance Coin is the direct opposite.