Will Centralized Institutions Cease to Exist in a Web3 World?

The major difference between Web3 and Web2 is decentralization—there is no need for a third party to sit between conversations or transactions.

A social network shouldn’t need to own or inspect your data, a company shouldn’t need to sit between a payer and a payee.

Aside from trust and privacy, centralized trusted third parties also represent a single point of failure — a company can fail overnight — and you also need to rely on their security measures, which are themselves costly endeavors.

If Web3 pays off, none of these middlemen need to exist — there will be a world of trustless transactions executed on decentralized blockchain networks.

But is there still a role for trusted third parties such as regulated decentralized exchanges and trusted custodians in Web3?

Table of Contents Table of Contents

1. Key Takeaways
2. Regulating Trusted Third Parties is Key
3. The Trade-off in Removing Trusted Third Parties
4. The Bottom Line
5. References

Show Full Guide

Table of Contents

1. Key Takeaways
2. Regulating Trusted Third Parties is Key
3. The Trade-off in Removing Trusted Third Parties
Show Full Guide
4. The Bottom Line
5. References

It was a topic of discussion at the Blockchain International Scientific Conference in Singapore, held towards the end of April.

Shawn Lim, Head of APAC at Axelar Network, which is developing a decentralized interoperability protocol, said:

“How Satoshi Nakamoto came out with the Bitcoin idea is that, post Global Financial Crisis, there was a lot of concern about trusted parties and intermediaries

“If you talk to my Greek friends, during the Greek crisis, they weren’t able to withdraw their money from the bank.

“There is a need for new technologies to come up. That’s what blockchain technologies and companies are trying to solve. How can you create a potential trusted state of implementation of the different blockchains?

“Are we there yet? I don’t think so, because as much as a lot of well-meaning blockchain companies, we try to decentralize, there are a whole lot of bad actors still in this space.”

Arthit Sriumporn, CEO of qualified digital asset custodian, Rakkar Digital, added:

“Bridging from Web2 to Web3, immediately Web3 people are going to look for the same setup that they’re familiar with: segregation of control, security, compliance, risk, governance, these are important and in Web3 we are in a very early stage.”

“A trusted third party is very important for trust and credibility. You need to have that in the ecosystem. Proper due diligence between the players and risk assessment is very important.

“We need to be able to assess their process, something like zero trust, something like no single point of failure — all these things are not proven by certificate, it’s actually proven by what they’re doing.”

Sriumporn said it is important for developers and firms in the Web3 space to build a credible ecosystem to encourage financial institutions to deploy in the space.

Regulating Trusted Third Parties is Key

The panelists noted that the largest trusted third party that failed in recent years was the FTX centralized exchange. Cryptocurrency investors and traders trusted FTX to hold their funds, but the company did not follow practices that would protect those funds, such as segregating its services.

“What is the bridge that’s required to prevent some of these trusted parties from failing? From our perspective, it’s really the regulatory framework—do we have the right policies in place to ensure the segregation of funds,” said Alvin Chia, Senior Vice President, Head of Digital Assets Innovations (APAC) at Northern Trust.

Chia noted that in the case of FTX, Japan’s regulatory framework that requires segregation of funds protected Japanese investors from suffering losses.

“But in the rest of the world, we haven’t seen this policy in place previously, hence it gave these bad actors the opportunity to exploit these holes and gaps.”

“So we do believe that this trusted third party it’s there for a reason, but we need the right policies to legislate and manage them so that will allow us to transition from the Web2 world into Web 3,” Chia added.

Lim added: “We need to distinguish between crypto blockchain companies versus centralized financial institutions like FTX.

“If you look at what happened with FTX, it actually didn’t cause any mayhem in the decentralized finance space.

The DeFi space continued to participate and work properly at that point versus what happened in the centralized space.”

The Trade-off in Removing Trusted Third Parties

Regulated DEXs and trusted custodians operate hybrid “centralized decentralized” models that require them to be licensed and protect customer funds.

Custodians store customers’ credentials in secure vaults and limit access even among their own personnel. Centralized providers are then offering decentralized services to institutions, which trust them to deliver managed solutions that they can package to their clients.

But these providers can design their systems in a way that aims to reduce the dependence on trusted third parties in their services, said Jag Foo, Head of Business Development at Safeheron, which provides a self-custody service platform for institutions.

“For instance, if an institution looks to recover clients’ private keys, they could access a provider’s open-source coding and “redesign the process where they can recover the private key in a way that’s fully permissionless,” Foo said.

“So they don’t need to depend on us or on any third party; they can do it themselves.”

Similarly, multi-party computation (MPC) solutions for individual cryptocurrency wallet users are emerging that allow them to recover their private keys from copies stored locally on their own devices.

As the keys are not stored on cloud servers, users do not need to depend on a third party to recover their assets, but they must be able to safely manage the copy to avoid it becoming compromised and be able to restore it when needed.

“This is always the trade-off — nothing is perfect in this world,” Foo said.

The Bottom Line

Blockchain developers and Web3 firms aim to eliminate trusted third parties to achieve true decentralization.

However as adoption increases among institutions, there is still a role for centralized service providers to offer a form of managed decentralization on their behalf.

For example, one of the challenges to the widespread adoption of cryptocurrencies and tokens has been the difficulty for novice users to manage their private keys, which are unrecoverable without a third-party solution.

As service providers attempt to decentralize, there is a trade-off in reducing dependence on third parties and leaving users without adequate support.

So with the adoption of blockchain technologies and crypto assets expanding with the rollout of Web3, the role of trusted third parties in a decentralized ecosystem will remain a subject of debate.