Named after Satoshi Nakamoto, the pseudonymous creator of Bitcoin, the coefficient is a metric used to measure the decentralization of a blockchain network. It calculates the minimum number of entities (such as miners, validators, or nodes) that need to collude to disrupt the system or control a certain aspect of it, such as consensus, governance, or control of network resources. In essence, the higher the Nakamoto coefficient, the more decentralized and secure the network is against attacks or centralization of power. A low coefficient, on the other hand, means the network is more centralized and potentially vulnerable to control by a small group of entities.
Let’s understand it with some examples of good ones and fraudulent ones.
The Nakamoto Coefficient for Solana?
For those unaware of Solana, as of September 2024, the coin is ranked number 5 in terms of crypto currency market cap, and it operates on a Proof of History (PoH) and Proof of Stake (PoS) hybrid consensus mechanism. The Nakamoto coefficient for Solana measures the number of validators that need to be compromised or collude to halt or manipulate the network.
As of 2023, Solana has a Nakamoto coefficient around 20 to 30, meaning 20 to 30 of the largest validators control enough stake to potentially manipulate consensus. This is relatively higher compared to some other blockchains, but still presents a centralization risk, especially given Solana’s goal of high-speed, low-cost transactions.
The Nakamoto Coefficient for Squid Game Token (a currency that experienced a Rug Pull)?
A rug pull occurs when the developers of a project or key figures drain liquidity from the project’s token or assets, leaving investors with worthless tokens. These incidents often occur in projects that are highly centralized, where one or very few people have control over the funds or governance of the network.
For example, Squid Game Token, a notorious rug pull, had an extremely low Nakamoto coefficient. The entire project was controlled by a small group of developers who had the power to manipulate and siphon off liquidity from investors. With a near-zero Nakamoto coefficient, Squid Game Token was highly centralized, making it easy for the rug pull to occur.
In projects like these, the lack of decentralization (e.g., single wallet control over liquidity) directly leads to a higher likelihood of fraud and exploitation.
Another Rug Pull Example: Thodex
Thodex, a Turkish cryptocurrency exchange, shut down operations in 2021 and disappeared with approximately $2 billion worth of user funds. In this case, the Nakamoto coefficient could also be considered zero, as a single entity (the CEO) had complete control over the exchange and the funds, demonstrating an extreme lack of decentralization and oversight.
The lesson from Thodex and other similar cases is that platforms or projects with centralized control are at high risk for misconduct. Decentralization, measured by the Nakamoto coefficient, can significantly reduce these risks by distributing control across a broader group of entities.
Where Can You Learn More About the Nakamoto Coefficient and How to Calculate It?
To learn more about the Nakamoto coefficient and assess it for different cryptocurrencies, you can refer to blockchain analytics platforms, whitepapers, and community forums. Sites like Messari and CoinMetrics often provide detailed analyses on decentralization metrics, including the Nakamoto coefficient for major cryptocurrencies.
When assessing a coin, consider the number of validators or miners, the governance structure, and the control over resources like token supply or staking. A safe Nakamoto coefficient varies depending on the blockchain’s goals, but in general, a coefficient of 50 or more indicates good decentralization. For emerging projects, anything below 10 could suggest a centralization risk, and investors should exercise caution.
Monitoring the Nakamoto coefficient, you can better understand the resilience of a blockchain against potential attacks and the overall security of your investments.