I was recently asked by someone: what are short arguments as to why permissioned blockchains are preferable than public ones for regulated financial services companies?
There are multiple reasons why permissioned blockchain are currently more appropriate than public ones specifically for regulated financial companies:
- Governance: public blockchains are designed around being censorship-resistant which makes the ability to change, enhance or upgrade the network difficult to do (e.g., as shown by the current block size debate). “An Act of Congress” is the inside joke on how difficult it is supposed to be to make major changes to fully decentralized blockchains. In contrast, permissioned chains are usually built with a known, agreed upon governance structure with explicit decision making processes. One trade-off comes with reduced censorship-resistance. See Appendix A for more.
- Most public blockchains were intentionally not designed around the needs of regulated financial institutions, quite the contrary: many were designed with the goal of circumventing institutions and regulatory bodies. As a consequence, they likely cannot in their current form fulfill the functional and non-functional requirements that large regulated financial institutions need in order to operate. And in order to modify an existing public blockchain to do so, you typically end up breaking their core utility (censorship resistance)
- Financial institutions need to know who they are dealing with, who their counterparties, customers and staff members are. As a result, architects building systems for financial institutions have a different set of design assumptions than those programmers designing public blockchains. In short: participation and validation on a permissioned blockchain involves known, trusted parties that are legally obligated to perform certain tasks. In contrast, participation and validation on public blockchains is assumed to involve, unknown and untrusted parties hence the reason for proof-of-work. If financial institutions are already working with trusted parties, then design features found in public blockchains — like proof-of-work — effectively are very expensive dice rolling machines, they provide no real utility other than to generate random numbers. And to compound this issue, due to AML / KYC / KYCC regulations for financial institutions in many countries, payment service providers (which effectively what “mining pools” are) potentially requires KYC of the mining pool. If you know the identities of all the pools then you are no longer operating an unknown network, the design assumptions change.
- Who are you going to call when something goes wrong with a transaction? For instance, in the traditional financial world, institutions and organization create and sign service-level agreements with service providers: contracts with specific guarantees and conditions — along with clauses for when something goes wrong (e.g., customer service reqs). In a permissioned blockchain ecosystem, this tradition will continue because mistakes will be made and will need to be fixed. In contrast, when something goes wrong or is broken on a public blockchain, you are probably out of luck unless you know some mining pool operators.
- Sustainability. Because public blockchains are effectively unowned, then you end up recreating a ‘tragedy of the commons’ in which no one wants to pay but everyone wants to use. We see this with the Bitcoin network, where no one wants to pay (higher) fees to use the network and no one wants to pay developers to enhance the network. As a consequence, there are now over 100 dead altcoins because their was no incentive to maintain the network — the commons collapsed as it was no long sustainable to operate via charity and altruism. In contrast, permissioned blockchains are closer to owning private property: a set of stakeholders have a direct incentive to maintain the network through business and commercial incentives. This is not to say that either Bitcoin or Ethereum will collapse tomorrow, but the longevity of a public blockchain is an open question.
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