The private vs. public blockchain debate gets it wrong
If traditional finance wants to be serious about using blockchain, going the private blockchain route won’t bring the success some think it will
Vittorio Caramazza/Shutterstock modified by Blockworks
At the American Bankers Association event this June, the acting head of the US Office of the Controller of the Currency acknowledged blockchain technology’s promise to improve settlement through tokenization of real-world assets, citing it could reduce costs up to 65 percent.
The catch? Secure and scalable asset tokenization “is not possible with a public blockchain.”
Prefacing his argument, acting head Michael Hsu said he had to “discuss crypto.” The self-proclaimed crypto skeptic then went on to list the industry’s failures — including losses exceeding $5 billion in 2022 just from frauds, hacks and scams — which in his eyes, means that crypto “remains immature and rife with risks.”
Sure, there are many losses and collapses in the public blockchain space — Terra and FTX as two outsized examples — but the same could be said regarding any nascent technology. And it’s an oversimplification to conflate flaws in infrastructure (the underlying blockchain technology) with the failings of its use cases (the applications it supports).
Plus, the biggest crypto failings come from operations and use — these are mostly human failings, not technological. And, aside from the United States, regulators are quickly passing legislation to prevent such failures from happening.
But according to Hsu, the flaw of the public blockchain is “trustlessness,” which requires the technology to have a decentralized consensus mechanism such as proof-of-work or proof-of-stake.
Hsu’s argument goes something like this: The problem with public blockchains and decentralization is that it’s impossible to achieve institutional-grade security at scale without “tokenomics” and highly technical workarounds, so we should instead turn to centrally operated, trusted blockchains. These blockchains purportedly don’t require as much critical calculation, innovation or game theory to function.
Now, this is mostly a convenience and efficiency argument, but he claims that “trusted blockchains” — private blockchains or consortium — are “easily permissioned, making full compliance with [anti-money laundering] rules achievable” and capable of deterring illicit finance.
Here’s where Hsu’s argument is incorrect: Asset tokenization shouldn’t require a private blockchain, but rather one that’s permissioned — this is what will protect against threats to security and compliance while preserving the benefits of decentralization and transparency. Most people are only aware of public permissionless and private permissioned blockchains, hence “private” gets equated with “permissioned.”
It’s time for “public permissioned” to take the spotlight.
A public permissioned blockchain is a public network — one that’s decentralized, open source and visible to anyone — but gated with a control layer. This control layer protects the network, only allowing authorized users to access certain roles and functionality while prohibiting others as per a predefined set of rules.
The permission layer involves identity and authorization as a minimum entry prerequisite. Depending on the exact criteria, this can be used to ensure there’s a known identity behind network participants, a common requirement in many regulated markets.
Permissioned validators (nodes that validate transactions on the chain) can also alleviate worries that the entities operating the network aren’t incentivized to compromise consensus or fund sanctioned groups. An added bonus of publicly-known validators is extra security from the “reputational risk” they face in addition to the economic risk.
Read more from our opinion section: Blockchain can save the media
Permissioned blockchains make sense for financial markets that want to benefit from blockchain infrastructure to improve operations and efficiency. Public permissioned blockchains make sense for financial markets that want the above along with minimized trust and transparent governance.
Once the companies in these markets have this blockchain infrastructure, they can use it to on-ramp to decentralized finance (DeFi) and access other digital native ecosystems while maintaining compliance. The identification process required to access the network provides confidence to institutions that they can fulfill know-your-customer and anti-money laundering obligations and that the entities they’ll interact with aren’t blacklisted, facing sanctions or engaging in terrorist financing.
It’s not whether a blockchain is public or private that will prevent illicit finance, non-compliance, network vulnerability or hardware failure. It’s whether it’s permissioned or not.
With a private permissioned blockchain, you have to fully trust the network operators (and perhaps an all-seeing, all-knowing notary node), and this raises huge problems for institutions transacting in trillions of dollars. With a public permissioned blockchain, everyone on Earth can agree on the state of the network, and necessary regulations can still be easily followed.
That’s the whole point of institutional DeFi — that financial institutions don’t need to rely on something so emotional or elusive as “trust” to deliver security. And this promise is materialized with the public permissioned blockchain, which shows that secure and scalable asset tokenization is, in fact, possible on a public network.
At the same time as Hsu’s negative comments around public blockchains, BlackRock, the largest asset manager in the world, has filed for a spot bitcoin ETF. Many in the industry suspect it will be approved by the SEC. If the world’s largest asset manager is confident enough to put its name on a public blockchain financial product, this may be a watershed moment for the public perception of this entire space — public blockchains and all.
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