Do private blockchains have a point? Let’s ask the Bank of Canada
It's probably more accurate to describe "private blockchains" as "blockchain-inspired systems".
Blockchain has been stylish for a few years now, with many of the world's largest financial institutions and tech companies doing their own experiments and running private, or permissioned, blockchains to see what the technology can offer.
But as tends to happen with fashion, it has started to turn back on itself in a counterculture way as people increasingly ask whether permissioned blockchains serve a purpose or if they're just glorified buzzywordy databases.
The permissioned blockchain
"I see no evidence of a convergence between public and private blockchains. Instead, I see non-adoption of private blockchains, because the model is not a good fit for most businesses," said Cornell professor and widely-respected blockchain guy Emin Gün Sirer. Many others share the same sentiment.
- Public blockchains: These are decentralised distributed ledgers that are publicly accessibly by anyone and aim to theoretically be beyond the control of any single entity. Examples include bitcoin and Ethereum. The general consensus among industry experts is that these types of ledger are conceptually the bee's knees, but still need to overcome many challenges.
- Private blockchains: These are private blockchains which are controlled by a single entity that decides what can and can't go on the ledger, who's allowed to access it and generally has total control over it. Examples include most of the blockchain tests going on behind the scenes of banks and other financial institutions around the world. Industry experts are increasingly sceptical of whether they serve a purpose beyond the buzzwords, but it's still a contentious issue.
As the thinking goes, there's functionally no difference between a private blockchain and any other centrally controlled database. A newly developed so-called private blockchain might be a thousand times better than a legacy system, but it's still just another database and will not necessarily be the ideal solution to the business problem at hand.
"Institutions and individuals should be evaluating permissioned blockchains like any other technology: it isn't magic, and it should be assessed like one would assess any other. The benefits of a technology should never be assumed based on buzzwords, hype or fear that 'everyone else is doing it so why shouldn't I?'," writes former EY blockchain consultant Angus Champion de Crespigny.
"Instead, benefits should be assessed by asking what is the business problem, what are the different technology options available, and what are the quantifiable costs and benefits of each. There is no reason why an institution should change its technology selection approach for the sole purpose of blockchain projects: they need to be discerning and choose the technology that can demonstrably solve the problem for the lowest cost."
Fortuitously, that's exactly what the Bank of Canada has been doing for the last two years with Project Jasper (PDF), a rigorous study of whether it can benefit from the use of a permissioned blockchain. The study was completed recently and the report published on 22 October.
Right now it might be one of the best places to find answers to the future, or possibly lack thereof, of permissioned blockchains.
Project Jasper in brief
Project Jasper was a study of whether a permissioned distributed ledger technology (DLT, or "the blockchain") system could improve the CDSX (PDF), Canada's current clearing and settlement system for debt and equity securities, since 2003.
That DLT could be cool, specifically in respect to:
- Technical efficiencies: Reducing the technical frictions that exist in current market infrastructure silos, "resulting in better and more efficient securities and cash interactions among participants".
- Operational efficiencies: Using shared processing conditions and a shared network to reduce the costs involved in making and finalising transactions.
- Cash and collateral efficiencies: New opportunities to consolidate and optimise collateral requirements between large-value interbank payments and securities settlement systems.
The study employed the following steps:
- Build a blockchain. Specifically, a Corda R3-based system.
- Take that bad boy for a spin. Or more accurately, tens of thousands of spins over eight weeks to simulate a series of transactions which replicate potential real-world use of this kind of system.
The conclusions in respect to each of the three hypotheses were maybe, maybe and maybe. Project Jasper stakeholders subsequently made genial and cautiously optimistic statements regarding the findings, stressing the need for further research.
The detailed version
A deeper dive finds a number of interesting points, which highlight some points on both sides of the "are permissioned DLTs useful?" debate.
The gist might be that a permissioned blockchain can unlock a lot of benefits relative to existing systems, but:
- Suitably advanced and functional public blockchains will generally still be better down the line.
- There's nothing inherently "blockchainy" about permissioned DLTs. Rather, it's more like a standard distributed network that includes features inspired by elements of blockchain and cryptocurrency, such as asset tokenisation and the cutting out of traditional intermediaries.
As such, in the long run it looks like the success of private blockchains is dependent on public blockchains never satisfactorily overcoming limitations like scaling or centralisation problems. Then they can serve as useful closed systems for managing tokenised assets in a way that's compatible with public blockchains. The tokenised assets themselves might then be moving between public and private blockchains more seamlessly as needed.
In the long run private blockchains might be something of an evolutionary stepping stone. But in the absence of clear definitions, most arguments around permissioned blockchains are still largely semantic.
Right now it might be more accurate to describe permissioned blockchains as "blockchain-inspired systems". That blockchain inspiration brings some undeniable benefits though.
Asset tokenisation offers benefits on permissioned ledgers
Using tokenised variations of both securities and cash proved potentially useful, the report says. The advantage was found by letting any appropriately authorised parties directly interact with the tokens, in ways appropriate to their permissions.
Essentially, by programming digital versions of assets in line with the rules established by the DLT system itself, you have a system that can set and automatically enforce the rules for trading almost anything. This can then take place all in one neutral place, on the permissioned blockchain itself, rather than relying on different entities to make inputs and enforce rules from their own separate systems.
"Tokenization of both cash and equities on a shared ledger resulted in better asset interactions... relative to the currently siloed... systems, whereby any participant or function can directly interact with the assets on-ledger."
Asset tokenisation as a concept offers potential opportunities to further streamline future implementations in a way that moves beyond the current bounds of technology, the report says, and it "merits further exploration". The key to unlocking this benefit might be to expand the scope of a DLT system to include multiple assets, it observes.
Immediate finality and re-use of cash and equity tokens
Efficiency could be improved through the use of a system that offers real-time finality of settlements, which then lets participants instantly re-use cash and equity tokens. In this way, the benefits of tokenisation coupled with blockchain-inspired finality of consensus, which in Project Jasper just meant a notary node stamping transactions, can theoretically improve liquidity efficiency with minimal downsides.
The current system also improves liquidity, but it does so with a system of market participants pledging collateral and being issued credit, which is then settled daily. The current system therefore adds new credit risks and inefficiencies in the form of another party to lend the money.
It might be nice to eliminate an unnecessary cost and risk factor with blockchain-inspired systems, but cutting out the lending element would require a more complete overhaul of the existing system, which wouldn't necessarily go down well with the stakeholders who currently profit from it and whose approval might be required for the overhaul to go ahead.
This starts drifting beyond the scope of Project Jasper.
Basically, the study asked whether there are benefits to immediate finality of settlements, but the question was answered with a new question: Is it safe, reasonable and feasible to start modifying the role of collateral, credit and the central counterparties?
This is an entirely different question which has yet to be answered and will call for more exploration in its own right. Perhaps the most effective option is to use a blockchain-inspired system to facilitate the central counterparty lending process rather than go for immediate finality and reuse of cash and equity tokens?
Blockchain-inspired permissioned ledgers can offer theoretical improvements, but actually using them is complicated by legacy systems and real-world factors.
Integration with external ledgers, either centralised or decentralised
"DLT enables an easier step forward by permitting a loose coupling of two separately governed systems without compromising the control of either authority over its system or assets. By issuing tokens using a DLT system, central bank-backed cash digital depository receipts can be used for settling securities transactions in the POC environment without the further involvement of the central bank in verifying each transaction," the report says.
"By providing the appropriate assurance to the issuer that contracts on the DLT platform are well defined, the central bank can feel more comfortable that this 'token in the wild' can be used safely in a decentralized environment outside the boundaries of the RTGS (the current interbank settlement system) to settle multiple asset types, make payments, etc."
Is it worth using a blockchain-inspired permissioned DLT system?
It probably makes sense to stop futzing with blockchain-inspired solutions and start thinking about using actual blockchain solutions, the report says. It can bring the same benefits and more, and allows for the incorporation of a much wider range of assets across a much wider range of markets.
"Overall, a more ambitious re-imagining of clearing and settlement in a decentralised form, guided by market pain points in the settlement life cycle, would also create a more informed premise for benefits assessment," it says.
"Our overall concluding hypothesis is that, while DLT still shows promise in terms of its ability to deliver efficiency improvements, a significant expansion of the scope of coverage of the ledger to include additional assets and the full trade and post-trade life cycle may be required to realize these benefits."
Blockchain-inspired systems can provide a lot of benefits over legacy systems, but real-world factors will often make their actual implementation problematic and in many cases there won't necessarily be a good business case for them even if they are objectively better than the legacy systems.
Overall the future of permissioned blockchains, that is to say "blockchain-inspired DLT systems", might be a bit dubious in the long run. The best permissioned systems in the end will just be inspired by the good parts of blockchain thinking and dispose of the downsides where possible.
For now, "private blockchain theatre" is probably as good a description as any.
Disclosure: At the time of writing the author holds ETH, IOTA, ICX, VET, XLM, BTC, ADA
- Bitcoin is gearing up for something big, as record amounts of BTC leave exchanges
- Ethereum price crashes as so-called killers continue to muster investor support
- Ethereum price moving upward again amidst growing NFT mania
- Bitcoin price in recovery mode ahead of tomorrow’s AUD$1.1 billion options expiry
- Bitcoin price reaching AUD$70,000 in the near term looking likely, experts suggest