Connected Blockchains: Embracing Hybrid Solutions
In Part 1, we clarified the distinctions between public and private, permissioned Distributed Ledger Technology (DLT) networks. We found that you only need to focus on two things: choosing the right tool for the use case and ensuring it is interoperable with other systems. Now, we will explore how both types of networks can work together to advance regulated financial markets using DLT.
Caught in a crossfire
The debate between the use of public and permissioned DLT networks has grown without a clear basis, particularly with recent regulatory developments. To progress regulated financial markets through DLT, it’s important to have a shared understanding of the combined potential of both public and permissioned networks. This allows us to leverage the inherent characteristics of each type. For example, the regulatory compliance and inherent security of private, permissioned blockchains and the open accessibility of public ones. On a public chain everyone sees everything, and privacy cannot be built respectively. The industry must move beyond debating which type is superior and focus on how their shared advantages can drive innovation and efficiency. This has become particularly evident due to a recent development.
There is an increasingly widespread acknowledgement of the need for permissioned blockchains when dealing with regulated use-cases, as it mitigates compliance and regulatory risks because participation is limited to known and trusted entities. Despite this, the Basel Committee recently faced opposition regarding its recent proposal. The Basel Committee’s proposal aims to classify permissionless blockchain tokens as high-risk cryptocurrencies. While this seeks to mitigate financial risks, it has sparked opposition from industry bodies.
Those who oppose the proposal argue that public blockchains are essential for developing efficient, scalable tokenized asset markets and that banks can manage the associated risks of these public networks. If tokenized assets are issued, traded, and purchased on separate blockchains, their markets will struggle to grow and become liquid. Critics of the Basel Committee’s proposal likely warned against excluding permissionless public networks considering misunderstandings surrounding how interoperable permissioned blockchains are. They argued that excluding public networks could impede scalability and the expansion of liquid tokenization markets.
However, what these industry bodies failed to acknowledge in their opposition is that interoperability between private, permissioned networks is already being worked into most designs. Unlike public blockchains, permissioned blockchains can be tailored to meet specific regulatory requirements – a crucial factor given the varied regulatory landscapes we operate in. These combined characteristics of interoperability and regulatory compliance make permissioned DLTs powerful in optimizing value flow.
That said, the interoperability challenge predominantly deals with moving value across DLT networks, however, challenges also emerge at the intersection where DLT systems meet existing and traditional markets. Interoperability alone is not sufficient; seamless integration with traditional financial systems is equally vital. Successful integration can enhance operational efficiency, reduce costs, and facilitate smoother transitions for businesses adopting digitization. For instance, integrating DLT with existing banking infrastructure can streamline processes like cross-border payments, ensuring faster and more secure transactions.
Interoperability in action
Interoperability between public and permissioned blockchain technologies has been in swing for a while. The industry shouldn’t worry about picking public or permissioned, nor fear that once this is done, there’s no going back.
Choosing a DLT network should not prevent future interoperability and integration. The ability to leverage interoperability across public, private, permissioned and beyond, strengthens the overall power of digital currency and digital asset networks. An interoperable network opens new opportunities for enterprises and governments to access new markets while maintaining privacy for business, financial, and identity information.
There are several successful industry-leading examples where both public and permissioned networks can work in sync to maximize the benefits of DLT. 2022 showcased the first cross-chain repo swap pilot led by Fnality and HQLAX, and has since paved the way for the settlement of intraday transactions. This initiative proved interoperability across the Fnality Payment System and HQLAX’s Digital Collateral Registry, bridging Corda, as a permissioned blockchain, and Enterprise Ethereum, a public blockchain.
The Fnality and HQLAX pilot demonstrated that cross-chain transactions can be efficiently conducted, bridging public and permissioned blockchains. This enables the recognition and interaction with each other’s data and assets – a critical factor in the wider delivery of a functioning digital asset market. With this, greater shared sovereignty can be unlocked, providing individuals with ownership and control over their data. This in turn extends the mobility and use of collateral for participants across networks.
Another example can be seen in last year’s initiative by ESG1, the sustainability division of award-winning energy blockchain company GuildOne. ESG1 is enabling the seamless creation of transparent, public tokenized assets on Cardano, while leveraging R3’s open, permissioned platform, Corda for regulated management of the entire asset lifecycle.
Both examples demonstrate interoperability across diverse DLT networks, disproving the common belief that permissioned blockchains are ‘closed’. This highlights the importance of developing open, and interconnected financial markets that can scale – a ‘networks of networks’.
At R3, we believe that the future of DLT in regulated financial markets depends on collaboration and the seamless interaction between different types of networks. True liquidity and industry advancement stem from industry-wide cooperation. This involves not only ensuring that all types of DLTs can interact seamlessly with each other and traditional financial infrastructure while adhering to strict regulatory frameworks. Interoperability and integration are key to realizing the full potential of DLT in regulated financial markets.
