Pledging the ledger: At the tipping point of blockchain networks that work together

Interest in distributed ledger technology (DLT) is gaining momentum, sparking lively debates among proponents and detractors. The key question is: which version of DLT is suitable for advancing financial markets—public/permissionless or private/permissioned networks? Stefano Dallavalle, head of product—digital assets at R3, provides the answer.

Until recently, it had become common for market participants to choose between the two versions of DLT. However, the emergence of reliable, open interoperability protocols—buoyed by regulatory initiatives—is now challenging that assumption.

Permissioned versus permissionless

The hype surrounding DLT stems from its ability to enable transparent, secure and efficient peer-to-peer transactions through cryptographic techniques, and its capacity to support the full transfer of ownership of digital-native assets. Blockchains are one type of DLT, but all are essentially decentralized databases that provide a secure way to record and conduct digital asset transfers. This technology promises to optimize data management and asset transfers, modernizing entire markets by streamlining processes, improving risk management and reducing costs.

Public blockchains, such as the Ethereum Mainnet, are permissionless, open networks accessible to anyone. These networks emphasize decentralization, transparency and censorship resistance, making them attractive for use-cases where trust or openness are paramount. Public blockchains have driven innovation, but they also present challenges, particularly for firms in regulated industries. The lack of control over who can participate, and the inherent pseudo-anonymity of these networks, can create security risks and complicate adherence with compliance requirements.

Private DLTs, better thought of as “permissioned” networks, are controlled by designated entities and only allow participation by approved users. These networks sacrifice some degree of decentralization to provide enhanced privacy, scalability and data control. Such networks are well suited for enterprises in regulated markets, where knowing who you are transacting with, and the ability to show compliance with strict legal and regulatory requirements, are critical. Furthermore, permissioned DLTs are typically designed to ensure data is only distributed among those with a need to know, something that often requires additional layers of technology to achieve in a permissionless setting. The public versus private blockchain debate often frames these approaches as mutually exclusive, as though businesses that choose one type of network must resign themselves to never interacting with a network of another type. However, this is simply untrue.

An increasing number of permissioned networks are being built on top of public/permissionless layer-one networks like Ethereum. Furthermore, new interoperability protocols are further challenging this dichotomy by allowing public and private blockchains to work together seamlessly.

The value of interoperability

Interoperability is key to unlocking the full potential of DLT. It enables networks—whether public or private, permissioned or permissionless—to communicate and interact with each other, allowing businesses to leverage the strengths of each type while mitigating their weaknesses. Rather than being forced into a one-size-fits-all solution, firms can use the right tool for the job and retain the ability to connect with other networks as their needs evolve.

SIX Digital Exchange (SDX), the world’s first fully regulated digital exchange and central securities depository (CSD), provides a compelling example of interoperability in action. SDX’s CSD is on a permissioned ledger network. Last year, SDX and Aktionariat demonstrated that shares issued on the Ethereum blockchain could be transformed from public ledger-based securities into intermediated, bankable securities on SDX’s regulated platform.

Interoperability is crucial for regulated markets because it allows businesses to leverage the efficiencies of both permissioned and permissionless networks without being constrained by the limitations of a single blockchain. This promotes operational efficiency and industry collaboration while providing firms with the flexibility to adapt to future business needs, technological advancements or regulatory changes as needed.

Regulation’s crucial role

Regulation plays a complementary role in ensuring DLT-based networks and applications operate safely and effectively within the broader financial system. After all, financial regulation provides a necessary framework for promoting innovation within clear parameters, while protecting consumers and preserving market integrity.

Luckily, the DLT industry is widely cognizant of this need and is already working alongside regulators to develop secure, scalable, interoperable DLT solutions. Initiatives such as the UK’s Digital Securities Sandbox and Harmonia, a Hyperledger Lab, now a part of LF Decentralized Trust, exemplify this collaborative approach.

Sandboxes provide an opportunity for regulators and industry participants to collaboratively explore how existing securities trading and settlement regimes might apply to or be adapted to fit new technologies. Meanwhile, Harmonia is promoting public-private sector cooperation, bringing together technology firms, financial institutions and regulators to develop interoperability protocols for regulated financial DLT networks.

By working with regulators and incorporating industry insights, such initiatives are creating standardized protocols that will support settlement across blockchain networks, protecting future markets from potential silos or vendor lock-in, and mitigating the risk of fragmentation of value and liquidity across multiple disparate networks. Regulatory oversight further mitigates these risks while giving confidence to firms that implement this technology, creating a safe, competitive environment for innovation to thrive, and ensuring the financial system can keep up with the rapid pace of digital evolution.

A unified financial ecosystem

The future of DLT lies not in the black-and-white choice between permissioned or permissionless networks, but in interoperability and regulation. Rather than viewing these technologies as competing paradigms, the industry should recognize that each has its respective use-cases and their value is best realized when they are designed to work together. Both have their place in building a future-proof financial system, as the Bank of International Settlements (BIS) has also argued with its proposal for “the Finternet”.

The need for regulation and interoperability solutions will only intensify as the digital finance landscape evolves. A World Economic Forum survey predicts that 10% of global GDP could be stored on blockchain technology by 2027, underscoring the urgency of addressing these challenges.

Those who successfully integrate interoperability and regulation into their blockchain strategies will be best positioned to thrive in the new era of digital finance.

Sponsored content