In 2014, databases operating on the blockchain technology started gaining popularity in the financial sector. Banks began to develop concepts and prototypes using this technology. For example, the NASDAQ stock exchange plans to use the Open Assets Protocol based on colored coins to ensure a full control cycle over the customers’ valuable securities.
The largest French BNP Paribas bank is now exploring the possibility of introducing Bitcoin into its currency system. Australian banks like Commonwealth Bank of Australia (CBA), Westpac Banking Corporation, and Australia and New Zealand Banking Group are also experimenting with payments based on the Ripple protocol.
While working to implement opensource protocols, companies are exploring possibilities of developing their own private blockchains. For instance, the Citigroup Company has built three blockchains and an internal currency based on them designed to minimize risks when interacting with other banks. As it turns out, both public and private blockchains are ready to find application in the financial sector. Today, we will see how they differ with each other and what advantages and disadvantages they have.
Decentralization, minimal trust assumptions, transactions transparency are among the main advantages of the blockchain technology. The decentralization of trust allows exchanging assets, involving no authorities which store access keys. As the entrepreneur and author Andreas Antonopoulos says, “Bitcoin implements a trust model of trust by computation.”
“Trust does not depend on excluding bad actors, as they cannot “fake” trust,” Andreas said. “They cannot pretend to be the trusted party, as there is none. They cannot steal the central keys as there are none. They cannot pull the levers of control at the core of the system, as there is no core and no levers of control.”
As for the transactions transparency, a large shared FTP folder can serve as an example. You are able to see all of its contents, and you also know who downloaded files, when it happened, and in which directories. However, at the same time, each user has different access rights. Someone can only look through the list, and someone (to whom the file is destined) can download the data.
Private blockchains are the ones where block creation is centralized, and all the rights to carry out such procedures belong to one company. “The general public” is only able to read the data. However, exclusively trusted nodes can conduct audits and manage databases and other applications.
Advanatages of private Blockchains
At the same time, private blockchains have certain advantages. Firstly, it is their low transaction costs since their validation is conducted by high-performance trusted nodes instead of tens of thousands of user devices, as it happens in the case of public networks. Secondly, it is possible to configure a blockchain in such a way that the TPS (transactions per second) index will be significantly larger than the same index in public networks (at least in the near future). The only bottleneck in this system is the throughput capability of the weakest node in the network.
Another advantage of private blockchains may be more thorough control over the system by the company. The matter is that a private blockchain allows quick functionality updates for example. That is why it is so attractive for institutions handling registries and accounting systems as the technology creates a controlled and predictable environment different from publicly accessible blockchains (which we will discuss below).
Furthermore, creating blocks in a private blockchain oftentimes does not require proof-of-work. We can take the block creation protocol used in BitShares as an example. A set number of transaction handlers have a pair of keys – a secret one and an open one. Block creators are known and identified by a digital signature in the header.
Operators take turns in creating blocks at specified time intervals. The order of block creation is either fixed or mixed after a full cycle (N blocks). If an operator fails to create a block in the time specified, they miss the round. If such behavior is the result of intruders, an investigation takes place. Therefore, if the transaction handlers are the only users of blockchain data, it is possible to develop a reliable block creation protocol (e.g., making the abovementioned algorithm slightly more complicated) which will skip using proof-of-work.
Even though private blockchains may have no use for proof-of-work, it is still possible to enable protocol to improve security, simplify auditing and, as a result, increase control over the system for end users. Actually, proof-of-work shifts the trust to a blockchain from subjective (trust to a system is equivalent to trust to a controlling company) to objective (trust to a system follows from mathematical laws and is secured by the high economic cost of an attack on the system irrespective of the attacker’s identity).
“Private blockchains provide interesting opportunities for businesses to leverage [their] trustless and transparent foundation for internal and business-to-business use cases.” Dan Wasyluk, Syscoin’s team manager says. “With the advent of smart contracts, this technology could eventually replace many centralized businesses.” In other words, private blockchains can become a foundation for blockchain innovation in services using ledgers or financial accounting systems.
Any user can read public or generally available blockchains, and everyone has the right to create transactions. At the same time, cryptographic verification mechanisms such as proof-of-work or proof-of-stake keep transactions safe.
The entire community of network members “controls” a public blockchain, including developers, users, service providers, and miners. They all ensure the network integrity and ease of use. A number of protocol updates increase network performance, preventing harmful changes. This is why the system allows creating decentralized applications with minimal maintenance costs.
Advantages of Public Blockchains
They also provide a way to protect application users from developers, limiting possibilities for the latter. No developer can change the code or data in the public blockchain applications independently. As Thomas Schelling said, “Weakness is often strength.”
Besides, public blockchains have network effects. People often start using new public blockchain applications because they use other software based on the same blockchain, which helped them learn about the new applications due to software interoperability. For instance, a mobile wallet run on a public blockchain may add a function helping to interact with other distributed applications on the same blockchain, significantly expanding its user base.
It is worth noting that public blockchains also allow solving products transfer issues. For example, user A wants to sell the domain to user B, and they face certain difficulties. If user A transfers the domain first, they risk losing money and the domain. Transferring money first may pose the similar threat to user B. To solve this issue, intermediaries charge contracting parties with an interest fee for the transaction.
However, in case a blockchain has a system of domain names and currency, the expenses are reduced to zero through smart contracts utilization. One party sends the domain into a system, and the other one transfers the money into it. No issues arise because the system is trusted since it operates within a public blockchain.
Solutions based on the blockchain technology create a secure and naturally decentralized framework for transaction processing. Bitcoin blockchain is currently the most secure public blockchain in terms of cost of attacks against the system. In a generally accessible environment, the cost of an attack is proportional to the block creators’ reward, which is approximately $2.1 million daily in the Bitcoin system. At the same time, maintaining security is relatively cheap and is founded on two factors: a transaction commission fee and controlled money supply (about annual 7% in 2016).
Integration of data processing, correctness tracking, and security in a single protocol minimizing the human factor impact is one of the main advantages of the blockchain technology compared to other models of distributed databases. Due to legal and technical reasons, institutions involving financial accounting systems or registers in their operation may in mid-term perspective be interested in using blockchains with limited access to transaction processing.
As for public blockchains, their advantages (in particular, their transparency and basic technologies and protocols openness) may result in the situation where the technology will replace many functions carried out by traditional financial institutions, changing the financial system operating principles.
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