What is a decentralized blockchain network?

At their core, shared computing systems, or decentralized networks, are systems that allow many computers to collectively come to an agreement over a shared set of data.

At any moment, the last agreed-upon set of data represents the authoritative state of the network. Efforts are underway to design systems that can enable a large range of platforms for trustworthy shared computing. A fundamental question in the design of any distributed platform is who can participate in the network, and how do they participate in order to reach a consensus over the data. As discussed below, the design of the network and the rules dictating who can participate in the network and how the consensus is reached result in meaningful differences among systems.

What is the difference between “public” and “permissioned” blockchain networks?

In a public blockchain network, anyone with a computer and an internet connection should be eligible to download the network software and access the network. As a result, anyone can view the shared data and play a role in forming a consensus as to the data’s authoritative state.  Public consensus mechanisms include proof-of-work based mechanisms, as well as proof-of-stake mechanisms and social consensus mechanisms. Participants on most public blockchain networks can operate anonymously or pseudo anonymously, and no centralized authority is available to regulate the access or activities of network participants. In a public blockchain network system, possession of a private key provides ownership of an asset, regardless of how one came into possession, because there is no way for the blockchain to discriminate among spend transactions obtained through legitimate trade, defrauding a counterparty (e.g., via a double-spend), or theft of someone’s private key.

In a permissioned blockchain network, only those persons who have been identified by a known authority that provided authorization are allowed to participate in the network. Further, permissioned blockchain networks can be designed to provide specific roles to node operators tailored to their role in the business process. Permissioned blockchain networks can be designed to ensure consensus through the separation of transaction endorsement and data replication, materially simplifying the operation of the network and reducing costs for all participants. Permissioned blockchain networks do not require complex Proof-of-Work or Proof-of-Stake consensus mechanisms and do not require internal currency to operate.

As a result, the known authority that provides permissioned blockchain services can set eligibility requirements, determine which entities can participate in reaching a consensus over the state of data in the network, determine how information can be viewed, and screen bad actors from the network. In addition to using trusted third parties for authentication of a transaction, permissioned blockchains also require identity authentication of transaction validators. As a result, a governance structure over the nodes is implemented and the system is capable of ensuring fraudulent or illegal transactions on the network are not validated.

Why are “permissioned” blockchain networks more aligned to traditional regulatory frameworks?

The known authority in permissioned networks provides a structure that is similar to the way in which securities transactions typically take place – each participating party is known, and only certain designated parties have the ability to validate transactions. Anonymous participation in the network is not permitted. Similarly, only certain designated parties have the ability to validate transactions on permissioned networks. These differences warrant different regulatory treatment of “permissioned” and “public” blockchain networks because as described below, permissioned networks like iownit’s provide for certain safeguards that facilitate private placements to occur in the already established regulatory regime. Indeed, at least one financial regulator has recognized that:

the DLT [distributed ledger technology] that would be used for financial services would differ from the Blockchain designed for Bitcoins in a number of ways. In particular, while the Bitcoin Blockchain is an open system where all can contribute to the validation process (‘public’ blockchain system), the DLT that is likely to be used in financial markets would be a permissioned-based system with authorized participants only. This difference is important to keep in mind because it has a number of consequences in terms of potential benefits and risks.

Additional Resources

  1. See ESMA, Discussion Paper: The Distributed Ledger Technology Applied to Securities Markets (Feb. 6, 2016) https://www.esma.europa.eu/sites/default/files/library/2016- 773_dp_dlt.pdf.
  2. The Depository Trust & Clearing Corporation (“DTCC”) in its recent white paper “Guiding Principles for the Post-Trade Processing of Tokenized Securities” highlighted the potential of using permissioned blockchains to provide confidence in securities platforms. http://www.dtcc.com/news/2019/March/13/dtcc-outlines-guiding- principles-for-post-trade-processing-of-tokenized-securities

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