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July 26, 2023

Make way for the rise of the public permissioned blockchain

What institutional issuers and investors need to know about public permissioned blockchain infrastructure, how its evolution impacts compliance and governance, and why its adoption is on the rise.

When selecting blockchain infrastructure to integrate, most financial institutions think along two lines: public versus private. 

A private blockchain network is traditionally closed and gated except to a select group of participants, as well as de facto centralized. In contrast, public blockchain infrastructure is open for anyone to view and, usually, access. 

This diametric model fits the earliest iterations of blockchains, but with Polymesh — a public permissioned blockchain — it no longer works to classify blockchains on one dimension. There’s now an extra consideration for blockchain organization and governance: the presence of a permissioning layer. 

What’s behind this rise of public permissioned blockchains? That’s what we’ll explore in this blog post by examining public permissioned on two sub-dimensions: compliance-capable structure and governance. 

The evolving structure of public permissioned blockchains

These days there are a few public permissioned blockchains challenging the status quo of public blockchain infrastructure. 

Polymesh is one example, and what we could call fully permissioned. All participants must pass identity verification to use the network. In discussions with regulators and financial institutions, this was identified as a critical requirement for blockchain’s wide adoption in institutional climates such as securities trading. 

Other blockchains are only partially permissioned. Hedera, for example, has permissioned ‘consensus nodes’ but is otherwise open for anyone to make transactions or come and go at any time, without needing to reveal their identity.  Its permissioning is also only intended as a temporary measure, as the network has plans to grow towards a fully permissionless state in the future.

The chart below shows how we can map existing blockchains on the public-permissioned axis.

Harnessing the benefits of decentralization

The extent to which a blockchain is permissioned and whether the network has plans to eventually reduce permissioning depends on the value placed upon pure decentralization. Businesses, individuals, academic institutions, governments, and other organizations may all gain value from public distributed ledger technology and decentralization’s primary benefit: trustlessness, i.e. no reliance on a “third party.”

While private blockchains can enhance efficiency and operations, it is distribution by a decentralized set of nodes that best guarantees security and stability. It’s simply too risky to rely on master nodes operated by a central entity as the entire network could be switched off at any minute due to human error, harmful actors, technology failure, or a system hack. 

However, complete removal of intermediaries or censorship-resistance often comes at the cost of known or reputed identity, which isn’t compatible with how legacy institutions work or their regulatory requirements. Moreover, existing public blockchains have tended towards centralization in practice as the power over the network concentrates in those with the most tokens or mining power. 

Public permissioned networks evolved as a way to harness the benefits of decentralization — such as security, transparency, immutability, and auditability — while ensuring a level of control in the logic and governance of the ledger, so that these benefits won’t be compromised by power-hungry on-chain actors. In other words, public permissioned blockchains evolved to make decentralization more than just a promise. 

Typically, public permissioned infrastructure provides this by ensuring that network operators (the entities who run the network’s validator nodes) are permissioned by a primary governing body (whose members comprise the network’s key decision makers). For example, on Polymesh, validator node operators (referred to as Node Operators) are permissioned by the Polymesh Governing Council. 

The exact requirements to become a network operator vary network-to-network. On some blockchains, there’s crossover between node operations and governance, where entities participating in the network by running validator nodes must not only be permissioned by but also owned and operated by governing members. 

On other blockchains, the requirements to operate a validator node are distinct from governance. For example, on Polymesh, only licensed financial entities may become node operators, but this isn’t a requirement to join the self-autonomous Governing Council, of which membership is decided upon by the Council itself. 

Privacy vs. transparency 

One of the main challenges in the private vs. public debate centers on privacy vs. transparency. 

Institutions value privacy in transactions, especially when they need to maintain confidentiality about trades and positions or protect client information for compliance. On public ledgers, however, it’s often possible to view token holders’ complete holdings or identify them from what’s available. And while there are layer-2 solutions that can make transactions and balances confidential, these come at the cost of meeting ownership and reporting requirements. This is one major reason why financial institutions have traditionally been hesitant to use public blockchains. 

However, public blockchains definitely hold potential and — if harnessed correctly — could immensely transform the industry. The benefits of a public blockchain on transaction auditability are priceless when you consider the billions of dollars and time the industry pours into accounting, auditing, fraud prevention and recovery, legal costs, or otherwise loses from human error, inefficient manual processes, and misconduct. 

Ultimately, the transparency and immutability of public ledgers will motivate tightly regulated industries like finance towards public permissioned blockchains compared to private. The key to unlocking this change is establishing a permissioned blockchain that can provide confidentiality in transactions without compromising on compliance — something that Polymesh is proving possible with confidentiality on assets, trades, and positions

Making regulatory compliance truly possible

Permissioned blockchains were initially equatable with private consortiums, but the evolving structure of public permissioned infrastructure is proving to be the turning point in blockchain’s future. 

The biggest blockage to public blockchains — and arguably the most influential to blockchain’s adoption — is from the financial industry. Licensed financial entities, for instance, need to know who they’re participating in transactions with, who’s receiving tokens from network fees, and who they’re relying on to validate transactions or govern the network. Hence institutional issuers and investors have been hesitant to use public blockchain infrastructure. That is, until now. 

In EY Parthenon’s 2023 report Staying the course: institutional investor outlook on digital assets, 60% of surveyed institutions said they planned on tokenizing assets on a public permissioned blockchain — such as Polymesh — compared to a public permissionless or private permissioned one. 

It’s not hard to understand why. Financial institutions place high value on security, transparency, immutability, and auditability — all benefits of decentralization that, as described above, public networks best deliver on. Above all that, however, these institutions need to know who they’re dealing with to fulfill requirements around regulatory compliance — and this is something only possible with a permissioned network. 

Polymesh’s origin lies in meeting these institutional requirements for identity and compliance. On Polymesh, the entities that run validator nodes and author transactions – called Node Operators – must be known, licensed financial entities. This both increases reputation risk for its proof-of-stake operations and provides extra trust among its participants that Node Operators will align to the network’s best interests. 

What makes Polymesh truly unique, though, is that permissioning encompasses all users. Every user must pass through identity verification in order to participate in the network — a requirement that, combined with Polymesh’s identity system and compliance engine, makes it possible to allow KYC and fulfill compliance requirements on-chain. Otherwise the chain remains public — open source and anyone is free to deploy or remove applications, join and contribute a regular node, or view the network’s data. 

The impact of blockchain governance on public-permissioned networks

Above we discussed the evolving structure of public permissioned blockchains, but there’s one important and highly influential factor we haven’t touched on and which deserves its own section: blockchain governance. 

Blockchain governance describes the rules and mechanisms that dictate the blockchain’s operations, use, and evolution, including community collaboration. It can also define how applications built on top are coordinated, as well as how the network complies with relevant regulations. 

Generally, blockchain governance is classified as centralized or decentralized. This is where public vs. private governance models differ. 

Centralized vs. decentralized governance 

Private networks, typically only open and accessible to select participants, use a centralized mechanism to enforce rules and agreements. In contrast, public networks are open to anyone and rely on a decentralized, incentive-based mechanism for consensus and coordination.

The benefit of a centralized model is a high degree of control, efficiency, and stability — but at the cost of transparency and fairness. Moreover, this control is disproportionally beneficial to the centralized entity, which all other parties are required to trust. 

Public or decentralized networks are more “trustless” — that is open, fair, and often innovative. However, many important use cases can’t fit fully into a decentralized model. For example, institutional finance faces regulatory and security hurdles around relying on a completely open network where anyone can participate in any capacity. 

For legacy finance to truly benefit from the transparency, accountability, and audibility offered by public infrastructure, the network needs a level of permissioning as occurs in private networks. Here’s where the hybrid “public permissioned” comes in. 

Governance councils in public permissioned networks 

On public permissioned networks, anyone can access the network but only authorized entities can perform certain roles or functions.

Who can join the network and why, who can validate transactions, who can propose changes, and who makes (final) decisions in governance — these are the questions developers will need to provide preliminary decisions for. 

Different use cases will benefit from different requirements, but by and large, trust and compliance will be a priority for financial institutions. Regulated entities need to know that the entities controlling the validator nodes, holding voting power, or involved in final decision-making as could affect transactions worth billions of dollars won’t cause trouble. 

On public permissioned blockchains, the power to permission network operators, vote to effect changes in the codebase, or have final word on the blockchain’s direction is commonly held by a governance council. For example, on Polymesh, node operators must be licensed financial entities and all users must pass identity verification. Behind both these lies the Polymesh Governing Council, the key decision-maker in Polymesh governance and the entity that permissions node operators and identity verification providers. 

Governance councils on public permissioned blockchains are initially centralized and later grow to increase decentralization as the chain ramps up in security and stability. They have to be centralized initially because their members have to be granted membership and authority from the blockchain’s core developers upon its launch (they can’t come out of nowhere!). Unless a governance council is very large at launch, the council will mostly continue to carry a level of centralization. As the ecosystem developers, the governance council can grow and increase decentralization, usually with the council itself voting members in or out. 

In other words, the governance council is permissioned in two phases: its initial members are permissioned by the blockchain’s developers, and later membership is permissioned by the council itself. 

For financial institutions, the robust governance council of public permissioned networks can provide confidence that the network’s path to further decentralization involves thoughtful planning, execution, and a balance of control in coming to consensus. And, since a council usually maintains itself, institutions can better trust that the chain’s key decision-makers are like-minded entities who hold a central vision compatible with what’s best for the ecosystem. 

The path forward: public permissioned as the on-ramp to DeFi 

Permissioned infrastructure is what will be the innovating force behind institutions’ migration to public blockchains. This is because on two dimensions — compliance-capable structure and governance — public permissioned blockchains harness the benefits of decentralization in a way that’s compatible with financial institutions and regulatory requirements.

But there’s another reason public permissioned blockchains are on the rise: by solving the problems with public infrastructure, permissioned networks offer an on-ramp to the world of decentralized finance, which until now has remained largely inaccessible to traditional financial institutions. 

There’s an estimated $800 trillion in real-world assets waiting to be tokenized and benefit from public blockchain infrastructure — not to mention billions of dollars in untapped markets from new financial products possible on blockchain, such as in the fan economy or social finance.

Identity, compliance, confidentiality, and governance have, for the most part, been missing from public blockchain infrastructure. Resolving these issues has often come in the form of complex layer-2 solutions or compromise. This is changing with public permissioned blockchains — take Polymesh, for which these components form four of its key pillars.

With public permissioned blockchains, institutional users can have their cake and eat it too. 

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