The evolving landscape of public permissionless blockchains signals a potential transformation in the infrastructure of financial services, according to a recent report published by the European Commission in November 2024. These advanced technologies promise numerous advantages, including transparency, decentralisation, and composability, positioning them as the future cornerstone of financial systems.
Public permissionless blockchains, characterised by their decentralised nature, allow unrestricted participation for users without the need for prior authorisation. This feature promotes inclusivity, enabling participants to interact pseudonymously while all transactions are securely recorded on an immutable ledger. Examples of such networks include Bitcoin and Ethereum, which operate based on cryptographic proofs rather than traditional intermediaries.
According to the European Commission report, both financial market infrastructures (FMIs) and blockchains are fundamentally databases that facilitate the management of assets. However, there are significant operational distinctions. Traditional financial systems rely on multiple ledgers maintained by various entities, leading to a verification process at each step. In contrast, blockchains employ decentralised protocols that manage peer-to-peer transactions and achieve consensus on the ledger state through virtual machines.
Another pivotal concept highlighted in the report is composability. While traditional finance is constrained by a myriad of mostly incompatible ledgers due to isolated systems, decentralized finance (DeFi) adopts a more innovative approach known as the “Lego pieces approach.” This method allows for the integration and reuse of smart contract-based financial protocols and assets within other frameworks, promoting the creation of novel solutions.
The report also brings attention to the concept of atomicity, which ensures that multiple transaction steps are executed as a single, indivisible process. Traditional finance often necessitates intermediaries—such as central counterparties or central securities depositories—to ensure that transaction stipulations are fulfilled, introducing additional costs and potential risks. In contrast, blockchains have developed solutions like multi-ledger trigger systems and hashed timelock contracts, fostering cross-chain interoperability and diminishing the reliance on intermediaries.
Governance presents a notable divergence between public permissionless blockchains and more regulated systems. Permissioned systems depend on gatekeepers for access and validation, leading to centralised control. In contrast, public permissionless blockchains operate on a neutral foundation, where governance is inherently decentralised, allowing flexibility in the creation of services built on this framework.
Despite their advantages, the integration of permissionless blockchains into existing financial frameworks is not without its challenges. The report indicates that these systems often encounter limitations in transaction throughput, which is critical for global financial operations. Increasing block sizes may initially seem like a solution; however, this would necessitate robust hardware and improved network infrastructures that could inadvertently limit accessibility and decentralisation.
Additionally, there exists a tension between transparency and user privacy. The inherent openness of public blockchains exposes transaction details, which may not align with the confidentiality requirements of certain financial applications and could hinder institutional acceptance. Moreover, the visibility of monetary movements may incite risks akin to bank runs, thus raising concerns over financial stability.
Transaction finality—where a transaction is irreversible—is essential in financial contexts and poses its own challenges, particularly in how consensus rules are enforced on the blockchain. The governance structures of these decentralised networks also require meticulous consideration, particularly in addressing protocol changes and resolving disputes among users, leading to a critical emphasis on establishing effective governance mechanisms.
In Switzerland, the Swiss National Bank (SNB) is actively investigating the integration of tokenisation and distributed ledger technology (DLT) to create a more efficient and reliable ecosystem for cashless payments. Ongoing studies by the SNB are exploring the role of central bank digital currencies (CBDCs) within a regulated token environment, particularly focusing on the enhancements DLT could provide to payment systems, including simplified transactions and reduced reconciliation costs.
This emerging landscape of AI automation within the financial industry highlights a paradigm shift, anticipating significant impacts on operational practices while fostering innovations in service delivery. As public permissionless blockchains gain traction, the intersection of technology and finance will undoubtedly evolve, challenging established norms and shaping future financial infrastructures.
Source: Noah Wire Services