Private vs Public Blockchains: Why Banks prefer private networks?

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Last week, the launch of the Canton Network made the headlines.

Some were excited about the potential of a new network focused on financial services, and others questioned how different it was from previous private solutions (like the famous Hyperledger & Corda – private DLT solutions).

Canton Network

Financial firms like?Deloitte, S&P Global, and Moody’s?have come together to support the launch of the?Canton Network, a blockchain designed to streamline financial markets with Web3 tech.

The network aims to provide companies with a decentralised infrastructure that could make transactions more efficient, linking financial systems together and allowing them to operate in a synchronized way.

Canton vs Hyperledger & Corda

Anthony Day was one the initial voices on this topic; you can read his full analysis?here.

Hyperledger & Corda solutions were rolled out in 2014/2015.?Yet, eight years later, the new solution in the market still uses private networks.?Why is that?

Private vs Public Blockchains

Why do Banks prefer to use private blockchains instead of public blockchains?

Especially if we consider the number of new solutions being built by Defi companies.

Today, we will look at the private vs public debate from a Bank’s perspective and understand why their preference is still private networks.

• If you are in Web3 and looking to partner with Banks, this article will help you understand what Banks have to consider. You should use this to tailor your solutions and help you navigate discussions with your partners.
• If you are in Banking, this article will give you a holistic perspective of the industry and the key topics to discuss internally.

Private Networks?

With new technologies, Banks must maintain a perfect balance between?Innovation?and?compliance/safety. Blockchain, given its association with crypto, can have a bad reputation in financial services and so maintaining the right level of compliance/safety is even more important for banks experimenting in this space.

While decentralisation/openness is a crucial principle for Web3 native companies, transparency and openness in banking can lead to the exposure of confidential and important information, putting vulnerable customers at risk.?

Reasons for selecting private networks:

• Privacy and Confidentiality:

Banks handle vast amounts of sensitive customer data and trade secrets. By starting with a closed network, they can ensure that only trusted participants, such as other banks or regulatory authorities, can access the data. This protects sensitive information from public exposure or potential breaches.

• Compliance and Governance:

Banks operate in a heavily regulated environment. A closed network enables better control over compliance with legal requirements and internal policies. Banks can define governance models, access controls, and data-sharing protocols per their specific needs.

• Controlled Environment:

By starting with a closed network, banks can establish trust among participants in a controlled environment. This allows them to experiment, gain confidence in the technology, and gradually expand their blockchain network to include more trusted partners.

Defi and private blockchains

Having understood the position of the Banks,?some Defi companies have tried to build similar permissioned networks.

• Solutions would be built on public blockchains, but the network would be closed to a segregated group of people.
• Only a pre-selected group of entities will have access to the network to see and approve the blocks.

Even though this solution seems more aligned with the ethos of web3, it wasn’t adopted as expected.?Why so?

While bankers will have a few concerns with this approach, some less discussed topics are covered below.

Considerations for Defi Solutions:

• Gas Fees/Transaction Fees:

While many retail banks want to leverage the potential of this new technology, they want to?avoid holding or being associated with Crypto.

In public blockchains, transactions typically have associated fees (gas fees in Ethereum networks). Those transaction costs are paid with the network token (e.g. in Ethereum networks, gas fees are paid with Eth).

So, if a bank builds a solution on a public blockchain, they will need to pay transaction fees and, as a result, buy/hold the network token (i.e. crypto). This would mean?banks would have to hold crypto in their ledger.

Additionally, since gas fees vary so much, it would be?harder for banks to forecast their outgoings.

• Token Value:

Something particular about Web3 is the fact that web3 and Defi companies have tokens, so if the community and use cases increase, the token’s value will also increase.

Let’s say a Bank creates a partnership with a Defi company and starts transacting using their network. As a result, they?indirectly increase the Defi company's token.

This is a new concept and consideration for the Bank.?Do they need to account for that? What’s the regulatory requirement?

Final Thoughts

In my experience, the business for private networks does not hold in the long term.

Given how the solution is set up (closed, pre-selected entities), the benefits of a private blockchain are very similar to a database, but the costs are much higher.

However, those experiments are still essential to enable teams to understand some of the concepts of web3 and its potential. Working groups should include cross-teams (business, compliance, legal and finance teams) to ensure governance and principles are set up for this new technology.?

Until next time

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This is a new and exciting space, so ideas and perspectives may change as we learn more and technology improves.?

Any views or opinions represented are personal and belong solely to the author and do not represent those of people, institutions or organisations with which the author may or may not be associated in a professional or personal capacity unless explicitly stated.