Public blockchain: An asset or a liability?

Coronavirus in 2020 has had a radical impact on the global economy. The need for a digital infrastructure in all domains, including the finance, has unequivocally come to the forefront. This digital economy would need resilient technological tools to build an infrastructure that is capable of a secure, automated delivery of products and services, while adhering to the existing regulations. Blockchain is one such potent technology that can assist in developing this digital infrastructure.

Blockchain helps to reduce the intermediaries normally required in financial transactions, thereby reducing the cost of the procedure. The technology guarantees immutability of the data that is stored on its database, thus providing transparency. The negative connotation of this data transparency is loss of privacy and inability to adhere to the privacy laws dictated by a region, like the European General Data Protection Regulation for the European Union. The technology provides the capability to access the utility of the distributed network through a permissioned or a permissionless platform. Permissionless blockchains are public blockchains like Neo, Algorand, Tezos, Waves and Bitcoin among others. They allow any user to read the data from the blockchain platform as well as add a data record to it. This public nature increases transparency, ensures data immutability but incurs loss of privacy and security. Further, the public, permissionless blockchain platforms are not controlled by any authorizing body and any loss of capital through the blockchain platform cannot be challenged. Permissioned blockchain platforms on the other end can be customized to provide an additional access layer, restricting who can read data as well as add data to the blockchain database. This results in the platform being transparent for the entities, selected by the owners of the permissioned blockchain platform. Permissioned blockchains are closer to the existing legacy systems in finance and provide a more secure platform to conduct financial transactions with loss of funds capable of being compensated for by the owners of the platform, as the legal responsibility of the platform rests with them. 

The technology is still dealing with bottlenecks that are a hindrance to its large scale use like scalability. Proof of concept and a sandbox are a way forward to test any business model built on the technology to verify its robustness for mass usage. In consideration of the differences between permissionless and permissioned blockchain platforms, the choice of one would necessitate the need governing its employability. In Islamic finance the applications of blockchain have been discussed in a comprehensive way, both in the industry and academia. The utility of blockchain for Islamic finance, especially the functionality provided by smart contracts, is undisputed. However, the finer implications of using a public or a private blockchain platform is still a matter under deliberation. Majority of the use cases in the industry have been developed using a public blockchain. Consortium and permissioned blockchain-based distributed ledgers are still in the proposition and prototype stage.

Some of the characteristics of a public blockchain together with its implication for Islamic finance are given below:

• Transparency: Public blockchains are highly transparent and hence all data and associated financial transactions can be seen by the public. Pseudonymous nature of the blockchain platform has proved to be insufficient for hiding the identity of the users and this had led to the advent of privacy-preserving blockchains like Monero and Zcash. These privacy-preserving cryptocurrencies have also proved to be vulnerable to breaches of privacy by attacks like temporal analysis and discovery of an inflation bug respectively. Moreover their usage is much more complex than other blockchain platforms, making them like a black box for finance professionals, shifting the trust entirely on the developers. The good aspect of this is that forensic tools can be developed to ensure law enforcement for public blockchains. However till the time these tools are not into existence, the transparency can prove to be detrimental for the privacy of users as well as for the financial institutions using the technology as they would be providing their data to their competition in the market to derive valuable insights through machine learning.
• Immutability: This implies that the data on the public blockchain is protected against any corruption and manipulation. Public blockchain platforms have comparatively more users than permissioned ones and as such attempts to manipulate the data would be known as all validating users would have a local copy of the distributed database, which would require to be changed for the manipulation attempt to be a success. The negative aspect of this is that public blockchains can potentially be used to add vulnerable data defying the ethics in Islamic finance. Once added, the immutability would prevent deletion of the data. This immutability also prevents public blockchains to be compliant to laws like European General Data Protection Regulation and California Consumer Privacy Act.
• Security: Public blockchains are not as secure as permissioned ones as they have no access layer to restrict unverified participants in the network. This can allow attacks to transfer funds from different accounts to a certain target wallet taking advantage of erroneous code or theft of security keys from a hot wallet. The undesirable consequence of this in a public blockchain is that it has no owner or legal entity that would be liable to compensate for any monetary losses. Islamic finance functions on the principles of trust and if a blockchain platform cannot be trusted to compensate for a monetary loss on account of the vulnerability in the blockchain platform, then a more secure option needs to be utilized as per Islamic principles, which do not encourage risky initiatives. 
• Cost of transactions: The cost of conducting transactions depends upon the blockchain platform. The average cost per transaction in Bitcoin as of November 17, 2020 was $58.03. At the same time, Ethereum was $2.434 but on account of user error and a flaw in the code in Metamask, a user recently paid over $9000 transaction fee for a $120 DeFi transaction. Since the public blockchain is not owned by anybody, a possible reimbursement for this extra payment cannot be accomplished in the decentralized blockchain network. This puts public blockchain again in a risk-prone area as of now for Islamic finance ventures. In a permissioned blockchain, mechanisms can be built to ensure return of the lost funds through the stakeholders of the permissioned network. 
• Trust: Public blockchains are a trustless initiative, absolving the need to trust intermediaries for financial dealings. The existing system in Islamic finance inherently relies on trust and users trust the existing financial institutions as they have a history of having provided secure products/ services. Blockchain, despite being a novel, disruptive technology has still not proved to be trustworthy for usage by the population at large. An unstable economy on account of COVID-19 and loss of jobs would trigger a more defensive response by users in handling their money. In such a scenario, public blockchains without the support of any existing financial institutions to be legally responsible for the financial product/ service offered through them stand in a zone of mistrust for the coming years till the global economy recovers from the pandemic.
• Regulatory adherence: A public blockchain by virtue of its decentralized and permssionless infrastructure is not owned by any single entity. Infact, one of the capitalizing features of a public blockchain since its advent has been that it is not owned by anybody. This instills a sense of power in the users, who had lost trust in the traditional financial systems after the financial crisis of 2007-2008. However, blockchain usage puts them in a vulnerable situation, as in the absence of any legal body responsible for the platform, there is no mechanism for complaint redressal. Regulatory adherence makes the users of the financial services secure as there is a legal body to reach out to in case of fraud, which is presently still in development phase for public blockchains.
• Performance: The performance of a permissioned blockchain will nearly always be better than public blockchains, which have a large number of validators, potentially geographically distributed, verifying the transactions. This increases the latency and adds to the transaction confirmation time with users even waiting for hours in case of network congestion, to get their payments across. In Ethereum, not all the submitted transactions are accepted despite being valid and the user is forced to resend as transaction inclusion probability for valid transactions was reported to be nearly 70% only. This performance where transactions take hours to be validated might not be a feature users would look forward to in this digital age, where instant transactions is the goal. Further the feature of having to resend the same transaction, even though it was valid, makes Ethereum an unattractive platform of choice though it is one of the most popular ones in terms of market capitalization, that offer the functionality of smart contracts.
• Governance: Governance in a public blockchain can be either on-chain as in Tezos or off-chain as in Bitcoin and Ethereum. In off-chain governance, lack of participation by the users during voting on novel proposal changes makes the governance process somewhat centralized with the founders/ stakeholders taking decisions, defying the fallacy of power in the hands of users. However, on-chain governance seeks to improve and remove this by inculcating voting as a part of the code in the blockchain. In contrast to this, permissioned blockchains can function as existing technological firms having their own governing body to take decisions, supplemented by inputs from the users. They can also imitate the on-chain or off-chain governance processes.
• Know your customer (KYC): This is a vital functionality when it comes to compliance to Anti-Money Laundering and Countering the Financing of Terrorism (AML/ CFT) obligations. Any financial institution that embarks on using public blockchain would need to implement its own KYC solution to cater to this need. This would entail additional costs apart from the transaction fee that the users would pay. In a permissioned blockchain, the transaction fee and KYC procedures can be managed together to take a just fee from the user but no such combined control exists when using a public blockchain.

In assessment of the above highlighted characteristics, public blockchains cannot be deemed to be robust for all kinds of financial dealings but can prove to be a panacea when the need for public disclosure of any information exists. Public blockchain ensures immutability and non-repudiation for the publicly disclosed information. However for those financial organizations who seek for immutability without delving into the complexity of dealing with the nuances of deploying a blockchain-based solution, Microsoft has come forward with the concept of immutable Azure Blob storage. This storage blob can be considered to be equivalent to a permissioned blockchain platform in terms of immutability. Hybrid solutions can always exist between legacy systems and a public blockchain but relevant expertise to implement such technical solutions is a scarce resource.

The article was originally published in ISFIRE, December 2020.