The European Union has recently released a comprehensive report delving into the realm of permissionless blockchain within traditional finance (TradFi). This exploration holds significant implications for the future of financial markets and infrastructures. Fabian Schär from the University of Basel, an author of one of the most cited early papers on Decentralized Finance (DeFi), presents an objective and thorough analysis in this paper.
Unlock the Potential of Permissionless Blockchain in TradFi
Exploring the Potential of Permissionless Blockchain
The European Union's report emphasizes that permissionless blockchains should be seriously considered as options for TradFi. It highlights that while these blockchains offer more neutrality and encourage competition compared to private ones, their adoption should be cautious. Public blockchains, with their unfettered access, contrast with the siloed permissioned blockchains that are on the rise. Despite their drawbacks such as scalability, privacy, finality, and governance issues, there are well-known workarounds, especially at the smart contract level. 1: Permissionless blockchains can provide an interoperability layer for layer 2 blockchains, including regulated ones. When smart contracts are on a single chain, they can be composed into more complex functionality. This composability is possible across multiple blockchains but is currently weaker and more complex. In the TradFi space, composability is often overlooked, as our recent report on DLT payments has shown. Some application designs fail to address this crucial aspect. 2: The EU paper doesn't shy away from discussing the drawbacks of public blockchains. It thoroughly examines topics like scalability, privacy, finality, and the contentious issue of maximal extractable value (MEV). Block proposers sometimes reorder transactions at the expense of blockchain users, a form of front running. Mr Schär details each challenge and the pros and cons of the various workarounds.Asset Managers and Permissionless Chains
Clearly, asset managers are showing great interest in the potential of permissionless chains. Prominent players like BlackRock and Franklin Templeton have launched on-chain funds, indicating the growing appeal of this technology. 1: From a policy perspective, the EU's report is timely. It comes at a time when there is a need to reevaluate regulations related to central securities depositories. The EU DLT Pilot Regime, which came into force in early 2023, relaxes some regulations and allows the use of permissionless blockchains. For example, candidate 21x plans to operate a trading and settlement infrastructure on a permissionless blockchain. The workarounds mentioned in the EU paper will be put into action by 21x and other participants. 2: 21x participants are restricted to known entities and use a central limit order book. This allows for market surveillance to identify MEV activities and seize the assets of frontrunners. In case of blockchain infrastructure issues, assets can be moved to a different blockchain. This shows the practical applications and potential solutions in the TradFi context.The Basel Committee and Permissionless Blockchains
The ongoing debate by the Basel Committee on Banking Supervision is another factor making the EU paper timely. The committee has imposed tighter rules for permissionless blockchains, especially for tokenized assets. This encourages banks to focus on permissioned blockchains, creating a divide between them and asset managers who face fewer restrictions. 1: The Basel Committee has also published a paper addressing potential workarounds. However, the EU paper is more technical and goes into greater detail. It provides a comprehensive understanding of the challenges and opportunities associated with permissionless blockchains in TradFi. 2: For those seeking a deep understanding of the ins and outs of permissionless blockchains in the context of TradFi, this paper is an essential read. It offers valuable insights and practical solutions that can shape the future of financial markets.READ MORE