The Risks of Private Blockchain: Too Many Chains

Part two in a series about blockchain early adoption risks. Read the first article here.

In our previous article, we discussed the differences between public and private blockchain-enabled applications. Many financial institutions are wary of enabling their customers to engage with public blockchain and crypto currency, for fear of the affiliation with possible money laundering or other illicit activities. But the implementation of a private blockchain has implications that can greatly benefit existing bank processes. The accurate, tamper-proof record-keeping means that processes, such as interbank payments, trade finance transactions, and correspondent banking services, could be enacted quickly and seamlessly. But private blockchain doesn’t come without risks.

The first prevalent blockchain-affiliated risk pertains to the use of private blockchain environments. The private blockchain space is fragmented. Currently there are many blockchain projects in development simultaneously, and companies are forming islands of consortia, each revolving around one specific blockchain implementation.

Most of the progress in private blockchain is seen in the banking sector. Right now, there are four consortia of banks using one of the four private existing blockchain technologies, namely R3, Hyperledger, Ripple, and Quorum.

Having multiple blockchains is undesirable for a couple of reasons.

1. Fragmentation of Users (Network)

Any single blockchain will not have the full picture of everything. Each blockchain’s protocol and implementation are different and that results in different models of data storage, confidentiality, and permissions control. Currently, there are hundreds of financial institutions scattered across 4 main private blockchain consortia. The problem with a fragmented network like this is that the benefit each bank receives by partaking in a consortium is proportional to the number of members in its own network.

For example, if there are 600 banks distributed evenly across 4 consortia, each with 150 banks, then each bank can only interact with, at most, 150 banks. What if one of the banks needs to work with someone outside of its own network, such as a bank from a different consortium? Will both consortia maintain the records? How can they trust the information is kept correctly on the other side? How much longer does payment settlement become because of this? These questions bring back some very familiar challenges that we have today–the same challenges blockchain aimed to solve in the first place.

Fig1. The value of a network is proportional to the square of the number of connected users of the system. Two telephones can make only one connection, five can make 10 connections, and 12 can make 66 connections. A single consortium of 600 banks can make 360,000 connections, while 4 consortia of 150 banks each can only make 90,000 connections.  (https://en.wikipedia.org/wiki/Metcalfe%27s_law)

2. Fragmentation of Applications (Interoperability)

Just like the App Store on a mobile device, each private blockchain can host many applications that its members can use. These applications range from simple record-keeping apps to complex applications for supply chains. However, unlike mobile apps, blockchain applications are interoperable, meaning the applications themselves can talk to one another. When applications can communicate with each other, they enable developers to re-use code and build richer and more complex applications.

For example, if a consortium wants to build a payment application, it could utilize an existing identity application that already has millions of identities stored, this way the payment application can simply request permission to access any account information during account opening. Later, if the consortium wants to build a trade-finance application, the payment application would already be available.

The challenge with the current private blockchain landscape, is that this web of dependencies is fragmented across different blockchains. If a personal financing company wants to extend a loan to person, it might be useful for the lender to get permissions to access credit score from a banking application, education history from an education application, and employment information from another application. These kind of use cases can go on and on, from commercial application to law enforcement auditing.

Now what if all these applications are scattered across multiple blockchains? For example, someone with a great education history and stable salary may not receive good terms on a loan because the loan company is unable to obtain a complete record of their background. Thus, the fragmented nature of data residing in private blockchains may make them a less-than-ideal option today.

3. Cooperation and Competition

In blockchain, network size and interoperability will be two of the greatest value propositions for companies when deciding which consortium to be part of. After all, when a bank can fully interact with every other bank, it is able to offer the lowest transaction fee to its users. And if the bank can find a way to connect and interoperate with the general economy, then it will be able to offer lower financing, better securities, and other more personalized services.

There are certainly some arguments that point towards a single blockchain, but one may argue that competition is necessarily good and we need to have multiple chains for innovation to thrive. These arguments have some merit. We need competition to solve some of the hard problems that we face today such as scalability, security, and confidentiality.

However, it is important to understand that at some point, we may find that the blockchain technology is no longer a product or service that can come and go. It will have evolved into a utility, like the electricity that powers the world today, and like electricity it will enable millions of organizations, serving billions of people, devices, and facilitate trillions of relations and social contracts. By that time, it will have no easy substitute as the world is built on it. At that point, the reward of cooperation will far exceed the reward of defection. And users will hold much more power than they do today, as they will be more efficient at navigating and choosing the services that best serve them.

Although the fragmented nature of private blockchain today makes it an uncertain prospect for many organizations, pioneers are needed to innovate and develop this technology into a more comprehensive solution. In our next article, we’ll discuss some of the risks for these early adopters.