From ledgerinsights

The European Union has published a report exploring the potential for permissionless blockchain in traditional finance (TradFi). It argues that permissionless blockchains should at least be considered as options for TradFi and financial market infrastructures. However, adoption should happen in a cautious manner.

Fabian Schär of the University of Basel is the paper’s author. He wrote one of the most cited early papers on Decentralized Finance (DeFi). While Mr Schär is a proponent of permissionless blockchains and DeFi, the paper is nonetheless objective and thorough.

It argues that permissionless blockchains can be more neutral than private ones, and in turn encourage competition. Unfettered access enabled by public blockchains contrasts with the siloed permissioned blockchains that are proliferating. While public blockchains have drawbacks, there are many widely known workarounds to their challenges, particularly by adding permissions at the smart contract level.

Mr Schär proposes that permissionless blockchains can provide an interoperability layer for layer 2 blockchains, including regulated ones. When smart contracts are on a single chain, they are capable of being composable into more complex functionality. Composability is possible across multiple blockchains but is weaker and messy. We’d note the point about composability is sometimes a blind spot in the TradFi space. Our recent report on DLT payments highlights that some application designs overlook composability and how to address that.

The EU paper doesn’t gloss over the drawbacks of public blockchains, such as scalability, privacy, finality and governance. It delves into each topic, as well as the contentious issue of maximal extractable value (MEV) in which block proposers sometimes reorder transactions at the expense of blockchain users, a type of front running. Mr Schär describes each challenge and the pros and cons of the various workarounds.

Why permissionless blockchains are so topical in TradFi

Clearly asset managers are attracted to the potential of permissionless chains with the likes of BlackRock and Frankin Templeton launching on-chain funds.

From a policy perspective, the paper is timely for three reasons: