Permissioned blockchains are the virgin margaritas of cryptocurrency

Sandeep Kumar Sood
Oct 13, 2017 · 6 min read

While initiatives such as Hyperledger are interesting, they should not be considered a replacement for a strategy that addresses the game-changing disruption that cryptocurrency may bring to our industry. Instead, permissioned blockchains should be seen for what they are — marginal improvements to data management and inter-company collaboration.

A still from “The Chess Players”, a 1977 film by Satyajit Ray, in which 19th century Indian princes spend all day squabbling and playing chess against each other, while the British systematically conquer their whole country

Back in the late 90s, many reasonable people believed that the Internet would work better as a closed network. As a result, companies attempted to build their own closed versions of the Internet, rather than deal with the new reality of an open protocol for communication and commerce.

Perhaps the best example of this approach was the strategy employed by America Online. Being early enough to control the entire market, AOL built a walled garden for their subscribers…essentially a public Intranet. At the time, many reasonable people couldn’t imagine how it would be possible for independent websites to produce the same quality or quantity of content that America Online was producing. This is, of course, laughable in retrospect.

Marc Andreesen (founder of Netscape and partner at A16) put it well, in a 2015 tweet: “Big companies desperately hoping for blockchain without Bitcoin is exactly like 1994: Can’t we please have online without Internet??”

AOL eventually lost as the public Internet exploded, and it was soon vividly clear that the open protocol would not only win, but that it would revolutionize human communication and commerce. The web browser gave every person and organization the opportunity to have equal footing in the eyes of the consumer.When corporations eventually came around to this new reality, they were late. Silicon Valley startups who understood how to leverage open protocols were already the kings of this new ecosystem.

In this post, I’m hoping to explain that we are seeing a similar pattern in corporate attitudes toward cryptocurrency. Permissioned blockchains are the new Intranets and walled gardens. While these technologies offer some marginal value to the existing system, we cannot afford to pretend that they are a viable alternative to the powerful networks being built by public cryptocurrencies.

The Blockchain
In the thousands of years that humans have been using money to measure debt and value, they have required a central authority (gods, nation-states, and central banks have all played this role) to guarantee the viability of the stone tablets, coins, paper, and plastic that they use to buy stuff. The blockchain is a fundamental shift in the way we create and use money because it removes the need for a central authority.We now have a solution for the ownership and transfer of money (and really any form of a digital asset) through a sophisticated system that uses cryptography and an incentive-driven network to create an accurate, distributed memory. If financial institutions fail to invest in and understand what happens when banks are no longer necessary to facilitate transactions and authenticate identities, we run the risk of one day facing their Blockbuster moment.

A blockchain is essentially a shared memory. In the case of cryptocurrencies, the blockchain serves as a distributed ledger of transactions and holdings. Since this ledger is cryptographically secure and widely distributed, it creates an immutable, crowd-sourced source of truth. Cryptocurrencies are built on this open protocol; the blockchain is what makes this decentralized asset class possible. Literally anyone can join the network and become incentivized to help the collective confirm transactions and continue to build the blockchain. Successful cryptocurrencies like bitcoin grow organically through this mechanism, and this network has quickly become the world’s most powerful super-computer by at least a factor of 4.

A Permissioned Blockchain is not a Blockchain

Permissioned blockchains are the “walled gardens” of 2017. They have value, but their value consists of bringing marginal improvements to the existing system. By confusing permissioned blockchains with cryptocurrency, we risk missing a paradigm-shifting disruption.

So how does a permissioned blockchain differ from the open blockchain networks that power Bitcoin and Ethereum?

While many permissioned blockchains use a few of the components from Satoshi Nakamoto’s blockchain (such as Merkle trees), they differ in extremely important ways. Permissioned blockchains function through a centralized authority that decides who can and cannot have access to the shared ledger. In the case of something like IBM’s Hyperledger, those who have access will most likely include large, established financial institutions. When you are registered on a permissioned blockchain, a central authority gives you certain rights or “permissions” to one or many closed blockchains.

Hyperledger is a solution built to be compliant with government regulation. This is a logical approach; it’s just not how disruption works. The Internet wasn’t built to a regulatory spec; instead, regulators evolved their system to address the unique problems the Internet created. In the case of Hyperledger, there is a dual need for anonymity and transparency. The ledger should be anonymous and unintelligible to all normal players who have access to it; this ensures that one institution can’t gain an advantage by using transaction information. However, the ledger also must be available to regulatory officials that need the ability to audit transactions and the parties involved in them. Hyperledger accomplishes this through a clever hack; for normal players, the blockchain is anonymized, but a central authority can essentially provide a decoder ring to auditors.

So, in summary, Hyperledger gives absolute control to a central authority. This authority can decide who does and doesn’t join the network. It can also decide who does and doesn’t get to see a decoded version of otherwise anonymized transactions. This is neither democratic nor transparent, and the network does nothing to prevent collusion, which is one of the main problems that cryptocurrency attempts to solve. Given the public’s deep distrust of financial institutions, exacerbated by the financial crisis of 2008, does a closed network that only these players have access to seem like the right solution for a new global finance network?

Permissioned blockchains also do not run on a currency. Blockchains can be useful without a currency, but the currency is what turns the protocol into a market, with clear incentives to grow the network and maintain its accuracy. Nodes are incentivized to review transactions, create blocks and receive a bounty for the use of their memory and processing power. In a closed blockchain, this sort of incentive is seen as unnecessary, since the blockchain’s members should have plenty of motivation to contribute to the network. In the case of Hyperledger, that motivation should come in the form of increased speed and efficiency.

However, without a currency, the network fails to encourage widespread involvement or reward its most dedicated constituency. This might be by design, but it leads to what I see as the biggest problem — without the involvement of a large, motivated user base, the network doesn’t cultivate innovation or experimentation. Did one organization design the Internet in 1998 and then just release a new version every year with updates? Were iOS apps truly interesting before Apple opened up its ecosystem to third party developers (and enable them to charge for their products)? Of course not. These networks became what they are through the innovations of thousands of developers around the world. Blockchains will be no different, and a permissioned blockchain is just setting itself up to be surpassed in exponential fashion.

What’s good about permissioned blockchains?

I want to make sure I’m clear; there are definitely good things that can result from permissioned blockchains. Anyone who has waited for a bank to clear a check or transfer funds understands the potential gains that a faster, shared ledger can provide. Permissioned blockchains can lead to important improvements in the speed and efficiency of collaboration among financial institutions.

If our goal is to take the existing system and improve on it, we could do a lot worse than a shared ledger. In an ecosystem where competing parties have potentially competing interests, a blockchain can serve as a strong consensus solution and therefore be a compelling improvement on a regular shared database.

That said, this is a marginal improvement on the existing system, equivalent to upgrading from an outdated database to its shiny, new competitor. It’s also arguable that you may not even need a blockchain to achieve this kind of improvement.

Take the example of Corda, a shared ledger produced by R3, which is a startup that began as a combined effort among financial institutions who wanted to leverage the blockchain. After spending a few years experimenting with solutions, R3’s executives realized that there wasn’t really a need to use a blockchain at all, and they instead opted for what is essentially a shared JAVA database. When you strip democracy, openness, and currency from the system, a blockchain just isn’t that useful or necessary anymore.

A distraction from what is truly disruptive

This is why permissioned blockchains are a dangerous distraction. By implementing a poor substitute for a public blockchain, financial institutions run the risk of persuading themselves that they are working on cryptocurrency. Instead, they will end up spending years building the equivalent of AOL’s walled garden, while all around them, the open protocols that power cryptocurrency explode in size and value.

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