Permissionless blockchains represent an innovative perspective for enhancing the traditional financial infrastructure. This article is based on research conducted by Fabian Schär of the University of Basel and prepared for the European Commission, Directorate-General for Financial Stability, Financial Services and Capital Markets Union. The research was completed in October 2024, with the support of Ivan Keller, Gundars Ostrovskis, Vasiliki Kalimeri, Matthias Nadler, Katrin Schuler, and Dario Thürkauf, and also involved collaboration with the Center for Horizontal Policies B4 for Digital Finance. This article focuses on the fundamental characteristics, potential advantages, and challenges that these technologies can bring to the financial sector, specifically examining how their neutrality, inclusiveness, and transparency can foster interoperability and competition in the global financial market.
Introduction to Blockchain Technology
Permissionless blockchains are based on a network of distributed nodes that operate without the need for a central authority to ensure trust between parties. This decentralized structure is essential for ensuring that anyone can participate in the network without restrictions, allowing complete neutrality and ensuring transparent access. In permissionless blockchains, every node is equal, and there are no intermediaries that can alter or influence transactions without the consent of the entire network.
One of the central elements defining a permissionless blockchain is transaction capacity. The attached research highlights that the capacity to process transactions in permissionless blockchains is, at present, limited compared to traditional financial systems. Blockchains like Bitcoin and Ethereum, for instance, can handle only about 7 and 30 transactions per second, respectively, compared to the tens of thousands of transactions per second processed by centralized networks like Visa. This represents a significant challenge, especially if blockchains are to support global volumes of financial activity. However, innovative techniques such as sharding and Layer 2 protocols (e.g., rollups and state channels) are seeking to improve scalability without compromising network decentralization.
Transaction legitimacy is another fundamental aspect. Every transaction must be cryptographically verified to ensure the network's security and integrity. The use of cryptographic signatures ensures that only the holder of a specific private key can authorize a transaction. This legitimacy is managed through two main models: the UTXO (Unspent Transaction Output) model, used by Bitcoin, and the account-based model, adopted by Ethereum. In the UTXO model, every transaction tracks unspent outputs, creating a sort of value chain that increases security and traceability. Conversely, in the account-based model, each account has an associated balance, and the transaction simply reduces the sender's balance and increases the recipient's. Both models have advantages and disadvantages: for example, the UTXO model offers greater privacy, while the account-based model is more intuitive for those familiar with traditional financial systems.
To maintain the consistency of the ledger state, the blockchain uses distributed consensus mechanisms, such as Proof of Work (PoW) and Proof of Stake (PoS). PoW, used by Bitcoin, ensures network security by requiring nodes to solve complex mathematical problems, with high energy consumption. PoS, adopted by Ethereum with the transition to Ethereum 2.0, offers a more sustainable alternative, based on token ownership that is staked to participate in the consensus process. Both mechanisms are designed to ensure that the network reaches a common agreement, even in the presence of malicious actors, thus ensuring the integrity and security of the blockchain.
Another important aspect of permissionless blockchain is programmability through smart contracts. These contracts allow for the automation of complex operations such as loans, insurance, and derivative transactions without the need for intermediaries. However, the research highlights that these smart contracts are only as secure as the code that defines them. Vulnerabilities in the code can lead to significant security issues, as evidenced by some notable hacking incidents in DeFi (Decentralized Finance) protocols.
Furthermore, the blockchain operates on a peer-to-peer (P2P) network infrastructure, where all nodes participate in sharing information without the need for a central server. This increases the network's resilience, as there is no single point of failure that could compromise the entire system. Each node maintains a mempool, which is a queue of transactions waiting to be included in the blockchain. The process of selecting transactions from the mempool is essential to ensure efficiency and fairness in confirming operations.
Finally, the concept of consensus on the sequence of transactions is crucial for the functioning of the blockchain. The sequence of transactions can influence their outcome, especially in DeFi applications, where the order of operations can determine the difference between gaining or losing value (a phenomenon known as Maximal Extractable Value - MEV). Solutions to mitigate risks related to MEV include mechanisms for content-agnostic transaction ordering and the adoption of protocols such as proposer-builder separation (PBS).
These elements form the technological basis of permissionless blockchains and define their advantages and challenges compared to traditional financial systems. The ultimate goal is to create a more open, transparent, and inclusive financial infrastructure, but continuous innovation in both technology and regulation is necessary to achieve this.
Advantages and Features of Permissionless Blockchains
One of the main strengths of permissionless blockchains is their programmability. Thanks to smart contracts, it is possible to automate various financial operations, such as executing payments and managing loans. However, the true innovation is not just the ability to program processes but rather the ability to do so on a neutral, shared basis, without the need for trusted intermediaries. This way, potential points of vulnerability are eliminated, and the costs associated with third parties are reduced.
Another fundamental aspect of permissionless blockchain is composability, which allows the creation of new financial services and products by leveraging the ability to combine different protocols and assets within the same network. This approach enables the construction of innovative solutions, such as the integration of lending protocols in derivative markets, thereby increasing the flexibility and modularity of the financial ecosystem. According to the research, composability is one of the main factors driving the formation of a dominant base layer, as it allows for the maximization of network effects and the creation of an ecosystem comparable to that of a platform economy.
Liquidity is another crucial benefit derived from the use of permissionless blockchains. With the ability to have different assets and numerous protocols available on the same platform, integrating liquidity from different sources becomes simpler and more immediate. This advantage is particularly evident in decentralized exchanges (DEX), where tokenized assets can be exchanged without the need for a centralized intermediary, ensuring faster settlement times and lower transaction costs compared to traditional exchanges.
Another distinguishing feature is the atomicity of transactions. Atomicity ensures that all operations in a transaction are executed simultaneously, eliminating the risk of partial failure. This property is particularly useful in the context of complex financial transactions, such as delivery versus payment (DvP) operations, where both parties want to be sure that asset delivery and payment occur simultaneously. Blockchain enables these transactions to be executed in a fully automated and secure manner.
Permissionless blockchains also enhance the transparency and neutrality of financial operations. Since every transaction is recorded on a public ledger, it becomes possible to independently verify the validity of transactions and monitor value flows within the network. This level of transparency has been recognized in the research as an important advantage for reducing informational asymmetries and ensuring that no actor can have undue advantages over other participants. Furthermore, the neutrality of permissionless blockchains eliminates the need for intermediaries with the power to discriminate access or impose arbitrary rules, promoting a more equitable and open infrastructure.
Finally, the adoption of permissionless blockchains can reduce dependency on centralized infrastructures, thus mitigating risks associated with market power concentration. As highlighted in the research, centralized platforms, if not adequately regulated, can exert excessive power, extract economic rents, and create lock-in problems for users. Permissionless blockchains, on the other hand, promote competition and innovation, allowing the emergence of new players that can help improve the offering of financial services.
Challenges: Scalability, Privacy, and Transaction Sequencing
Despite the advantages, permissionless blockchains present several challenges that need to be overcome to be used as the foundation for traditional financial services. The first challenge is scalability. Currently, most blockchains struggle to handle large volumes of transactions. Increasing processing capacity without sacrificing decentralization requires innovative solutions, such as implementing layer 2, sharding, and efficiency optimization techniques. According to the research, solutions like optimistic rollups and zk-rollups have been proposed to significantly improve transaction capacity while ensuring security and decentralization. Zk-rollups, in particular, use zero-knowledge proofs to ensure transaction validity without the need to transmit every detail, thus improving both scalability and privacy.
Additionally, the implementation of state channels and plasma chains are key strategies for addressing scalability issues. State channels, like those used in Bitcoin's Lightning Network, allow users to make transactions off the main blockchain, limiting the blockchain's use to only the opening and closing of the channel. This significantly reduces the number of transactions that need to be processed on the main blockchain, improving execution speed and reducing transaction costs.
A relevant aspect to consider concerns privacy protection. While blockchain transparency is essential to ensure transaction security, it can pose an obstacle for users who require a high degree of confidentiality, especially in the institutional financial sector. According to the research, one of the main problems is excessive transparency, which allows anyone to observe and analyze all transactions, including amounts and counterparties. To address this issue, various privacy-enhancing protocols, such as zk-SNARKs and ring signatures, have been developed. Zk-SNARKs, for example, allow verification of a transaction without revealing specific details, while ring signatures offer a level of anonymity by creating a sort of "mixing" of public keys, making it difficult to trace the transaction's sender.
Some projects are exploring the use of fully homomorphic encryption (FHE) to enable computation directly on encrypted data. This approach could be used to ensure user privacy while maintaining the verification and control functionality necessary for regulatory compliance. Another method in development is the use of advanced zero-knowledge proofs, which allow demonstrating the validity of transactions while keeping both the parties involved and the details of the operation anonymous.
Finally, transaction sequencing represents an important challenge. Nodes responsible for confirming transactions can benefit from the order of transactions, a phenomenon known as Maximal Extractable Value (MEV). According to the research, MEV occurs when validators manipulate the transaction order to extract additional value, often at the expense of users. To mitigate this problem, mechanisms such as proposer-builder separation (PBS) have been proposed, in which the task of building blocks is separated from that of proposing them, thereby reducing opportunities for manipulation of sequencing. Additionally, the use of timelock encryption and threshold encryption allows temporarily hiding transaction content during selection, ensuring that the validating node cannot improperly influence the order of transactions.
Adopting models like PBS could reduce the economies of scale of larger validators, making the value extraction process fairer and supporting decentralization. However, the technical complexity of these mechanisms and the need for coordination among nodes pose additional operational challenges and centralization risks, especially if a small minority of actors manage to dominate the block builder market.
These challenges, although significant, also represent opportunities to improve the technological infrastructure and security of permissionless blockchains, making them increasingly suitable to support complex financial services in an open and decentralized environment.
Future Opportunities
Permissionless blockchains offer a unique opportunity to create a more open, transparent, and competitive financial infrastructure. However, a prudent and gradual approach is needed to introduce these technologies in regulated environments, starting with limited experiments that allow evaluating their effectiveness and security. For example, issuing securities for small and medium-sized enterprises on a public blockchain could represent a concrete first step towards integrating this technology into traditional financial markets.
According to the attached research, one of the main opportunities for permissionless blockchains lies in their ability to reduce reconciliation and settlement costs. In traditional financial systems, settlement operations can be slow and expensive, often requiring numerous steps between different entities. Blockchain, with its ability to guarantee transaction finality in an automatic and verifiable manner, could break down these barriers, reducing not only costs but also settlement times. The research estimates that the use of blockchains could potentially reduce operational costs by up to 30%, improving the system's overall efficiency.
Moreover, blockchain could facilitate the integration of different financial systems, enhancing interoperability between various markets and platforms. Currently, many financial services operate in isolation, with little interoperability between different providers. Integration on a public blockchain could enable the creation of a global network that allows the secure and transparent sharing of financial information between different institutions, fostering greater competition and reducing costs for end-users. According to the research data, improving interoperability could lead to a 15-20% increase in cross-border transaction volumes by 2030.
Another significant opportunity concerns the use of blockchains for the tokenization of traditional assets. This process allows representing assets such as real estate, equity, or bonds digitally on a blockchain, making their transfer easier and increasing liquidity. The research highlights how asset tokenization could create new financing opportunities for small and medium-sized enterprises (SMEs), which could leverage decentralized capital markets to obtain funding with fewer barriers than traditional channels. Estimates suggest that the tokenization market could reach a value of 16 trillion dollars by 2030, thanks to greater accessibility and reduced entry barriers.
In terms of financial inclusion, permissionless blockchains offer an unprecedented opportunity to expand access to financial services, especially in less developed regions. Since they do not require traditional intermediaries, they can enable millions of unbanked people to participate in a global economic system, providing access to loans, savings, insurance, and investments. This is particularly relevant in developing countries, where barriers to accessing financial services are often insurmountable. According to the research, blockchains could help reduce the number of unbanked individuals by over 1.7 billion by 2030, improving quality of life and economic opportunities for large segments of the world population.
Permissionless blockchains can also support the creation of new models of decentralized governance. This type of governance, based on predetermined and transparent rules, allows for more equitable and participatory resource management without the need for a central authority. Decentralizing the decision-making process could lead to greater trust from users, especially in sectors where trust in traditional institutions is low. The research highlights that 60% of respondents believe that adopting blockchain-based governance systems could improve transparency and reduce corruption in financial institutions.
It is essential that policymakers and financial operators work closely together to explore the potential of public blockchains, without prejudice but with awareness of the challenges that still need to be addressed. Only in this way will it be possible to understand whether and how these technologies can contribute to more efficient, inclusive, and secure finance. Collaboration between the public and private sectors will be crucial to developing regulatory frameworks that can accompany innovation without stifling it, while ensuring user safety and protection.
Conclusions
The analysis of the impact of permissionless blockchains on the financial sector offers a strategic vision that goes beyond the usual technological and operational advantages. The neutrality, inclusiveness, and transparency of this technology are fundamental elements for a profound transformation of the financial system. However, to fully understand the strategic potential of permissionless blockchains, it is essential to consider aspects that go beyond their simple technical implementation.
This innovation stands out for its ability to redefine competitive dynamics in the sector. Currently, financial infrastructures often operate with centralized governance models that tend to consolidate dominant positions and create lock-in costs for users. In contrast, the elimination of the need for intermediaries offered by permissionless blockchains introduces an open and shared infrastructure that stimulates competitiveness and promotes innovation. This approach results in reduced entry barriers for new operators and democratizes access to financial markets on a global scale.
Another element, although less explored, concerns the possibility of enabling more inclusive and innovative forms of governance. While traditional systems rely on decisions made in closed environments, the introduction of decentralized governance mechanisms in public blockchains allows for the involvement of a plurality of actors. The increased transparency derived from this model reduces the risk of arbitrary decisions or those misaligned with the long-term interests of various stakeholders.
The adoption of permissionless blockchains, from a strategic perspective, represents a paradigm shift rather than just a technological choice. The possibility of creating innovative business models, based on interoperability and composability, offers new perspectives. Composability refers to the ability to combine and integrate services and products in innovative ways, giving rise to modular and dynamic ecosystems. This characteristic makes permissionless blockchains enabling platforms for a sharing and knowledge economy.
Despite their potential, significant challenges remain concerning scalability and privacy protection. Technological solutions such as layer 2, additional structures built on top of the main blockchain, or zero-knowledge proofs, which allow proving the validity of an operation without revealing its details, seek to address these issues. However, large-scale adoption will require balancing technological efficiency, regulation, and user trust. The ability to meet stringent requirements in terms of security, performance, and regulatory compliance will be decisive, while maintaining the fundamental principles of openness and decentralization.
An additional reflection concerns the cultural impact that this technology can have on the financial sector. It is not just about implementing new technological infrastructure but rethinking the core values of the financial system itself, such as transparency, equity, and inclusiveness. The opportunity to optimize operational processes while strengthening trust and creating long-term sustainable value for all stakeholders is a crucial aspect.
In an increasingly interconnected world, permissionless blockchains do not simply represent an option among many but can form the basis for a more resilient and democratic financial system.
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