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How to Determine the Difference

Introduction to a Private Blockchain

A #private blockchain is a system, commonly known as a “Distributed ledger” that has an access control layer built into the protocol [1]. This means the network participants have control over who can join the network, and who can participate in the consensus process of the #blockchain.

This is in contrast to a public blockchain, which is open for all to participate in — as a user, as an entity that determines the validity of transactions, and the consensus process. Private blockchains, therefore have a very different level of security than public blockchains like #Bitcoin [2].

Private blockchains are a class of distributed ledgers that use transactions and blocks, first described in Bitcoin. Distributed ledgers are shared databases with access protection rights, with defined rules on what types of changes can be performed by what entities.

The value of distributed ledgers at the enterprise level arises from the ability to do away with the reconciliation of data among participating entities [3]. This is especially the case with financial institutions that trade with one another.

A lot of effort on the back-office today is spent in the reconciliation of records among different institutions [4]. Instead, distributed ledgers allow financial institutions to maintain a structurally consistent shared #database of transactions. This allows each participating institution to read data from the distributed ledger and be guaranteed that it is valid and reconciled against the data held by the other participating institutes.

Difference between a Public and Private Blockchain

Distributed ledgers are inspired from Bitcoin and other public blockchains. However, they differ in their fundamental characteristics of access and security promises.

The security of a public blockchain like Bitcoin comes from its proof of work, which makes it mathematically impossible to fake or reverse transactions without miners colluding, using the current state of #technology [2].

On the other hand, the security promises of distributed ledgers and private blockchains are only as good as the honesty of the entities validating the transactions. There are no mathematical guarantees behind the irreversibility of transactions in a private blockchain.

Blockchain vs. Shared Database

There is considerable debate in the community in the value of a private blockchain over a shared database. Some, like Prof. Arvind Narayanan of Stanford, contend that private blockchains are just another name for a shared database [2]. Others, like Gideon Greenspan of Multichain see several differences between private blockchain and SQL like databases, from disintermediation to robustness [5].

Traditional databases are completely contained within one entity, irrespective of their structure (SQL or no-SQL type databases). This includes read and write access, which is only possible via applications controlled by the entity to which the database belongs [9]. Shared databases, on the other hand, involve read and write access involving multiple entities.

Private blockchains mimic the security process utilized by public blockchains like Bitcoin, but do not involve mathematical guarantees at the validation level or with respect to irreversibility.

However, they still make use of cryptography and data structures like Merkle trees to ensure non-valid transactions aren’t added to the blockchain [6].

At the end of the day, private blockchains provide higher levels of error checking and transaction validity than regular shared databases.

Even though they don’t use proof of work, blocks of transactions are validated using some other forms of consensus mechanism. This can still be chosen to be Byzantine Fault Tolerant (BFT).

The most popular such algorithms include Raft [7] and Juno [8]. These consensus protocols work based on a leader-follower model, wherein for each block a leader is selected who creates the block and adds to the blockchain. There are various ways in which errors and anomalies are then corrected by the system.

The Security Paradigm

Shared databases in the past have suffered from the inability to prevent malicious activity. This would be the case, for example, when one of the participating entities is hacked, and that entity writes ‘corrupted’ data into the shared database, thus making it invalid for everyone involved.

This specific problem also exists in centralized databases.

Private blockchains solve this problem using cryptography and technologies similar to what Bitcoin and public blockchains use.

In addition, the consensus protocols used by private blockchains today are “BFT Hardened”, such as Juno [8]. This improves the security features of the blockchain by protecting against insular hacking cases, thus preventing individual participants from acting in a malicious manner.

Why Banks and Financial Institutions Choose a Private Blockchain

#Banks and financial institutions have been increasingly investing in blockchain technology.

However, most of this effort has gone towards the private blockchain space.

There are many reasons for this. Private blockchains scale significantly better than public blockchains [6] and the network parameters, such as network congestion and transaction fees are known in advance.

The underlying protocol development is also more predictable in the case of a private blockchain, and gives more control to the banks that control it.

Also, banks and financial institutions are regulated entities that cannot operate over open protocols without performing due diligence of the parties involved in the transaction [10]. It is unclear whether regulations require miners to be identified for certain classes of transactions to provide settlement finality.

There is also a reputational risk involved in using Bitcoin, which has been much maligned in the media with the associations to drug trade and exchange hacking.

However, even today, many private blockchains ‘anchor’ to a chain like Bitcoin periodically to ensure the integrity of its data.

Challenges in Launching Private Blockchain Consortiums

By their very nature, private blockchains require different entities to come together and agree to a common set of standards by which it will operate. This is challenging due to legacy inertia and due to the differing requirements of different participants in the system.

There are also unanswered questions around who should have the power to add or remove members, and which jurisdictions should be allowed to intervene (for example to reverse transactions due to legal or regulatory reasons).

The first problem is partly being solved by Hyperledger, a Linux foundation initiative that aims to provide common blockchains standards [11].

The future of these competing ideologies will be incumbent on issues of governance, scalability and reputation. These mandates will be required by incumbent institutions but conceived by innovative blockchain startups that see opportunity in mainstreaming the concepts of a blockchain, distributed ledger, and consortium chains.

Originally published at intrepidreview.com on October 4, 2016.

I’m always interested in meeting blockchain startups, and Chief innovation officers who are creating transformational products, so please feel free to contact by email at [email protected]

Collin Thompson is the Co-founder, and Managing Director of Intrepid Ventures, a blockchain startup and innovation studio that invests, builds, and accelerates Blockchain and #FinTech companies solving the world’s most difficult problems. Collin focuses on early stage investments, innovation and business design for corporations, governments and entrepreneurs working with blockchain technology.