Blockchain: we need to talk about governance
The booming speculative interest in cryptocurrencies during 2017 put a spotlight on the underlying technology that enables them: distributed ledgers, more commonly known as ‘blockchain’. Riding this wave of momentum, a number of sophisticated blockchain platforms have since emerged that, from a technical perspective, offer all the building blocks needed for credible enterprise-grade transaction solutions.
Despite this, my engagement with banks’ internal innovation teams seeking to bring blockchain applications to market has left me doubtful of their achieving mainstream production use. This is not a criticism of the talented people I’ve met, nor their passion for the technology. If anything, the focus on the technology is part of the problem: it fails to recognise the pivotal role that governance will play in determining the success of any blockchain project – arguably more so than the technology itself.
Governance is one of the first challenges that any blockchain project needs to confront when progressing from an internal proof-of-concept to a more substantial, inter-organisational exercise. Often, the participating organisations opt to establish a joint company, both to develop intellectual property inherent in the coded product and to govern the platform operationally (managing membership, setting technical rules, etc.). A variant to this model involves a large software vendor offering a blockchain platform to its customers and naturally assuming a governance role over it. Both models trend toward a similar outcome: centralised control of a blockchain platform by a single, quasi-autonomous corporate interest.
Such a centralised governance model poses several challenges to participation by banks and other institutions:
- Vendor lock-in: once a bank and its transacting partners become dependent on a given platform, migrating en masse to another platform can become operationally impossible. The provider then enjoys significant power to levy fees, etc., which can undermine the original cost/efficiency rationale for banks to adopt the DLT solution.
- Financial risk, implicit if the platform is the system of record for financial assets. Take, for example, a blockchain designed to manage tokenised cash: a body with technical control over the blockchain’s consensus mechanism could invalidate participants’ cash assets at will. Likewise, an authority empowered to govern its membership could render a participant unable to transact with others, leaving their assets permanently frozen. Incorrect use of such powers, through error or illicit action, could result in huge financial damages which a conventional legal system may not be well placed to recover.
- Loss of differentiation: A blockchain is necessarily more complex than a conventional Software-as-a-Service (SaaS) application served by a central authority. As a consequence, it is a less performant option which, overall, requires more resources to maintain. If the governance model requires a blockchain to be operated in the same way a SaaS platform would be, it follows that it will fail to demonstrate a positive business benefit over the conventional alternative.
Banks must now devote considerable resources to addressing these issues if the vision of authoritative, scalable blockchains in finance is to be achieved. At a minimum, two types of governance must be considered:
- Technical governance of the software: design decisions over how identities and assets are represented, what consensus mechanism(s) are used, etc., both now and in the future
- Operational governance of the network(s) in which the software is deployed: determination of membership, operating standards, legal framework, dispute resolution mechanisms, etc.
This doesn’t mean that blockchain adoption should be put on hold until the governance question has been fully answered. Governance models can evolve over time and a centrally-governed blockchain platform can, in principle, migrate towards decentralised governance in later stages. In fact, banks have a crucial role to play in obliging platform providers to innovate governance models beyond traditional vendor-customer roles.
To have a voice in that evolution, banks must take on a role as active, paid-up members of blockchain projects. Forming effective partnerships with blockchain consortia or software vendors is an important first step – it remains the most likely route to building viable networks of transacting partners. Having done so, however, banks must not behave as passive customers, ambivalent on questions of technical and operational governance. It is these topics which will make or break blockchain as a keystone in the foundational infrastructure of tomorrow.