The Inadequacies of Ethereum for Securities
Ethereum has pioneered some great ideas by attempting a generalized blockchain platform for decentralized apps and introducing the very catchy concept of ‘smart contract.’ Creating a truly decentralized technology, while providing economic incentives for participants and addressing issues of performance, is a very ambitious undertaking unto itself.
Trying to use Ethereum (or ERC-20 and it’s evolutionary versions) for legal securities raises the question of ‘the right tool for the right job.’ Vitalik wisely pointed this out way back in 2016, where he examined various arguments against the use of Ethereum for financial transactions, concluding, “Hence, all in all, the weaker argument, that for high-value assets the economic security margin of public blockchains is too low, is entirely correct and depending on the use case is a completely valid reason for financial institutions to explore private and consortium chains.”
Vitalik’s full article explores various trade-offs and contains a description of ‘weaker’ versus ‘stronger’ argument. It is well worth the read. [He writes in the context of settlement finality, a topic that I’ll comment on in a subsequent post.]
The wrong tool for the job
I think it’s important to study the characteristics of the problem space carefully and determine what tools and technologies will address the problem. Technologists have to be diligent in guarding themselves against the shiny-object syndrome. The underlying philosophy also plays a role in the choice of technologies (or any other type of solution, for that matter). Are we seeking to keep some of the status quo but introduce efficiencies? Are we trying to completely disrupt and cause a wrenching revolutionary upheaval?
For the securities industry, one of the most important requirements that I think would be undesirable to circumvent is investor protection. If we keep an open mind, securities regulation is designed to provide some of these protections. Arguably, some of the regulation is draconian, much of it inconvenient, and some of it provides loopholes or benefits some participants inequitably. What we need to think about is how to preserve the good intent of regulation while increasing efficiencies in cost and process.
Others are independently coming to similar conclusions. For example, Jesus Rodriguez, in his thought-provoking article, “The Case Against Security Token in Ethereum,” points out, “…there is a significant probability that Ethereum might not be the platform of choice to implement security tokens in the long run.”
What is the tip-off that the tool doesn’t fit the job? Continual rounds of patching, tweaking, and a redesign of the fundamental architecture, whether the issue is performance, scalability, security, or functionality. Other tip-offs are the Rube-Goldbergian methods of implementation, an issue that Vitalik, in the above-referenced article, recognized and agreed was a reasonable observation about applying Ethereum to financial use cases. Jesus Rodriguez also comments, “Can you model asset ownership in Ethereum? Yes, but it feels like a never-ending hacking exercise.” [Italics his.]
The best car is not a boat
A few examples where Ethereum is susceptible to Rube-Goldbergian hacking are the tortuous formulations for economic incentives that also prevent centralization, the difficult tradeoffs for personal anonymity versus legitimate participants (as well as legal recourse), performance and scaling, trustless consensus that also avoids collusion or forking, and so on.
To be fair, these are not trivial issues. I am continually amazed at the ingenuity of the Ethereum developers in creatively addressing them. Unfortunately, the nature of the problem space is full of unyielding alternatives, a bit like the Heisenberg Uncertainty Principle (or, in laypeople’s terms, you can’t eat your cake and have it too).
I think of Ethereum as a beautiful car. Continuing developments are adding power, size, and advanced ‘electronics’ to it. I’m confident that we will see some interesting and practical use cases emerge out of it. However, the deep and stormy oceans of global securities require a powerful Navy ship, not a Ferrari.
In a subsequent post, I’ll describe how the architecture of the KoreChain and the KoreToken Protocol, based on Hyperledger Fabric, are engineered from the ground up with a singular focus on the requirements of global financial securities. I’ll discuss how the KoreChain and KoreToken provide the technology foundation for managing the complete lifecycle of securities (from issuance, trading, corporate lifecycle actions, and exits), while also ensuring full compliance with securities law and corporate law in multiple jurisdictions worldwide.
Kiran Garimella, Ph.D., is the chief scientist and chief technology officer at KoreConX, leading the strategy and development of blockchain and machine learning solutions. A sought after speaker and author, Kiran has more than 25 years experience in information technology, consulting and financial services.