The Canton Network Demonstrates Interoperability, Privacy, and Control: Clearing the Way for Greater DLT Adoption and Production

By enabling information to flow freely and efficiently, the internet paved the way for a plethora of applications, reshaping practically every industry. In financial services, it has dramatically increased the capacity to market, distribute, and service products, while slashing costs and boosting efficiency. It has improved convenience for consumers, helped broaden financial inclusion, and fueled innovation.

The next such revolution in financial services will be driven by distributed ledger technology (DLT), allowing value to flow as freely as information does on the internet. Momentum towards what BlackRock CEO Larry Fink describes as the “next generation of markets” is growing, with Citi’s latest wide-ranging survey on the evolution of securities services revealing that three quarters of financial institutions were engaging in DLT and digital asset initiatives as of last year, up from 47% in 2022.

Most of the current activity is focused on building and preparing for a new financial infrastructure that leverages DLT and tokenization through pilots and proofs of concepts. By eliminating the need for manual reconciliation and streamlining the settlement process, this infrastructure will deliver benefits on speed, efficiency and reduce cost of financial transactions. DLT is already being deployed by regulated financial institutions to enhance processes and create innovative products. However, the industry needs to solve the interoperability challenge in order to fully realize the technology’s transformative potential.

Interoperability, in the form of trusted, secure exchange of data and value within and across applications, is necessary to connect islands of otherwise fragmented liquidity, hasten user adoption, and pave the way for innovation by turning financial products into LEGO-like building blocks that can connect and interact with each other in different combinations.

Unlocking Possibilities
Interoperability will open the door to a new generation of use cases. Consider, for example, the possibilities that would be unleashed if, through interoperable DLT applications, the industry was able to unlock the estimated USD200 trillion worth of marketable securities tied up in today’s markets for use as collateral.

Until now, no public or private blockchain has been able to deliver interoperability fit for the regulated financial industry.

Public-permissionless blockchains are designed for interoperability and scale, but that means sacrificing privacy and control, with transactions transparent for all to see and control ceded to unknown validators of transactions.

However, privacy and data control are – and will remain – essential for regulated financial services. They must be hardwired in any technology that tries to solve its problems, making public blockchains unable to meet the industry’s interoperability needs. And another issue with public blockchains is that applications compete for global network resources, which can make it difficult for application operators to independently scale or choose on which infrastructure to deploy.

By using private-permissioned blockchains, operators could reclaim privacy and control, but this creates new isolated "walled gardens,” which severely restricts their potential to be scaled up. While value can be moved seamlessly within individual private networks, bridges are needed to move it between independent networks.

Bridges facilitate an interoperability of sorts, but reintroduce the counterparty, settlement, liquidity, and privacy risks that DLT is meant to eliminate. When using bridges, every connection or workflow between applications needs to be agreed upon, prioritized, and delivered. That makes this solution hard to scale, too. Moreover, bridges can be a significant liability, introducing a new attack surface that hackers have exploited to steal billions.

The Revolution is Nigh
Because of these limitations, financial institutions have so far been unable to truly leverage the efficiencies that DLT can deliver. That is set to change, however, following the successful completion of a comprehensive pilot for tokenized real-world assets by 155 participants from 45 major organizations, demonstrating settlement across 22 independent permissioned blockchains. Participants included the likes of BNY Mellon, Broadridge, Cboe Global Markets, DRW, DTCC, EquiLend, Goldman Sachs, Oliver Wyman, and Paxos and State Street.

The pilot involved executing over 350 simulated transactions on the Canton Network, which was launched in May last year by around 30 firms. This shows how a network of interoperable applications – which can be thought of as websites – can seamlessly connect via the Canton Network – which can be likened to the internet in this context – to enable secure, atomic transactions across multiple parts of the capital markets value chain. It also showcased the potential benefits of using such a network to reduce counterparty and settlement risk, optimize capital, and enable intraday margin cycles. Perhaps most significantly, the Canton Pilot demonstrated the multilateral transactions that reflect the realities of actual markets, as opposed to the bilateral transactions that have been previously demonstrated in other POCs.

The Canton Network was designed specifically to address the industry’s interoperability challenge with a unique public-permissioned structure that makes it possible for financial institutions to capture the benefits of scale found on public blockchains while remaining in control of data privacy at the sub-transaction level.

Connection sparks innovation
As part of the pilot, assets were swapped instantly for cash, lent out intraday, and leveraged as collateral. But this is just the beginning.

As more institutions embrace tokenization by lifting and shifting their businesses into the Canton Network’s ecosystem of assets, network effects will multiply the value created by new connections and transaction flows.

Furthermore, as participants are able to connect an expanding universe of assets and applications in ways that were previously impossible, innovation will flourish. After all, nearly all innovation stems from combining existing elements in new and different ways, producing sums that are greater than their parts. The arrival, at last, of blockchain interoperability aligned with the needs of regulated financial institutions promises to bring DLT into the financial mainstream.

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Authored by Digital Asset