Essentially, the problem with the existing public infrastructure comes down to the fact these chains were built on principles that contradict market requirements. Regulated capital markets require identity, compliance, confidentiality, and deterministic finality. Yet the existing blockchains were built for pseudonymity, censorship resistance, and transparency, and relied on probabilistic settlement.
Polymesh is a securities-specific blockchain, purpose-built to address these issues with identity, compliance, confidentiality, governance, and settlement. By incorporating each into the core of the chain’s architecture, Polymesh has the potential to redefine the future of banking and finance by providing, for the first time, a chain that is capable of truly capturing the transformative potential of blockchain technology in a way that is compatible with capital markets.
Of course, it might be possible to overcome these issues by layering on existing infrastructure too. The problem with building on existing infrastructure, though, is that it ultimately only makes the process more inefficient. Extensive improvements would be needed, but these changes would occur in lengthy phases involving tiny incremental improvements. The increased complexity of the technology would only lead to new questions and constraints for regulators to consider. And finally, as we saw with smart contracts and standardization, it would likely require increased processing time and ultimately slow the process down.
Let’s now take a brief look at exactly how Polymesh is purpose-built for each of the five pillars.
Pillar #1: Identity
Securities regulation dictates that securities must be associated with an identity, but most chains were built for pseudonymity and censorship resistance. This makes it difficult to meet compliance requirements around identity verification and KYC obligations without some kind of layer-2 add-on, which only creates additional complexity in the end-to-end solution.
In contrast, Polymesh uses customer due diligence to ensure all actors on the chain are verified. A single identity on the chain is created for each real-world individual or organization, and attestations can be attached to this identity as needed. This modular two-stage approach to identity verification allows for efficient onboarding as well as specific checks.
Polymesh requires a verified identity for all participants, including block producers who will bring about transaction finality. This prevents pseudonymous entities from participating in the network and receiving transaction fees and also contributes to the chain’s security.
Pillar #2: Compliance
It’s important to provide an environment that allows the enforcement of transfer restrictions at scale for a large number of asset holders and assets. Unfortunately, most blockchains struggle with the complex logic needed to comply with the myriad of regulations security tokens are subject to.
While proprietary solutions can be built on top of the chain and automate key steps, as users begin to layer on successive rules, the number and complexity can push the chain to its computational limits. This drives up costs and processing time.
In comparison, Polymesh gives issuers the flexibility to set rules around ownership and transfer requirements based on their specific needs. Once the issuer inputs preferences and restrictions, Polymath’s technology automates its enforcement. Because this functionality is built into the core of the chain rather than as an add-on, even very complex compliance requirements can be automated efficiently (and cost-effectively) at scale.
Pillar #3: Confidentiality
Capital market participants value confidentiality and privacy. Financial institutions must protect client information to comply with privacy requirements and safeguard their own financial interests. Non-reporting entities, usually with a small pool of shareholders, often do not want any ownership or transfer information to become public. On general-purpose blockchains, layer 2 solutions can be used to make transactions and balances confidential, but to add transaction privacy, they must sacrifice the ability to automate compliance checks or ownership reporting.
Because Polymesh is intended for securities, it makes it possible to transfer and hold assets confidentially, while still automating compliance checks and cap table updates. This is done through MERCAT, a new patent-pending protocol for securely managing assets in a confidential and auditable way. MERCAT uses a hybrid design approach that combines zero-knowledge proofs with restrictions enforced by trusted mediators, giving issuers the option to make transactions with their security token confidential during configuration.
Pillar #4: Governance
Governance is a difficult topic for any blockchain, but especially when it comes to security tokens. In this case, the chain is not only the source of truth for potentially billions of dollars, but must also allow investors, issuers, and capital market participants to fulfill their regulatory obligations. Because of its decentralized nature, when there is a disagreement, a blockchain can be split into two separate chains, known as a fork, which can expose major legal and tax challenges for security tokens.
Polymesh addresses the challenges general-purpose blockchains face with governance by building it into the core of the blockchain. Normally, blockchains are susceptible to forks during upgrades. Polymesh is built on Substrate Framework, which provides Forkless Runtime Upgrades. This allows for seamless upgrades on the chain to avoid the risk of hard forks. In addition, Polymesh relies on a council of key stakeholders to review Polymesh Improvement Proposals submitted by committees or token holders, find a consensus, and chart a path forward for its future development. This provides a means of steering the chain past potential issues or disagreements.
Pillar #5: Settlement
Existing public blockchains rely on probabilistic finality - i.e. the assumption that after a certain amount of time (counted by a number of blocks produced in the chain), the cost of reverting a transaction would outweigh its benefits. Yet for the blockchain to contain a true representation of ownership and meet capital markets requirements, it must provide rapid and deterministic finality.
By creating assets at the protocol layer, Polymesh is able to provide a simplified approach to transfers and deterministic finality. It reduces delivery failure without requiring pre-funding and can provide deterministic transaction finality through the GRANDPA finality gadget, as well as stringent identity verification requirements, a comprehensive compliance validation framework, and a forkless upgrade process. In essence, settlement finality is possible on Polymesh because of how identity, compliance, and governance are woven together in the core of the chain.
In the coming weeks, keep an eye out for more blog posts containing information about Polymesh and its operations.