Why Privacy Is Crucial for Scaling Blockchain Across Financial Services

The marriage of blockchain and traditional finance is a paradoxical relationship.

The financial services, banking and payments sectors are among the world’s most regulated. As for blockchain? The Web3 space has traditionally been a bit more of a free-for-all when it comes to regulatory frameworks and adherence to them.

Financial institutions (FIs) handle sensitive data that must remain confidential to comply with regulations like the General Data Protection Regulation (GDPR), California Consumer Privacy Act (CCPA) and banking-specific rules such as Basel III. These rules mandate strict data confidentiality, capital adequacy and anti-money laundering (AML) compliance. Big banks cannot afford to have counterparties, transaction details and trading strategies exposed on public blockchains.

At the same time, blockchain’s operational ethos is built on a disruptive level of transparency, decentralization and openness. The 2009 Bitcoin whitepaper explicitly sought to remove the need for FIs as centralized intermediaries, in large part by making transactions immutable and visible to anyone with internet access.

This tension between blockchain’s inherent transparency and the need for FIs to maintain customer confidentiality and privacy presents a paradox that FIs must resolve if they aim to unlock blockchain’s transformative potential.

However, as comments made Tuesday (Jan. 21) by Bank of America CEO Brian Moynihan show, the U.S. banking sector will embrace cryptocurrencies if regulators allow it. Bank of America holds over 80 blockchain-related patents, making it one of the leading financial institutions in terms of blockchain IP.

Still, President Donald Trump’s inauguration Monday (Jan. 20) lacked any concrete policy announcements regarding cryptocurrency, despite rumors and promises to the contrary.

Read also: 5 Blockchain Projects the World’s Biggest Banks Are Behind

For traditional FIs, blockchain technology poses an existential question. How can they use its efficiencies without compromising customer privacy or running afoul of regulators?

On one hand, blockchain’s transparency promises greater accountability, auditability and efficiency in areas like cross-border payments, supply chain finance and securities trading.

On the other, FIs must safeguard sensitive data, such as counterparties, transaction details and trading strategies, which public blockchains inherently expose.

The answer may lie in emerging hybrid blockchain models and privacy-enhancing technologies (PETs).

Hybrid blockchains combine the best of public and private blockchain frameworks. They allow FIs to manage sensitive transactions in a private environment while using the security and interoperability of public blockchains. For example, J.P. Morgan’s Onyx blockchain uses Quorum, an Ethereum-based platform, to facilitate private and secure transactions while maintaining interoperability with public Ethereum networks.

J.P. Morgan released a whitepaper last year titled “Project EPIC: Fueling Tokenized Finance With On-Chain Enterprise Privacy, Identity and Composability,” showing the use of blockchain technology to enhance privacy, identity and composability within financial ecosystems is increasingly being explored by traditional banks and financial players.

PETs further address the confidentiality challenge. Zero-knowledge proofs (ZKPs) and secure multiparty computation (MPC) are also emerging. ZKPs enable one party to prove the validity of a transaction without revealing the underlying data, while MPC allows multiple parties to compute a function collaboratively without exposing their individual inputs. Both solutions are increasingly being adopted by FIs to ensure compliance with privacy laws while embracing blockchain’s capabilities.

See also: Why Banks Might Want to Have a Blockchain Strategy

The PYMNTS Intelligence report “Blockchain’s Benefits for Regulated Industries” found that blockchain technology has numerous potential benefits to serve the unique needs of regulated industries, including finance.

“As more banks integrate blockchain capabilities, customers will have greater choice in transferring value,” FV Bank CEO Miles Paschini told PYMNTS this month. “We’re blazing the trail for a future where blockchain is just another payment rail.”

Yet, without robust privacy mechanisms, blockchain adoption in financial services may be limited to niche use cases that don’t require stringent data protection.

“The largest financial institutions are eager to explore tokenized assets,” but they require regulatory certainty to do so at scale, Nikola Plecas, head of commercialization at Visa Crypto, told PYMNTS in October.

Ultimately, the relationship between blockchain and traditional finance exemplifies the broader tension between innovation and regulation. By embracing this paradox and investing in privacy-preserving technologies, collaborative frameworks and regulatory clarity, the financial industry can turn blockchain’s transparency from a challenge into a competitive advantage.

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