TL;DR: A new open source tool developed by Tezos corporate bakers lets users choose which bakers to interact with, which makes CSR and regulatory compliance easier.

 

When considering or designing a business project around blockchain technology, organizations are increasingly paying attention to legal and compliance aspects.

Energy consumption, sustainability, data protection, anti-money laundering rules, and regulatory risk are among common concerns voiced. In this post, we put the spotlight on a project created by one of our corporate bakers to help address such concerns.

It sent shockwaves through the crypto space when the US Treasury’s Office of Foreign Assets Control (OFAC) recently added Ethereum-addresses of privacy-preserving service Tornado Cash to its sanctions list, citing concerns the service was used by North Korean hackers.

This made interaction with Tornado Cash illegal for US citizens and businesses, and raised questions of possible retroactive “tainting” of assets and addresses.

While the decision is being widely challenged, including legally, such actions can put a damper on corporate appetite for the use of blockchain technology.

In order to create more certainty around compliance for corporate and institutional users, a new tool has been launched for the Tezos blockchain.

This tool is called “Choose Your Baker” and is an open source software solution developed by the IT service company Coeyxa with the technical support of Société Générale - Forge, Coinhouse, Ubisoft, and Nomadic Labs.

It allows users to choose which bakers (validator nodes that add new operations to the blockchain) on the Tezos network they wish to interact with. This guarantees that operations submitted will only be processed and included in blocks by a selected subset of bakers – i.e. those that are deemed as meeting the relevant compliance criteria.

Before we continue, let’s also make clear what “Choose Your Baker” isn’t:

  • It is not part of the Tezos blockchain protocol. It is an external tool, integrated locally by a user.
  • It is not a tool for censorship of others. It simply allows users to select which bakers they will use for submitting operations.

With that underscored, let’s look into the hows and whys of “Choose Your Baker”.

 

Ensuring compliance for security tokens

In most geographic areas, including in Europe, regulation now authorizes the tokenization of non-listed financial instruments, called security tokens (STOs), and Tezos is already a popular blockchain for such tokenizations.

Digitalised financial instruments bring a lot of advantages compared to the more traditional paper-based OTC process. More specifically, it enables instant transactions and settlement between parties.

Because STOs are financial instruments, they fall under different national and international regulations, including anti-money laundering, countering the financing of terrorism, and trade and financial embargos.

And because the risk of working with non-compliant bakers is borne by the operation’s issuer, it may be necessary to make sure such operations are not processed by bakers that don’t comply with relevant regulations on financial instruments. 

For example, a financial institution may want to make sure they are not potentially paying fees to a baker that is located in a sanctioned country or may be associated with funding of terrorist organisations or money laundering activity. 

Hence, many compliance officers believe that the issuer of operations must be able to select the bakers they want to work with from a predefined whitelist.

The same problem and the same solution may apply to other markets than security tokens where regulation on data location exists, e.g. health data.

 

Benefits with trusted bakers

At its core, Tezos is a public, permissionless blockchain, and will remain so. And for most users, it is not a concern who bakes a given block. 

But as described above, not all users are the same. The growing number of companies using Tezos for tokenization of financial assets, fan experiences, gaming, NFT marketplaces, document certification, etc. have more stringent requirements for their presence on the Tezos blockchain.

“Choose your Baker” makes it possible to address some of these requirements.

Similarly, it can help prevent the potentially costly phenomenon known as “MEV” (Maximal Extractable Value): when a block producer takes advantage of their influence on the order of operations in a block to extract value at the expense of the transacting users. Limiting operations to a selection of trusted bakers can prevent this (another tool for handling MEV is ‘Flashbake’).

Importantly, it is a tool that can be integrated at the client level by those that have such needs. It doesn’t change the open, permissionless nature of the Tezos blockchain itself.

 At Nomadic Labs, we are delighted to support the creation of this open-source project with the support of companies invested in blockchain projects. It shows that the decentralized model is increasingly understood and accepted by companies – including the challenges involved and the solutions required to address them.

To learn more about Choose Your Baker and getting started, visit the project website

For other questions, including general inquiries about launching a project on the Tezos blockchain, don’t hesitate to reach out to Nomadic Labs’ adoption and support team.