The very backbone of capitalism as we know is the language under which it is governed — double-entry accounting. This system of debits and credits has governed our business lives since the 900s, originating from the second Muslim Caliphate civilization. It was initially adopted as written accounting for the regulation of zakat (mandatory religious donations). This concept was further developed by Luca Pacioli, an Italian merchant who worked with Leonardo Da Vinci. He codified the system into his textbook as “Assets = Liabilities + Equity”. He is now known as the father of accounting. Since, we have been relying on this system to maintain the financial records of the world.
However, to gain the trust of outsiders, independent third parties such as auditors are required to verify financial information. An audit is an official inspection and verification of an individual’s or organization’s accounts by an independent body.
As a designated CPA, I am all too familiar with the role of an auditor. I would consider myself a master of Pacioli’s double-entry accounting system coming out of the CPA training programs in Canada. I have been exposed to it at various levels and situations and in all the major frameworks it operates within.
However, I have come to realize the many challenges and inefficiencies companies regularly face with an audit and the accounting function in general. This includes: irregular updates of bookkeeping causing information delays, high up-front cash costs for the audit and large opportunity costs caused by accountants investing months of their time on historical financial records. These factors often lead to finance functions being ‘stuck in the past’ instead of planning strategically for the company’s future.
Audits, like the double-entry accounting system have remained relatively unchanged for decades. The problems highlighted above lead me to believe that the audit and accounting functions require a “refresh” into to the modern age. There has to be a more efficient and effective way to deliver these results — one that serves the needs of stakeholders without the complications of expensive annual costs, lack of timely information and massive time commitments from their employees.
This is where the blockchain might present us with a solution. Let’s first get a grasp of what this technology is — as explained to you by an accountant.
What is the Blockchain?
Picture a ledger, one that as an accountant I’ve seen a million times. Now I want you to take that ledger, create millions of copies of it, each of which is stored on different users’ computers and cellphones across the world. This makes the ledger public record. Now let’s create a system that can synchronize these ledgers through a peer-to-peer update system, with each ledger verifying the accuracy of the other, thus holding each of them individually accountable. If there is a ‘conflict’ in the sync — the ledgers must reconcile the differences and will have to refer to the majority of the other copies to verify what is true.
Now most importantly — let’s encrypt this ledger to ensure that each entry is immutable.
In other words, every entry on this ledger is part of public record forever once posted and verified. To further solidify this concept, let’s create a self-governance protocol for this ledger. Let’s allow this ledger to be “audited” on a micro-scale constantly by millions of people across the globe with each transaction being verified for rewards. This process seals the transactions into a “block”. Next, each “block” is recorded in series on pages of this ledger creating a “chain” of transactions. In order to change any single transaction — one would have to first crack the encrypted and sealed block, and then change every single transaction preceding it as they are all linked. This is the process which ensures that all records are immutable.
The self-governance and distributed nature of this ledger allows the ledger to be publicly controlled. No single party controls this ledger and it has no central point of failure.
Sounds like something out of an auditor’s dream doesn’t it? A ledger that can never be cheated or changed and is controlled and governed by everyone who has access to it. Well, guess what — this is far from a dream, it currently exists. It is in action across the world with the most advanced version of it known in the form of Bitcoin.
This ledger will begin our evolutionary transition from the internet of information — to the internet of value.
The Bitcoin ledger (as of the date of this writing) is valued at over $40B. Over $2B transactions occur within this ledger daily making it one that transacts in one of the most valuable and liquid assets in the world. This all happens without a central bank, without any quarterly reviews or audits and produces almost instantaneous verifiable and trusted transactions worldwide.
This ledger primarily trades the “currency” of bitcoin, but can be used to store and exchange any asset of value.
A fully encrypted, immutable, publicly distributed and decentralized ledger used to exchange any asset of value. This is what the blockchain is and this is why it will forever change the world of accounting and business as we know it.
A hallmark of this ledger is the introduction of the new era of accounting, a natural evolution if you will, in the form of “triple-entry accounting”. Through the blockchain, instead of solely keeping separate records, companies can now write directly into the joint public ledger as well.
Once written and verified onto the public books — copies will be kept on their individual records as well. As discussed above — everything posted on the public books is cryptographically sealed making them immutable. This is because every single entry is verified through the book’s public “auditors” as they are individually posted.
This is incredible to me — transactions are verified, sealed and simultaneously posted as they occur into a single ledger of public truth.
But why should we stop there? The real problem I see constantly at companies is that many of them treat accounting as a back-end process. The classic ‘let’s get the real business done first and then we can deal with this accounting paperwork after’ approach. This obviously only causes further delays and inefficiencies. Just ask any accountant how fun it is during ‘busy season’ — peak periods between January-March where we frantically look to close out the December 31 year-ends. Overworked accountants are unhappy accountants, unhappy accountants don’t treat auditors too well (or anyone at all really).
With the blockchain, accounting no longer has to be a separate process, it can be an integral part of the transaction itself, one where it is initiated by the very act of the transaction.
Traditional: Alice wants to invoice Bob. Traditionally she would create the invoice, manually input into her accounting system as entries and then either email or mail the invoice to Bob. Bob would receive the invoice and then manually enter it into his accounting system as a received payable invoice.
Blockchain: Alice can create the invoice on the blockchain through a ‘smart contract’ and record her transaction with Bob. Bob receives the invoice through the blockchain and now simply settles it. The redundancies of multiple manual entries are completely avoided as the very act of the transaction is public record and entry of the transaction itself.
The above is just a single use case for how this will change accounting, smart contracts (essentially contracts written in code and verified as signed on the blockchain) open up many more opportunities as well.
Wrapping it all up…
The blockchain will change the very language of business forever. Not only does it create a significant improvement in efficiency, it establishes trust. In the age of information, trust is at an all time premium. The blockchain introduces a layer of transparency in business that we have never witnessed before, one which is immutable and publicly controlled. Furthermore, it provides global scalability to all businesses never possible before without multiple layers of middle parties and trust agents.