How the Ledger Unlocked Modern Business
Blockchain Concepts: The Ledger
At the most basic level, the Block Chain is just a decentralized ledger. We could also describe it as a new social architecture, a distributed organization, or an algorithm for trustless consensus, but most fundamentally and simply it is a decentralized ledger. Many people use this definition matter-of-factly, as if it explains it all. But there’s a tremendous amount packed into those two words, “decentralized” and “ledger.” We’ll be exploring the whys and hows of them over this series of posts, and showing just how transformative the unlikely combination of these two concepts really are.
But we have to start with the ledger, which for a very long time–until just the last few years, really–was the very embodiment of centralized.
It’s not a stretch to call the ledger, the journal of financial accounting, one of the more important ideas in the last five hundred years.
The ledger is the kind innovation so ubiquitous it has become invisible as an invention, like the equally disruptive Arabic numerals that populates it. It seems like something that’s always been there, like air. And yet.
All the math we learned in school relied on those unmistakable Arabic figures, 1-2-3-4-5-6-7-8-9 and, of course, the most powerful of all, 0 (see Zero, Biography of a Dangerous Idea to find out just how powerful). The Romans, whose number system was the standard in Europe for the vast majority of its history, didn’t even have a mark for zero, let alone a way to express the wide world of fractions. Much of the basic math we do every day, particularly multiplication and division, was MADDENINGLY HARD using Roman numerals, and you can forget about doing algebra, which was inextricably tied to the new system. Arabic numerals were a radical step forward when they were finally adopted in Europe in the fifteenth century, just in time to help Galileo, Descartes and Newton jump start the Scientific Revolution. There is no doubt that the Arabic system played a big role in making widespread mathematical literacy possible.
It was around this time that financial accounting as we know it emerged in Italy. As the great merchants in Venice expanded their trade across several continents they had need of sophisticated tracking of how they were spending and receiving money and other goods. Luca Pacioli, today considered the Father of Accounting (and one of the great underrated geniuses of the era), recorded these practices for posterity in the first mathematical encyclopedia. He was a first-rate observer–observation being the grandmother of invention. His masterwork included the standard elements of accounting in use today.
Luca Pacioli’s encyclopedia is also considered the first printed book to use Arabic arithmetic and algebra. Just as algebra was a key to modern science, accounting was instrumental in unlocking modern business. The ledger allowed merchants to develop confidence that they knew what was going on in their business, and make plans accordingly.
Accounting, Pacioli explained, was to done by recording numbers in a great book. He called this book a ledger, a word stemming from the German word, leggen, meaning “to place, or lay.” This term would have implied a book that lies permanently in place like an oversized liturgical book in a church. Pacioli was a Franciscan monk, so we can trace his choice of words back to the monastery rather than the marketplace. The ledger, then, was a canonic journal that had a kind of moralweight. It was to be treated with reverence.
The “Venetian Method,” as Pacioli’s accounting practice became known, can be boiled down to one indispensible innovation in record-keeping. In his own words:
“All the creditors must appear in the ledger at the right-hand side, and all the debtors at the left. All entries made in the ledger have to be double entries — that is, if you make one creditor, you must make someone debtor.”
Put simply, accountants must be certain that debits equalled the credits. This was the brilliant mechanism to ensure that the books were always in order. Today we know this approach as standard double-entry bookkeeping. (You can read much more about this history in Double Entry: How the Merchants of Venice Created Modern Finance)
If you’ve used Quickbooks or Quicken you’ve experienced double entry bookkeeping. Let’s say you purchase a new computer for $2,000, you would see an increase in your debit column of $2000 tied to assets (equipment), and a decrease in your credit column of the same amount, tied to assets (cash). Any transaction must affect both columns in order for the balance to be preserved.
In this way, double-entry bookkeeping provides a mathematical proof of its own accuracy. And it’s so simple anybody can do it with a bit of practice!
Thanks to this clever and reliable proof, modern ledgers gave merchants the confidence needed to make many more and bigger investments, faster, and with more trading partners. It allowed them to combine operations to create larger businesses. It unlocked sophisticated banking practices. It helped conjure the economy as we know it.
