5 Principles of Blockchain CPAs Should Knowby
Despite much discussion and hype, there is a gap of understanding about what blockchain and related cryptocurrencies are really all about and how the accounting profession will be impacted.
In order to help make sense of things for you, I see blockchain technology broken down into five key principles which I will discuss in this article.
The 5 Key Blockchain Principals
A primary fundamental of the blockchain is that its Decentralized, which makes it very different from traditional technologies. Typically, this decentralization happens in the public domain. The strengths of this are best understood by looking at the opposite—data held in one place.
Data stored on a desktop computer for example, has a serious chance of being compromised, corrupted, or altered. It can be stolen, the computer can break, or wrong data can be entered into a desktop ledger (given the fact that the other party involved with the transaction has virtually no involvement).
Even cloud-based accounting applications such as Xero and QuickBooks Online are still fundamentally centralized. One company controls the data, and it’s their responsibility to ensure its integrity and that it doesn’t get hacked, lost or stolen.
Potentially anyone can enter transactions that have little acknowledgment of the other party in that transaction, and the implications on that third party of changing that transaction is limited. By storing data across its network, the blockchain eliminates these risks that come with data being held centrally.
All blockchain transactions are peer-to-peer—at least two parties are involved. The best way to understand this is to compare a standard credit card transaction with the first practical use of the blockchain protocol.
When you pay by credit card for your groceries, there are up to five parties involved to move money from you to the store—the consumer (yourself), the merchant (your local grocer), the issuer (Visa or MasterCard), your bank, and the merchant’s bank. On the way through, each party takes money (typically between 2% and 4%) before your funds finally land in the account of the local grocer. Having all these parties involved provides a few benefits—ease of use and the double spend problem (you can’t spend money you don’t have).
With Bitcoin and other cryptocurrencies, the transaction can take place between two people for free, with a guarantee that the customer has the necessary funds before transferring the amount to the other party. This type of transaction has become expensive and slow for Bitcoin in particular, but these issues will get resolved.
The benefits of the peer-to-peer aspects of the blockchain is that two people who are involved in a transaction can both verify the transaction is correct, without the need for any other party to be involved. One person can issue an invoice to another on the blockchain, who verifies and accepts the particulars.
Then, the transaction has intrinsically connected the two together and neither will be able to change the transaction details without the permission of the other. The potential this can have on accounting and payments is significant.
3. Transparency with pseudonymity
The details of the two participants in a blockchain transaction can be kept secret, or they can be opened to ‘actors’ who might be party to a transaction. Transparency is provided with pseudonymity.
Look at payroll, for example, which has two key parties involved—the employer and the employee. The details are no one else’s business, unless someone has a right to be a party to the transaction—such as the taxation regulators in the appropriate jurisdiction.
In the UK, employers are expected to report every payroll to the HMRC. If this took place on the blockchain it would be automatic and (potentially) not require middleware software to be involved. The potential benefit to Governments is enormous.
There are many more benefits to transparency with disguised or selective identity. These include the transition of documents between known parties, supply chain and logistics, proof of origin of items and many others.
4. Irreversibility of records
Once a blockchain transaction is inputted in the database and the accounts are updated, the records cannot be changed. This is because they are linked to every transaction record that came before them, and is where the term ‘chain’ comes from.
Various computational algorithms and approaches are deployed to ensure that the recording on the blockchain is permanent, chronologically ordered, and available to all others on the network. This characteristic is extremely relevant to accounting.
Take audit, for example. If all relevant transactions were on a blockchain, they would be irrefutable because of multi-party involvement, and guaranteed to not have been changed in anyway. That doesn’t leave much left to audit.
In this situation, fraud can still be perpetrated, but it requires the consent of multiple parties in the very least. The blockchain will enable more connected and reliable transactions, with less manual intervention.
5. Computational logic
Each transaction in the blockchain can contain computational logic—a smart contract that acts as instructions for the transaction. Some examples include:
- Function as ‘multi-signature’ accounts, so that funds are spent only when a required percentage of people agree
- Manage agreements between users, say, if one buys insurance from the other
- Provide utility to other contracts (similar to how a software library works)
- Store information about an application, such as domain registration information or membership records
In theory, an accountant’s engagement letters could be smart contracts implemented on the blockchain. You agree to provide a certain set of services to your clients and they agree to pay you for those services rendered. The smart contract could trigger payment upon each milestone being reached, whether that be a date or completion of certain work items.
Ultimately, the whole management of workflow—invoicing, payment and reconciliation—could be completed entirely on the blockchain. This would leave very little for humans to undertake, other than the work itself. And potentially, this would could just be the very high-level value-add aspects, rather than the repetitive tasks. But that’s an article for another day.