Blockchain

The Blockchain

Already across the basics of bitcoin and blockchains?

Skip down to our view of the effects of these technologies on the accounting and bookkeeping industry.

 

Has a technology term been met with more blank-faced stares than blockchain? Even now, eight years after its launch (with the bitcoin currency) and more than 25 years after it was first conceived, confusion reigns over what, exactly, is blockchain.

"The blockchain could disrupt everything."

While Bitcoin has suffered the slings and arrows of its association with dodgy functions such as the darknet’s Silk Road and associated drug and weapons purchases etc., its underlying technology – blockchain – has risen dramatically in the estimations of technologists worldwide.

Let’s unpack these two terms – bitcoin and blockchain - so that we can separate their meanings and focus more closely on what blockchains can achieve, and how they might affect accountants and bookkeepers in the future.

What is bitcoin?

First things first – there’s bitcoin and then there’s Bitcoin. The lowercase bitcoin generally refers to the currency; the uppercase Bitcoin refers to the concept of peer-to-peer distributed ledger technology, and the ecosystem it has (and will) beget.

"A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution."

Satoshi Nakamoto, Creator of Bitcoin

Bitcoin: A Peer-to-Peer Electronic Cash System - 2008

Let’s talk about bitcoin the currency.

Bitcoin is a cryptocurrency that enables transactions to be conducted online without the need for a trusted third party such as banks or credit card companies.

Immediately, that changes everything. Did you ever imagine a currency that could operate without banks in the chain of exchange? No? And yet here we are. No more centralised gatekeeper or decision maker. Now, everyone’s a banker.

Digital currency or cryptocurrency?

Note the use of the term ‘crypto’ to describe the bitcoin currency as opposed to ‘digital’. Yes, it’s a digital currency, but then so is the NZ dollar, the AU dollar, the pound, the Euro and the rest. In fact, the majority of the world’s currency is around 90% digital only (that is, it only exists in bit form on ledgers, not in hard currency).

Investopedia defines cryptocurrency as, “[…] a digital or virtual currency that uses cryptography for security.” The ‘coins’ are virtually created by miners solving complex cryptographic puzzles. Quite a departure from Governments printing new money.

It might be easier to think of bitcoin the ‘currency’ as an app. Invariably, a currency is the first app built when creating a blockchain. Why? It’s a terrific proof-of-concept for one thing. If a blockchain is a distributed (shared) ledger with pretty much unbreakable security, a currency is a terrific flagship application to prove it works as directed on the box.

Interestingly, development of a currency is also a handy way to raise capital, with blockchain-based companies offering ICOs (Initial Coin Offering) as opposed to the traditional IPO (Initial Public Offering).

Did you know?

Light bulb

Miners are people with powerful computer set-ups that compete to create the blocks in the blockchain by solving complex puzzles. The first to solve the puzzle and add the block to the blockchain earns bitcoins.

Did you know?

Light bulb

Nodes are computers in the blockchain network.

As with any currency or unit of exchange, bitcoin depends on trust and belief. Bitcoin users believe in the security of the ledger (for that is all a bitcoin is – an entry in a ledger) just as most people believe in the value of a banknote, when that banknote possesses no true inherent value.

And believe in it we do, with Japan officially recognising bitcoin as a legal means of payment in May 2017.

So, why's it so good?

  • You can transfer bitcoin a LOT quicker than you can transfer money, to anywhere in the world
  • There are no legal hoops to jump through to authorise a payment (nor maximum transfer rates)
  • It costs a tiny fraction to transfer (and it doesn’t matter how much you’re transferring – it’s generally the same flat fee)
  • If something goes wrong in the network (a catastrophic power outage affecting all of NZ, for example), the system keeps going without problem (whereas if a bank decides to do work on its servers, all users are blocked out of internet banking for that period)

So, why's it so bad?

  • Security is an ever-present problem with all digital currency. Most bitcoin enthusiasts say that they welcome cyber-attacks and hacks as it makes the system stronger. In truth, major hacks have occurred.
  • Adoption. Bitcoin is suffering from ‘sharing the road’ with traditional currencies, which makes it seem difficult to use and ‘gimmicky’. If, as expected, widespread adoption occurs over the next decade, who knows - we may see internet banking as a quaint relic from an earlier, less fiscally-sophisticated time.

What can you do with bitcoin? At this stage, a bit – with a lot more to come.

Buying with bitcoin

For a long time, it’s been possible to pay for most things online using bitcoin. Want to book a flight? How about must-have wine accessories? What about exclusive bitcoin discounts when shopping at Amazon? Even Microsoft is in on it. It’s slow going, but it’s happening.

It’s worth noting that it’s not all plain sailing – freelance platform Fiverr, an early adopter of bitcoin payments, recently dropped the payment option due to lack of interest. OK Cupid has dropped support as well.

Transacting with bitcoin (whether buying a product/service or simply sending bitcoin to a loved one) is no more complicated than using internet banking or sending an email.

Investing in bitcoin

Many people are investing in bitcoin as opposed to spending it (or being paid in it). This goes against what the bitcoin community at large wants to happen; their desire is towards transactions not hoarding.

Still, the returns are extraordinary. At time of writing (9 May 2017), bitcoin has increased from a 1 January valuation of $997.69 USD to its current price of $1,639.32 USD – a 60% increase.

It’s not just bitcoin

It should be noted that at the time of writing, there are 830 cryptocurrencies, with a market capitalisation of $38.5 billion. Small feed compared to the US stock market’s $6 trillion, but not insignificant.

Some of the cryptocurrencies that are sharing the market place with bitcoin include Ethereum, Litecoin, Ripple and the internet meme-inspired Dogecoin.

With bitcoin, there tends to be two camps – those who believe in it believe in it passionately; while the rest of the world sees it as a novelty. Either way, it’s important for our industry to stay abreast of the latest goings on in the bitcoin and cryptocurrency world – you never know when a client will come to you with questions.

"A short description of Blockchain: Blockchain is to bitcoin, what the internet is to email. A big electronic system, on top of which you can build applications. Currency is just one."

Sally Davies, FT Technology Reporter

@daviesally

Beneath the bitcoin lies the blockchain. Just as beneath YouTube or beneath Facebook or beneath your company website lies the internet.

A blockchain is a data structure that enables a public digital ledger of transactions to be shared across a distributed network of computers. Users can record transactions on the blockchain without the need for a central authority.

The blockchain can handle complex transactions and maybe even reduce the need for companies. People may be able to connect and work together without companies and management.

Increased transparency for businesses is possible, as the blockchain becomes a global ledger storing all transactions, which are all viewable by all users.

Did you know?

Light bulb

There is NO bitcoin ‘coin’. There is no physical bitcoin whatsoever. Those stock images you seek a gold coin – they’re not real. The only coins you’ll get are when you cash out your virtual wallet into AU or NZ currency.

Richard Bradley, a director at Deloitte Switzerland, has created an excellent summary of the blockchain’s mechanisms versus current processes in less than 100 words:

You (a “node”) have a file of transactions on your computer (a “ledger”). Two government accountants (let’s call them “miners”) have the same file on theirs (soit’s “distributed”). As you make a transaction, your computer sends an e-mail to each accountant to inform them.

Each accountant rushes to be the first to check whether you can afford it (and be paid their salary “Bitcoins”). The first to check and validate hits “REPLY ALL”, attaching their logic for verifying the transaction (“Proof of Work”). If the other accountant agrees, everyone updates their file…

This concept is enabled by “Blockchain” technology.

Blockchain, a dumb network

The world’s foremost authority on blockchain, Andreas Antonopoulos, describes blockchain as a dumb network using smart tools that plug into the network. In his talks, Andreas often compares the landline phone network (a smart network with dumb phones) to the internet (a dumb network with smart plugs in like YouTube, for example).

The smart network – in this comparison think of Spark or Telstra - is managed centrally. Any innovation is implemented by the company and rolled out to ALL users, whether they want the update or not.

Conversely, the dumb network has little innovation – it’s simply a robust system that does its one or two jobs. What it DOES have is hundreds, if not thousands (and one day possibly millions) of people creating applications (just as millions of people build websites on the internet).

This is where the ‘decentralisation’ of technology is set to explode – the ability for anyone with the right know-how to build applications. The applications don’t need to go through rigorous approval processes as currently experienced with, say, the Apple Store; instead they’re simply deployed to the network without any permissions from a centralised authority. As the Ethereum Project states on its website:

“On a blockchain, anyone can set up a node that replicates the necessary data for all nodes to reach an agreement and be compensated by users and app developers. This allows user data to remain private and apps to be decentralized like the Internet was supposed to work.”

Did you know?

Light bulb

There’s more than one blockchain. Bitcoin is the best known, while many new cryptocurrencies are built upon the Ethereum blockchain. Companies are building their own private and public blockchains, too.

Building applications for the blockchain

Ethereum is currently the go-to blockchain platform for application building. Whereas the bitcoin blockchain only handles the bitcoin currency, the Ethereum blockchain has much more versatility.

That’s because it uses ‘smart contracts’ – an innovation that allows the near instant implementation of applications throughout the network. One example of the potential for this technology is that it could automate and replace the existing financial loans industry. This would be achieved by adding applications to the  blockchain that are shared throughout the network and automatically trigger actions based on actions (or inactions).

For example, Bob borrows money from Sally - this could be enabled via a blockchain loan application that automatically calculates agreed-upon interest charges. That application might automatically register the loan with a debt collecting application, as well as an insurance app that Bob uses. Bob’s payments to Sally are automatically withdrawn, unless Bob has insufficient funds in his digital wallet. At this time, another application might act as a third-party insurance cover for the debt, and pay Sally’s outstanding balance. All of this is done without the need for banks or lawyers or debt collectors.

Now think of this technology being made available to the 6 or so billion people who don’t have access to banks in the world. Suddenly everyone can be a bank, a loan facility, or more.

An independent website – State of the DApps* – lists several applications that have already been launched or are in the process of being built on the Ethereum blockchain. Browsing some of these projects gives a feel for the types of applications possible using blockchain’s powerful infrastructure.

*DApps = Decentralized Apps (apps specifically built for blockchain)

There’s no doubt that we’re still in the ‘early adopter’ phase of blockchain. It’s easy to mock the technology as a flash in the pan, but perhaps it’s sensible to compare it with the most recent innovation that shook the world – the internet. It took many years for the internet to move from joke to fad to business critical. Line the two technologies side-by-side timewise, and at the same time in their lifecycle, Google hasn’t even launched yet.

1989

Tim Berners-Lee
proposes the hypertext
protocol, leading to the
modern internet

1998

Google founded

2009

Satoshi Nakamoto
releases the first
bitcoin code

2018

TBA

Ways blockchain is used

While we tend to think of a blockchain as the basis for a cryptocurrency, its uses extend far beyond that scope. Here are six use cases outside of finance.

Supply chains

Walmart is piloting a blockchain for supply chain management. Their goal is to remove the hold-ups they experience in paperwork mismanagement when stock travels around the world from port to port.

Music industry

UK artist Imogen Heap is a champion of using blockchain technology to self-release music:

"Blockchains could enable artists to release their tracks themselves and gain greater control over the terms of the release and the profits received. They could use smart contracts to dictate who gets what share of the money generated and, on the consumer side, they could even implement a tiered pricing structure depending on who is purchasing the track and for what purpose."

Identity

Perhaps the biggest breakthrough for blockchain will come when a universally accepted identity solution is developed. Imagine doing away with scanning passports and driver’s licences, uploading recent utility bills, providing proof of residence; imagine doing away with passwords; these are possibilities with a crypto-secured application that’s accepted worldwide.

Voting

No more polling booths; no more doubts about the validity of vote counting. Again, this could be the real-world application that takes blockchain from obscure to essential.

Ride sharing

Lazooz is a decentralised ride sharing app currently in beta disrupting the recently disrupted Uber/taxi space.

Payroll

Get Paid in Bitcoin is a Launceston company that, as the name suggests, converts a percentage (or all) of your pay packet into bitcoin.

Blockchain in accounting

And so to the possible impact of blockchains and cryptocurrencies on the accounting industry moving forward.

One could be forgiven for thinking that the logical champions of a universally shared, indisputable, unbreakable ledger would be accountants and bookkeepers. And yet there’s little heard in the mainstream about its use and adoption. Over time we think this will change. Already there’s activity among the big four, with Deloitte in particular taking a large interest in the technology and its future uses.

There are two specific areas that blockchain may affect the accounting and bookkeeping industry.

Triple entry accounting

By now you may have had a lightbulb moment about the effect the blockchain could have for double entry accounting. Triple entry accounting using digitally signed receipts was first proposed by Ian Grigg in his 2005 paper ‘Triple Entry Accounting’ – an often-referenced work that paved the way for bitcoin and blockchain.

Instead of ledgers being kept separately by two businesses, they’re securely shared with a third entry – the blockchain register – officially, securely, immutably recording the transaction.

The main resistance to this concept is usually around the inflexibility of the technology when considering the way in which a business’s accounts are managed. With blockchain (and by extension triple entry accounting), a transaction has taken place or it hasn’t. Either the ledger has been adjusted and cryptographically confirmed or it hasn’t. In accounting, ledgers can be more philosophically managed, with transactions sometimes viewed as liabilities and sometimes as something else.

Still, this hasn’t stopped developers like Balanc3 from working on accounting solutions using this technology.

The audit

With its intrinsic and near unbreakable cryptographic record keeping, it’s reasonable to assume that the early deployment of blockchain technology for accounting may come in the field of auditing. Commentators – among them Matthew Spoke of Deloitte Canada – see a future where auditing is drastically changed through the removal of many time-demanding processes.

A decentralised ledger - available to all users, exactly the same for all users, unalterable by all users, in which all parties agree that transactions have taken place - has the potential to eliminate key tasks of the modern-day auditor.

Does that mean the end for the auditor? It’s doubtful. While the blockchain records the transactions, it doesn’t describe them (at this stage). An auditor would still need to confirm the classification of those transactions.

The tendency with observations like these is that one is inclined to imagine that outcome, but not the process and journey leading to that outcome. In all likelihood, auditors will still be required – perhaps to audit the blockchain itself in real time.

Final thoughts

We all dismissed the internet as a futile fad 30 years ago. None of us could see the potential of it because it didn’t fit our known world view of magazines, TV and newspapers. It would be risky to do the same again today with an equally disruptive technology.

Change may not become apparent this year or next; perhaps not for five years. Then again, with so many developers working exclusively in the blockchain space, it’s likely that innovation will accelerate exponentially from here.