January 17, 2015

Gendal on blockchains -- what's the fuss? Could the blockchain change accounting?

Richard Gendal Brown of IBM comments on the blockchain, asking what's the fuss:

Cost? Trust? Something else? What's the killer-app for Block Chain Technology?

Could decentralized ledgers change the face of accounting?

When I speak to people about decentralised ledgers, some of them are interested in the "distributed trust" aspects of the technology. But, more often, they bring up the question of cost.

This confused me at first. Think back to where this all started: with Bitcoin. Bitcoin is deliberately less efficient than a centralized ledger! Its design adds really difficult engineering constraints to what we already had. How could this technology possibly be cheaper than what we already have?

He then goes on to use some actual accounting to show that, amongst other things, cost isn't really what the discussion is about. By logic, he gets to a really interesting space, one that our readers will know well:

Sure - everybody still has a copy of the data locally... but the consensus system ensures that we know the local copy is the same as the copy everywhere else because it is the shared consensus system that is maintaining the ledger. And so we know we're producing our financial statements using the same facts as all the other participants in the industry.

Does this mean we no longer need audit? No longer need reconciliations? Obviously not, but perhaps this approach is what is driving some of the interest in this space?

Right. To which I added, for the record:

To me, the magic in this space is what we sometimes flippantly call triple entry, which innovation is highlighted by the blockchain's success in mounting an independent currency over a shared ledger.

We all know how insubstantial internal ledger entries are, and how we can really only lean on them to the extent that we trust our internal processes (e.g. slightly germane is the events of 2007-08 leading to a popular view that accounting and audit have failed us).

On the other hand, we also see how solid the payment systems are. Whether bank- or govt- or private-run, payments generally work. When these multi-party activities do not work, all hell breaks loose, and people run, sometimes quite literally, to other systems.

When accounting ledgers break, we shrug. Triple entry takes us from the unreliable fantasy of the accounting entry to the hard concrete reality of the payment: the distributed ledger is as solid as a payment.

This doesn't replace double entry, nor does it replace classical payment systems. Rather it augments it by providing a way for parties to share certain transactions as if they were as solid as payments.

E.g., when RichardCo decides to place its capital at Barclays, it will no longer rely on its accounting systems alone to describe this situation, and neither will Barclays. Both of these parties will share a "receipt" that is cryptographically signed by some party that has mediated it (could be Barclays, could be the Bank of England, or it could be VirginMoney).

That's three parties, each holding a copy of the same receipt, hence the label triple entry. In the Bitcoin world, that middle intermediator is the blockchain, but single servers or replicated servers or small partner groups are equally applicable and in many cases better.

The receipt itself is strong because it is cryptographically authorised by the payer, and cryptographically signed off by the mediator (as a minimum). It represents such high class evidence that it is practically irrefutable in terms of the facts on record, and it is trivially automatable in audit terms.

Holding this entry is far more flexible than RichardCo and Barclays relying on their double entry systems because firstly you can build the double entry systems out of the collection of receipts any time you need them, and secondly, it is so strong that it can be used as evidence to create derivative claims. E.g., it's a set-up for securitization or loaning or other more advanced uses. And, it's a lot easier to audit because it is such solid evidence.

Back to bitcoin and its blockchain. This is the first successful experiment in a large scale triple entry issuance. In part, seeing what happens on the blockchainn generates excitement because we perceive an ability for any company to turn its stalled internal assets into contracts that are then dynamically mediated through cryptographic receipts.

Now, that contracting arrangement isn't there yet (see for example the conceptual tussle between smart contracts and Ricardian Contracts as mechanisms of issuance) but it will get there. Once I can issue all my accounted assets into a triple entry arrangement that others will instantly respect, finance will democratise so fiercely that if you're not seeing where it's going, the shock will probably take you down.

Posted by iang at January 17, 2015 10:24 AM
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