A new way to do what we do

Blockchain in accountancy and beyond

by Ron Quaranta, chairman of the board, Wall Street Blockchain Alliance
September 2017

Much has been written in the past three years about blockchain technology and its impact across multiple industries around the world.

Indeed, global interest from technology companies, financial institutions, governments and the public continues to grow at an accelerating rate. Proponents have been comparing its innovation and long-term impact to the creation of the internet, with some going so far as to claim that the technology will so completely impact daily life in the future, that it will be impossible to imagine a world without it.

Blockchain and digital currency startups have been, and continue to be, funded to the tune of more than $1.7 billion since 20121 (to say nothing of "initial token offerings" that have raised more than $1 billion in 2017 alone,2 and would justify its own article). Virtually every major bank, brokerage firm, insurance company, exchange, technology company and more has dedicated resources to blockchain research and prototypes. Even the media and entertainment industries are considering it.3

And yet, despite all the hype and, in some instances, hyperbole, there remains a significant degree of confusion, distrust and overall lack of understanding about what blockchain technology does and what it truly represents. This article will attempt to provide a brief background on blockchain technology, a high-level understanding of how it functions and, importantly, what it may mean for the world of accountancy and finance.

What is blockchain?

It is worth starting with the basics. What is blockchain? Where did it come from? Why does it matter?
Several industry organizations, including the Wall Street Blockchain Alliance, work to provide a level of knowledge and understanding that supplements the deep technical aspects of blockchain which, though critical, often confuse and cloud professionals' perception of this innovation. What is important to understand are the uses for blockchain that make the most sense for a person's relative business and role, and the problems that blockchain is designed to solve. Ultimately, blockchain technology requires revisiting how businesses do what they do, and how that might change in the future.

By now, many people are aware that blockchain as a concept and first implementation has its origins in digital currency, most notably bitcoin. While this article does not delve into the creation of bitcoin, its anonymous creator (or creators) nor the challenges bitcoin has faced over time, it is worth understanding why it was created.

Fundamentally, bitcoin was only meant to be a payment system allowing for borderless, instantaneous transactions, conducted anonymously and transparently.4 It is a testament to the elegance of the underlying technical design that blockchain is being used for far more than originally envisioned.

Blockchain is a public, decentralized ledger (or database) that records transactions without requiring any trusted central authority to maintain the ledger. Maintenance of blockchain is performed by a network of nodes, with new transactions broadcast to the network. The network validates every transaction, adds each transaction to its copy of the ledger and then broadcasts these additions to all other nodes. Once added into the blockchain, a record cannot be modified; it is extraordinarily difficult to falsify records.

As originally designed, all records can be viewed publicly, allowing anyone to verify the authenticity of any transaction. The truth of any transaction is confirmed by what is known as a "consensus mechanism," which, for the purposes of this article, is simply a method of authenticating and validating a value or transaction on a blockchain without the need to trust or rely on a central authority to do so. As rightly pointed out by KPMG in 2016, consensus mechanisms are central to the functioning of any blockchain or distributed ledger.5

Over time, it became apparent that fully public, open and decentralized data sharing does not mix well with financial markets. The importance of protecting clients' personally identifiable information, as well as the litany of regulatory mandates such as anti-money laundering and "Know Your Customer" rules, make public blockchains difficult to leverage in financial markets, accountancy and other industries. Thus, the research and use of "private blockchains" has become prevalent.

Private blockchains are not fully public, decentralized networks. In these systems, access permissions are controlled and rights to modify or read blockchain are restricted to a few users. They are ideally meant to maintain the partial guarantees of authenticity and decentralization that blockchains provide, while complying with the realities of commercial life in the world today. Many technology purists continue to resist this trend, citing that full decentralization is part and parcel of the underlying "philosophy" of blockchain. Regardless of viewpoint, it is worth noting that private blockchains are the primary focus of research and testing for financial institutions and most corporate engagements.

So, why does this matter?

Fundamentally, blockchain represents a major evolution in how data is managed and value is transferred. Structurally, it greatly reduces opportunities for errors that arise when reconciling complex and disparate information from multiple sources as well as the impact of human error. For the realm of finance and accountancy, this opens some intriguing possibilities, and many accounting-related organizations are beginning to conduct deep research into blockchain.

For example, in a blockchain ecosystem where, once committed, accounting records are not alterable even by the owners of the accounting system, how might data reconciliations occur? How will the process of retroactively reviewing client data evolve?

How does the profession of accounting, or the role of the chief financial officer, develop if and when blockchain technology reduces the need for auditing resources and guarantees the integrity of financial records?

This thought exercise can be taken even further. There are technology vendors right now focusing on blockchain-based solutions in the areas of invoicing, bookkeeping, document management, payment processing and more, for both small and large organizations. As this ecosystem progresses, what will be the mechanisms by which accountants and financial professionals engage their customers, the markets and more?

To begin to understand how some of these questions might be answered, it makes sense to look at some high-level examples.

Future implications for corporate taxpayers

Today, corporations are typically measured annually for income tax purposes based on retroactive analysis of historical financials. Blockchain implementations in the future will be designed to record all revenue and expense transactions, as well as assets and liabilities, in real time. Theoretically, government software programs could calculate taxes owed and automatically deduct from a company bank account at transaction time.

In this universe, corporations would pay taxes far faster and, in concept, estimated tax payments could be eliminated. In addition, mistakes and fraud (again, in theory) could be eliminated. In this future, one could imagine that tax compliance administrators would evolve into blockchain technologists with tax knowledge.

Future implications for sales and use tax

Another example to consider might be the challenges associated with sales and use tax enforcement and collection. As readers will know, sales and use tax is paid to a governing body for sales of certain goods and services, and is levied on sales to the final end-user, i.e., charged every time an item is sold retail. Businesses that are registered for sales and use tax can also use a resale certificate for exemption from the tax when the merchandise being purchased is to be resold by the business.

In this example, blockchain technology could conceivably allow for two things: the automatic remittance of sales and use tax directly to the taxing authority, and the automatic invocation of resale certificates (complete with verified, blockchain-based corporate identity). In a future in which taxing authorities may be part of the blockchain network(s), one can readily see the efficiencies associated with this model, including confirmed authenticity of resale certificates, lower cost and confusion, and the elimination of tax avoidance or inappropriate taxation. Indeed, one of the most avidly researched solutions for blockchain technology currently is related to the immutability of blockchain-based identity, for both individuals and corporate entities.

Impact on audit and assurance

Finally, one of the more discernible impacts of blockchain technology for accountancy will be in the areas of audit and assurance. With an audit function designed to be "a systematic and independent examination of books, accounts, statutory records, documents, etc., ... of an organization to ascertain how far financial statements, as well as nonfinancial disclosures, present a true and fair view of the concern,"6 one can readily see where blockchain has an impact.

But, it is far too convenient to envisage a world where auditors, in their work to provide an opinion on the reasonableness and accuracy of a company's financial statements, are merely replaced with blockchain. The work involved is in many regards too important and often too involved. However, one can imagine a potential universe where multiple blockchains interact (an internal blockchain for the corporation and its divisions, an "audit firm" blockchain, banking and payments blockchains, customer blockchains, etc.).

In this regard, we begin to see the evolution of new interactions of data and value transfer.

If transactions are automatically guaranteed accurate and affirmed, will financial statement audits change to be an audit of blockchain, or an ecosystem of blockchains? Will forecasts and projections become even more complex, even in light of the efficiency and immutability afforded with blockchain technology? Research and effort is underway right now to not only define what these interactions look like, but also how the new works seamlessly with the old. The function of auditors is no less an important a part of this dialogue.

Granted, these are all limited and arguably futuristic examples, which barely scratch the surface of the effort needed to leverage blockchain technology. In addition, none of this speaks to the integration and interoperability challenges posed to industries working with this technology. While significant research and prototypes are underway with protocols like Financial Product Markup Language (FpML), Extensible Business Reporting Language (xBRL) and many more, much study and work remains to be done.

What this means to you

No part of this article is meant to imply the elimination of tax experts, accountants or financial managers at all, although alarmists (and technologists) will often lead with questions about future roles for any industry. Articles with provocative headlines such as "Will Blockchain Render Accountants Irrelevant?",7 while thought-provoking, certainly do not aid the dialogue.

On the contrary, this author, and many others involved in financial markets, accounting and other relevant fields, believe that the innovations that are beginning to appear (blockchain, smart contracts, artificial intelligence and more) will undoubtedly require accountants, financial officers and others to pivot, adjust and evolve. This means they will need to learn not only new skill sets, but also showcase the ability to understand where their true value-add lies for their clients and their profession.

As has always been true for new innovations, from the advent of double-entry accounting to the birth of the internet, professionals will evolve to become valuable participants in a new future. The future in a blockchain world will be no exception.

Ron Quaranta possesses more than 25 years of experience in financial services, and currently serves as chairman of the board of the Wall Street Blockchain Alliance, a leading nonprofit trade association. You may reach him at ron@wsba.co.

1https://www.coindesk.com/bitcoin-venture-capital/

2https://www-forbes-com.cdn.ampproject.org/c/s/www.forbes.com/sites/laurashin/2017/07/17/how-to-invest-in-icos-10-practical-

\financial-tips/amp/

3https://www.ibc.org/tech-advances/what-blockchain-could-mean-for-media-and-entertainment/
2069.article

4https://en.wikipedia.org/wiki/Bitcoin

5https://assets.kpmg.com/content/dam/kpmg/pdf/2016/06/kpmg-blockchain-consensus-mechanism.pdf

6https://en.wikipedia.org/wiki/Audit

7 https://channels.theinnovationenterprise.com/articles/will-blockchain-render-accountants-irrelevant


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