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How is Blockchain the Future of Accounting?

Karan Khatri 
on 26 May 2020

LinkedIn


Introduction

I know you might be wondering, what is blockchain? & how it's gonna be the future of accounting? So, the concept of blockchain was described in the '90s when the internet was growing. And after reading about blockchain, I understood 5 things about blockchain

  1. Blockchain was under development early in the '90s
  2. It went hand in hand with or we can say parallel to the internet
  3. Blockchain sounds simple but its actually far much complex
  4. Also, it has the potential to change our lives in the next 20 years, in the same way, the internet changed our lives.
  5. Earlier Blockchain was called B-I-T-C-O-I-N

To understand what is blockchain first we need to understand our current accounting system.

Blockchain - The Future of Accounting

Double Entry System

Take a look at the photo below:

Double Entry System

He is Luca Pacioli. Born in 1447 & died in 1517. He was the math teacher of Leonardo da Vinci and a very smart guy. Also, He is the most important figure in the Financial world, which nobody has ever heard off. He is the Father of Modern Accounting.

He published the concept of Double Entry System. Nowadays everyone in the world uses it for its accounting.

T-Account

Let's take an example if Mr X from Mumbai wants to transfer money to Mr Y in Delhi by issuing a cheque. Here, this transaction is recorded in 4 different ledgers or books. In Books of Mr X, Mr Y, Bank of Mr X and Bank of Mr Y. Similarly, there are different transactions between corporate, banks, companies & individuals. All this have a bunch of ledgers and entries.

Now, these ledgers need to be reconciled, because of which creates friction & this consumes time as well as money. Also, whose ledgers do you trust? is the question. Many times this double-entry system has failed. Look at the Satyam Scandal, Enron Scandal, Punjab National Bank Scandal, etc.

From here comes for the rescue is the Blockchain.

Blockchain History

Blockchain History

Stuart Haber and W. Scott Stornetta wanted to develop a system where document timestamp could not be tempered. They designed this system.

Blockchain

But the first Blockchain was conceptualized by a person (or a group of persons) called Satoshi Nakamoto in 2008 the creator/creators of BITCOIN.

What is Blockchain?

Now imagine you send an excel sheet to your friend to make changes. The problem is here that you need to wait until your friend makes a change and send you the revised excel sheet. Both cannot work simultaneously on one single sheet. Also, this will create multiple duplicate excel sheets. In Blockchain this problem is removed. Now in Blockchain, you both can make changes simultaneously and no duplicate excel sheets will be created.

To, further understand this let's take the same example of Mr X who wanted to transfer money to Mr Y. In the double-entry system, Mr X, Mr Y, Bank of Mr X & Bank of Mr Y makes ledger entries in their own books and then this is reconciled. Now, in Blockchain there will be no 4 different ledgers and no reconciliation required.

Since in Blockchain there will be one single universal ledger and all the parties to the transaction will have to just authenticate the transaction. This means no multiple books or ledgers, no reconciliation and this will also create a combined trust. (which the double-entry system fails as explained earlier).

Also, in Blockchain one can trace the whole transaction from the start to its end. All the transactions linked together. And if anyone tries to hack or make mischief in any one transaction the whole block of a chain will be affected. The advantage of this is that it creates trust since many organisations and people will be involved in the whole transaction.

Confused? Let's make it more simple

What is Blockchain?

Despite the sound of the word, there's not just one blockchain. The Blockchain is shorthand for a  whole suite of distributed ledger technologies that can be programmed to record and track anything of value, from financial transactions to medical records or even land titles.

Distributed ledger technologies

You might be thinking: we already have processes in place to track data. What's so special about blockchain?

Let's break down the reasons why blockchain technology stands to revolutionize the way we interact with each other.

1. The way it tracks and stores data

Blockchain stores information in batches, called blocks, that are linked together in a chronological fashion to form a continuous line: metaphorically, a chain of blocks.

The way Blockchain tracks and stores data

If you make a change to the information recorded in a particular block, you don't rewrite it. Instead, the change is stored in a new block showing that X changed to Y at a particular date and time. Sound familiar?

Blockchain stores information

That's because blockchain is based on the centuries-old method of the general financial ledger. It's a non-destructive way to track data changes over time. Here's one example. Let's say there was a dispute between Arpita and her brother Salman over who owns a piece of land that's been in the family for years.

Because blockchain technology uses the ledger method, there is an entry in the ledger showing that Kiran first owned the property in 1900. When Kiran sold the property to Dayaben in 1930, a new entry was made in the ledger, and so on.

Every change of ownership of this property is represented by a new entry in the ledger, right up until Arpita bought it from their father in 2007. Arpita is the current owner and we can see that history in the ledger.

Now, here's where things get really interesting.

Unlike the age-old ledger method - originally a book, then a database file stored on a single system - blockchain was designed to be decentralized and distributed across a large network of computers.

Blockchain network

This decentralizing of information reduces the ability for data tampering and brings us to the second factor that makes blockchain unique: it creates trust in the data.

2. Creating Trust in Data

Before a block can be added to the chain, a few things have to happen.

  1. A cryptographic puzzle must be solved, thus creating the block.
  2. The computer that solves the puzzle shares the solution to all of the other computers on the network. This is called a proof-of-work.
  3. The network will then verify this proof-of-work and, if correct, the block will be added to the chain.

Creating Trust in Data

The combination of these complex math puzzles and verification by many computers ensures that we can trust each and every block on the chain. Because the network does the trust-building for us, we now have the opportunity to interact directly with our data, in real-time.

3. No More Intermediaries

Currently, when doing business with one another, we don't show the other person our financial or business records. Instead, we rely on trusted intermediaries, such as a bank or lawyer, to view our records, and keep that information confidential.

These intermediaries build trust between the parties and are able to verify, for example, that “Yes, Arpita is the rightful owner of this land.” This approach limits exposure and risk, but also adds another step to the exchange, which means more time and money spent. If Arpita's land title information was stored in a blockchain, she could cut out the middleman, her lawyer, who would ordinarily confirm her information with Salman.

As we now know, all blocks added to the chain have been verified to be true and can't be tampered with.

blocks added to the chain

So Arpita can simply show Salman her land title information secured on the blockchain. Arpita would save considerable time and money by cutting out the middleman. This type of trusted peer-to-peer interaction with our data can revolutionize the way we access, verify and transact with one another.

Blockchain Durability and Robustness

The Blockchain is not controlled by one entity instead, it is controlled by multiple peers. Also, the whole point in this technology is creating trust. How trust/accountability is created?

Simple, 1st it is not controlled by a single entity and also it has no single point of failure.

Bitcoin was invented in 2008. Since that time, the Bitcoin blockchain has operated without significant disruption.

Blockchain truly is a mechanism to bring everyone to the highest degree of accountability. No more missed transactions, human or machine errors, or even an exchange that was not done with the consent of the parties involved.

Above anything else, the most critical area where Blockchain helps is to guarantee the validity of a transaction by recording it not only on the main register but a connected distributed system of registers, all of which are connected through a secure validation mechanism.

Implementation of Blockchain in many Different Ways

Some blockchains can be completely public and open to everyone to view and access.

Others can be closed to a select group of authorized users - such as your company, a group of banks or government agencies.

 

And there are hybrid public-private blockchains too. In some, those with private access can see all the data, while the public can see only selections. In others, everyone can see all the data, but only some people have access to add new data.

A government, for example, could use a hybrid system to record the boundaries of Arpita's property and the fact that she owns it while keeping her personal information private.  Or it could allow everyone to view property records but reserve to itself the exclusive right to update them.

It is the combination of all these factors - de-centralizing of the data, building trust in the data and allowing us to interact directly with one another and the data - that gives blockchain technology the potential to underpin many of the ways we interact with one another. But, much like the rise of the internet, this technology will bring with it all kinds of complex policy questions around governance, international law, security and economics.

How Blockchain will enhance today's accounting practices?

Today's accounting system is based on a double-entry system. It solved the problem of managers knowing whether they could trust their own books. But, to gain the trust of outsiders, independent public auditors also verify the company's financial information. Each audit is a costly exercise, biding the company's accountants for long time periods.

 

Blockchain will be the next step for accounting. Instead of keeping separate records based on transactions receipts, companies can write their transactions directly into a joint register. Creating an interlocking system of enduring accounting records. Since the transactions will be distributed and encrypted it will be practically impossible to falsify or destroy.

The companies will benefit in different ways. It will standardize the verification process for auditors of the most important data behind financial statements. Cost for audit and other expenses will automatically decline. Due to which auditors and accountants will have more time to work on internal control mechanisms.

To view / enroll course on Blockchain: Click Here


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