Uses of Distributed Ledger Technology in Accounting and Finance
In the future, accounts will be settled utilizing blockchain technology. Easier understood by CPAs through its equivalent name, distributed ledger technology (DLT) will become the platform for an array of payment, clearing, title transfer and asset tracking functions in the 21st century.
Simplistically stated, a block is comparable to a single transaction. The “chain” memorializes a ledger from its first transaction — the genesis block — to its balance as of the latest transaction. The term “distributed” describes the breakthrough element that provides complete transparency as all interested parties share a single ledger in real time. Each party’s side of the transaction is posted to a commonly accessible source. Timing differences and the need for repeated account reconciliation will become as antiquated as footing journals and preparing trial balances.
Bitcoin was the first application developed using DLT. Cryptocurrency was the industry created, which, as of this writing, included more than 1,600 unique digital currencies. It is fundamental to understand that DLT is a general-purpose technology. It will permeate the evolving digital economy and affect every industry in multiple and unique ways. Like other general-purpose technologies — the wheel, electricity, computers and the Internet — DLT is generic with multiple uses. To begin, blockchain applications will run parallel with current systems. As development and acceptance continues, blockchain will entirely replace these same legacy systems. Finally, as blockchain matures and becomes widely adopted, it will disrupt business processes, and entire financial systems will be grounded on this currently emerging technology. This will have profound effects on the theory and practice of accounting and finance.
If you’re seasoned enough to have practiced accounting in 1980, a legitimate question was “What can a personal computer do for me?” Then the CPA’s killer app, the spreadsheet, came of age, and the computer became indispensable. During the turn of the millennium and the dot-com bust, a similar question was posed, “What can the Internet do for me?” Then every business person’s killer app, email, came of age, and access to the Internet became indispensable. Less than 10 years ago, the “cloud” was a relative mystery and again financial professionals begged the question, “What is the relevance of being continuously tethered to the Internet?” Then humanity’s killer app, the smart phone, was introduced and we now rely upon the cloud for real-time access to track, manage and react to every facet of both our personal and professional lives. Bill Gates is quoted saying, “we always overestimate the change that will occur in the next two years and underestimate the change that will occur in the next ten. Don’t let yourself be lulled into inaction.” With those insightful words, let’s delve into the implications that DLT might hold for CPAs and finance professionals as we wait for blockchain’s killer app(s) to unfold.
Financial Activities and Systems Affected
In essence, a distributed ledger is a generic platform technology upon which automated and integrated settlement processing systems are developed. Transactions are posted in real time, more securely and at a fraction of the cost currently extracted by third-party intermediaries. While the current emphasis on cryptocurrency is focused on public networks which are accessible by anyone, it is likely that future inroads will focus on private networks only accessible to designated and authenticated users. While this concept may seem vague, viewing deficiencies in existing financial transaction processing systems may shed light on the solutions to be developed.
Currently the settlement process for trading equities spans several days. Participation by multiple intermediaries including trading exchanges, clearinghouses and regulatory authorities requires that cash, stock certificates and fees be transacted and settled separately. Utilization of DLT holds the promise to reduce settlement times from days to minutes while simultaneously reducing errors and minimizing cost. Since the distributed ledger is transparent to all parties involved, and could be integrated between multiple systems, the need for reconciliations and audits would dramatically be reduced.
Accounts payable and associated treasury functions are also predisposed for dramatic change as DLT melds the transfer of title to assets with the associated assignment of liability between counter parties. Time lags, omissions and ambiguity will be minimized as Electronic Data Interchange (EDI) and other automated applications incorporate integrated digital forms as the already antiquated scheme of paper bills of lading, delivery tickets, invoices and checks all become part a consensus-driven digital ledger. Beyond the benefits of increased security, accuracy and timeliness, enormous transaction costs will be saved as settlement processing becomes more pedestrian.
Distributed ledger technology will significantly change the manner in which traditional audits are conducted. Instead of waiting for year end and reviewing transactions from the source (bottom) to their effect on the financial statements, transactions will be audited in real time and anomalies revealed and addressed before the books are closed. Sample-based substantive testing will give way to the electronic review of entire populations of activity. New auditing engagements for the assurance of IT systems and risk management mitigation will begin to replace the labor-intensive process of cross referencing and documenting transactions after the fact. Additional techniques will be deployed including tracking high-value assets via third-party systems utilizing the Internet of Things (IoT) and applying data analytics to real-time streams of the transactions under review.
Like general-purpose technologies of the past, the evolution of DLT will gradually be weaved into the fabric of our financial systems, the economy and our lives in general. However, it will only be in retrospect that we recognize that this transformation occurred.
This article appeared in the March/April 2019 issue of New Jersey CPA magazine. Read the full issue.