Introduction

One of the most searched phrases in relation to blockchain is “blockchain is too complex”.  Not a question, a statement.

My aim is to offer punchy but information-packed points to help improve your basic understanding of blockchain.

Whilst most of the content is snappy, short sentences I will also give real-life examples to demonstrate how blockchain is already being used, expanding in more detail as we work our way through.

I will explain how it is treated from an accounting point of view and demonstrate overall that blockchain will (in some way, shape or form) likely become common in the future.

One thing that is especially interesting and will be touched on is the goal to return ownership of our personal identities back to us as individuals, in an age where many peoples lives and data are held online due to social media and common business practices.

When blockchain started

The idea started in 2007 when work on developing bitcoin began.

Its creation is credited to ‘Satoshi Nakamoto’, but if you do some brief digging you will see that this is not a confirmed person, and it is not actually known who created bitcoin.

It was likely a group of individuals who have managed to keep their identities private.

What blockchain means

Blockchain is a digital record of transactions.

A “block” is an individual record. Each record can be one or more transactions.

A blockchain is literally a list of linked records, called a chain.

Blockchain is often public and aims to ensure that all transactions that happen are viewable by anyone, and impossible to change, hack or cheat – all whilst without revealing any sensitive data.

So… Can blockchain be hacked?

Yes.  Unfortunately, hackers have discovered vulnerabilities in blockchain.

There is an argument that, despite the vulnerabilities, it may be safer than current alternatives i.e. central banking.

In time, blockchain could in fact be used to combat fraud.

It could also result in much better transparency between corporations and consumers (i.e. imagine if you, yourself, could track where the banana you are eating came from, rather than simply trust the sticker that’s been put on it) – more on both of these points this later.

What is cryptocurrency?

Transactions in the chain are made by exchanging cryptocurrency, rather than traditional currency (£, $, € etc).

Cryptocurrency (which I will begin to shorten to crypto!) is a digital asset that is exchanged.  A virtual currency if you will.

The most well-known crypto is bitcoin.  Bitcoin is a publicly traded asset, but there are also private crypto’s where access is controlled.

Many people are only familiar with the fact that people trade (public) crypto to try and earn profits.

Whilst this is true, don’t forget that people also trade ‘normal’ currencies too.  Just because people trade currency, it does not mean this was the purpose of its creation.

How blockchain works (basic outline)

By understanding what blockchain would be replacing, you will begin to understand how it may work.

Remember that blockchain is a link of transactions, transactions carried out by exchanging crypto.

Crypto and the blockchain are 2 separate things.  So:

1. Crypto would in theory replace traditional currency

Replacing traditional currency would make traditional banks redundant if they did not adapt, and in response it looks like banks are starting to come up with their own digital versions of currency.

2. Blockchain would in turn replace the supply chain.

The supply chain refers to all the steps a product goes through, from start to finish, before it reaches the customer.

The chain could involve numerous steps, as demonstrated in the following diagram:

Using our banana example from the start, this might look like

• Banana is grown, picked, washed, and packed into cartons by supplier in Ecuador
• Banana cartons packed into refrigerated shipping containers
• Containers transported to shipping port
• The container will go through pre-shipment checks
• Bananas transported on ships to another country
• Post-shipment checks carried out in the country of receipt
• Goods ultimately then transported to wholesalers
• Banana’s labelled and possibly packaged
• Transported to retailers
• Sold by retailers to customer

How blockchain could work (using the same banana example)

Okay, so you are probably wondering “but how would blockchain compare to the current supply chain system?  The current system clearly works?”

Blockchain is not yet a finely tuned system that is being widely used, so is going to require a bit of vision.  This banana example represents a vision.

Imagine for a moment all the parties in the chain use crypto in exchange for their goods and services.

Now also imagine that each organisation or person in the chain has already proven their identity, without having to share their personal data with anyone else in the chain (a confusing concept, that will be covered later).

Furthermore, also imagine any documentation relating to the movement of the bananas is processed automatically in the blockchain, including documents such as transport notes.

At any time, someone could check in on the progress of the above events in real time, by looking at the blockchain.

Payments to and from each party could have been automatically / quickly made as the product moved through the chain.  No more waiting on customer or supplier payments.  Governments no longer waiting on the payment of taxes, as those could be taken at the point of transaction too.

There would be reduced time wastage previously spent checking certain paperwork at the borders.

Sounds impossible, right?  And I appreciate that so far, the “how it works” question has not been answered.  But let us first look at some examples of blockchain technology being used already to get a better understanding.

Why blockchain is the future (real-life examples)

Blockchain technology can be used for a specific purpose and does not need to be a long chain of events described above.

Below are just a few real examples of blockchain being used, to give you an idea of what I mean:

Barclays

• has launched several blockchain initiatives that involve tracking financial transactions, compliance and combating fraud.

Guardtime

• a company that uses blockchain to secure the health records of 1 million+ Estonian citizens.

Mitsubishi

• have partnered with SkuChain, a blockchain system that allows the tracking and tracing of goods through the supply chain

Bitgive

• aims to provide greater transparency to charities, showing clearer links between the donations given and the same donation money subsequently being spent on specific projects. It is working withcharities such as Save The Children and The Water Project.

How blockchain could be used (more detailed)

This is where things get a little more involved.

Blockchain aims to be:

CENSORSHIP RESISTANT

–          No third parties, or centralised control

–          Can’t hack, censor, or coerce with physical threats (as identity hidden)

NEUTRAL

–          There is no human bias as the technology is predefined algorithms and protocols

–          The system will always be neutral (even if the users of it may not be!)

BORDERLESS

–          No geographical boundaries, so transactions are instant

–          No political boundaries (so events like ‘BREXIT’may not be as big an issue)

–          No bank holidays, 24/7 active and much lower fees than banks

OPEN

–          Freely accessible

–          No restrictions

–          Innovation is happening quickly as the code is visible to anyone

…………………………………………………………………………………………………………………………………………………………………………………………………………………………………

Hopefully, the real-life examples given in the previous section give you a glimpse at how blockchain technology can at least be used in some capacity.

Reading the table above likely leads to many more questions.  Questions in relation to corruption, individual country laws, practicality, among many others.

Remember, the above table is the aim but not necessarily the current reality.  For example, bitcoin has been outright banned in certain countries such as Pakistan, Nepal and Ecuador (Oh no! The bananas!)

I won’t delve too much deeper into the table, as it would quickly spiral into complexity beyond my own understanding.

How is data verified?

Prepare for some unavoidable, technical lingo!

Blockchain would use ‘Zero-knowledge proof (‘ZKP’) to verify transactions.  ZKP is a form of cryptology, or cryptography, which is “the practice and study of techniques for secure communication”.

In a nutshell, ZKP uses an algorithm to verify that a piece of data from Entity A (the “prover”) is true to Entity B (the “verifier”), without leaking any personal data of either party.  It will simply provide a ‘verified’ or ‘not-verified’ result.

ZKP must ensure no false statements can be made by the prover, to falsely convince the verifier that something is a fact.

It is at this point your eyes will likely begin to glaze over!  So, I will hit the brakes and state this:

If ZKP can effectively be incorporated into blockchain then everything in the chain (transaction amount, who sent it, who received it etc) could be verified without anyone revealing their personal data to each other along the way, allowing business owners and individuals to take back ownership of their identities.

How many times have you been asked to provide proof of ID, bank statements, utility bills etc to organisations?

This would become a thing of the past, but the technology is a way off where it needs to be.

If the idea of ZKP interests you, I’d suggest an internet search for “Yao’s Millionaires’ problem”.

How is data stored, and secured?

Some more unavoidable lingo, I’m afraid!

Blockchain would look to use ‘distributed cloud storage’.

Imagine your piece of data is a sheet of paper.  When it is saved, the sheet of paper is ripped in to, say, 100 tiny pieces.  These 100 pieces are then stored on 100 separate and completely random PC’s around the globe.

Only the person that saved the piece of data can then put back together the 100 pieces to see what it is.

Sounds odd, confusing, and maybe a little risky, right?

Well, regarding risk, the pieces of data would not announce themselves to each person as being present on the machine they are using.

In fact, even if they did become aware and found the “piece”, it would only be 1 of the 100 pieces required, and it would essentially be impossible for that person to retrieve all 100 pieces to see the original data.

The level of understanding required to know how the 100 pieces are retrieved and put back together for the original user is utter wizardry, a few grades above Dumbledore (so, a several hundred levels above me)!

It may seem bizarre, but the concept appears unbelievably clever and could revolutionise how data is stored in the future.

Blockchain application (some more examples)

Compliance & tax collection

If you read my post “Do automated systems signal the end for bookkeepers?” you will already be familiar with the governments Making Tax Digital plans in the UK.

Blockchain could represent a far improved vision compared to MTD, resulting in taxes (such as VAT) being recouped at the point of sale, when a transaction is carried out.  Rather than months later, when reported on a VAT Return!

Online Retail Marketplaces

Since blockchain is de-centralised and transactions would be directly between the seller and buyer, it could eliminate platforms such as eBay which many sellers believe have excessively high fees and that the platform is heavily biased towards the buyer.

Legal

If you are a home owner then you will know that the most stressful part of the buying process is probably the endless exchanging of paperwork with your solicitor, ensuring the money will go through on time and making payment of any taxes (such as Stamp Duty) to HMRC.

Through ‘smart contracts’ within the blockchain, contracts could automatically control, execute and record any events relating to the contract/agreement.  This could include the automatic release of funds upon the successful execution of an agreement, such as a house sale.

Accounting

If you have found this article from an internet search, you may not be aware that I am an accountant.  I will now take a moment to geek out with the other accountants to explain how crypto transactions would be recorded.  If you are not interested in this then feel free to skip ahead!

As we know, traditional accounting follows the principals of double-entry; for every Debit transaction, there is a corresponding Credit transaction.

If you pay £50 for a job ad placement, you would be used to seeing the debit in the advertising nominal, and the £50 credit come out of the business bank account.  But what if the ad was paid for using crypto via blockchain?

If the ad was paid using crypto, then the credit side of the transaction would be in the blockchain and not out of the company bank.  The customer and supplier share a single ledger within the blockchain, which is off the books.

For this reason, blockchain is being referred to as single-entry accounting.

For those businesses who already incorporate blockchain as part of their business, they are said to be using triple-entry accounting!

If you are familiar with the term “hybrid accountant” – and have read the entirety of the article so far – you can see how in time, us accountants will be able to focus on more value-adding activities in the future if blockchain eradicates elements of traditional accounting.

Blockchain constraints

Whilst earlier examples prove that blockchain is being embraced by some, I will finish off by listing just a few constraints that will need to be addressed before we see its widespread use:

• The first issue is not with the blockchain ‘per se’, but the cryptocurrencies used to exchange with. There are far too many, and their values are too volatile.
• The risk-adverse public will be fearful not only to put their money into something that is volatile, but something that also lacks regulation. With less regulation, it may be easier for criminals to hide proceeds from crime.
• It’s too complicated! Understanding will only come over time, but even for some users its complexity can be jarring making it hard to appreciate its benefits.  It is easy for the average person and business to sit back and think “well it isn’t broke, let’s not fix it…”
• The way blockchain works now takes incredible computing power, which requires considerable energy, which of course has an environmental impact.
• Whilst the aim is for crypto and blockchain transactions to be instant, it is simply not true right now. Due to network lag they can in fact take hours and sometimes days.

My opinion is that – as exciting as all these developments are – we are AT LEAST 5-10 years away from seeing widespread adoption of blockchain.

Author: Justin Davidson CIMA Dip MA (Davidson Services)

I have written this article from my own personal knowledge, and from knowledge gained during a CGMA blockchain course conducted by Kirk Phillips, a certified public accountant and certified bitcoin professional, and Amy Vetter, who is also a CPA as well as chartered IT professional and chartered global management accountant.

If you feel there are any errors within the article, please feel free to message me via my website enquiry form and I will endeavour to verify and amend the content as required.