Blockchain Overview- What Auditors Need to Know (Part 1)

September 3, 2018

Blockchain technology has been the hottest topic at virtually every accounting conference and in journals, magazines, and in-person dialogues. While the technology itself, namely the specific coding and computer science requirements to operate a blockchain, will not be the responsibility of auditors or accounting professionals, practitioners will need to understand how this technology works. Prior to diving into the implications of blockchain on audit and other attest work in higher education, it is important to note the pace of blockchain adoption. To a certain extent, the hype and excitement around blockchain may have overshot the reality of applications for now, but blockchain technology is coming. Regardless of whether accountants and auditors work in the public sector, the private sector, or at an institution of higher education, every professional needs to understand blockchain fundamentals and its possible applications within their industry.

BLOCKCHAIN BREAKDOWN

There have been hundreds (if not thousands) of articles and podcasts focusing on blockchain technology and the implications it may hold for the accounting profession. However, summarizing the core functionality of the technology is necessary to ensure no misinformation or misinterpretation occurs, considering all the debate and
dialogue about this topic. Some of the components that make blockchain so interesting to accounting, audit, and attestation professionals include:

Institutions of higher education do need to track and monitor financial performance; the real-time transmission and communication of information between network members is a definitive value-added function enabled by blockchain.

1. Decentralization – One of the most fascinating, and potentially most frightening, aspects of blockchain implementation is that a public blockchain can replace many functions performed by accountants. Such functions consist of confirming information, verifying the accuracy of data, and ensuring reports issued to stakeholders are accurate. Private blockchains, organized by an aptly named “organizing” firm, combine some of the positive attributes of blockchain and also have a central hub for dispute resolution. Check out this AICPA article (https://tinyurl.com/AICPA-blockchain) for more details.

2. Real time transmission – A common complaint, whether with financial statements audits or other operational audits, is the substantial lag between when data is generated and when that data is audited or tested for errors. This lag is, at best, an inconvenience that reduces the effectiveness of audit procedures and, at worst, leads to audit failures. Institutions of higher education do need to track and monitor financial performance; the real-time transmission and communication of information between network members is a definitive value-added function enabled by blockchain.

3. Data is encrypted – It is unlikely for a week to go by without a story, headline, or media coverage centering around a data breach or hack. Accountants and auditors in all industries handle information that can be both confidential and sensitive. This complicates blockchain adoption, especially when dealing with international students and individuals through the passage of the General Data Protection Regulation (GDPR). See this IBM article (https://tinyurl.com/IBM-blockchain-GDPR) for more details. It is a fiduciary duty of all practitioners to protect information.

4. Standardization of information – Every accountant, auditor, or attest professional has experience with different systems that do not talk to each other. This prevents the efficient testing and examination of information. The number of different systems that professionals in higher education work with can make conducting a comprehensive control or operational audit extremely difficult. Curriculum information, student information (again sensitive in nature), grade information, tuition, and the other types of information created by students may all have different characteristics. Blockchain may be able to help address this issue by reducing the manual labor and time spent sorting through inconsistent data sets.

THE CONNECTION BETWEEN BLOCKCHAIN AND CRYPTOCURRENCIES

With all the buzz and investment surrounding the cryptocurrency environment, especially the excitement that revolved around Bitcoin in 2017 and 2018, it is not uncommon that individuals associate blockchain with cryptocurrencies. This association and relationship is not incorrect, but it requires a further level of differentiation and understanding for practitioners to be able to offer quality advice. When trying to educate colleagues, adopt blockchain technology, and inform management professionals of what blockchain entails, think of blockchain as either the beginning of the Internet 2.0, the Internet of Trust, or as a tool enabling the creation of trustless networks. Blockchain can be thought of as an underlying technology that other applications can operate on. Different cryptocurrencies, including the most famous cryptocurrency (Bitcoin), operate on a
blockchain system. Cryptocurrencies need a blockchain to function and operate, but a blockchain does not have to use a cryptocurrency. In 2017 alone, over 900 different cryptocurrencies launched, and by mid-2018 over 50% of these cryptocurrencies failed. Assuming that some of these new currencies operated on the same blockchain, that is hundreds of new blockchains in the marketplace. Being able to understand and articulate the differences between different blockchains and the connection between blockchains and cryptocurrencies is a responsibility of every practitioner.

DIFFERENT TYPES OF BLOCKCHAINS

Other common misconceptions are that there is only one blockchain and that every blockchain is exactly the same. This would certainly make this topic easier to understand, but it represents an incomplete view of how blockchain technology works. The different types of blockchains represent a topic that can, and is, generating articles, books, and analysis. However, for the purposes of this article, the following two categories are sufficient:

1. Public blockchains – Perhaps perceived as the original or pure blockchain concept, this type of blockchain underpins decentralized cryptocurrencies like Bitcoin. While anyone can download operating software and become a part of a public blockchain, the completely decentralized nature also poses risks. In a public blockchain, if anything goes wrong or if any issues arise, there is no central hub for conflict resolution.

2. Private blockchains – If the idea of a completely decentralized public blockchain does not sound entirely appropriate for business purposes, a private blockchain may offer a viable alternative. The majority of investment dollars and people are focused in the private blockchain space. Although a private blockchain is closer to a hybrid rather than a pure blockchain, it is more useful for business applications. Organized by an organizing firm, a private blockchain can be customized, adjusted, and modified to reflect the needs and expectations of network participants. Most importantly, membership can be restricted to certain individuals or organizations and the organizing firm can establish rules and protocols for conflict resolution.

Blockchain is a technical and complicated subject. It could not possibly be covered in a single article, but the reality is this technology represents a potential paradigm shift in how accounting and auditing professionals interact with colleagues and external end users. While it is not expected these professionals will become developers, coders, or otherwise technical experts, having a working understanding of how blockchain functions will be increasingly important moving forward. This article focused on introducing core blockchain concepts and ideas. Part 2, “Blockchain and Higher Education Applications: What Accountants and Auditors Need to Know,” will drill down into how blockchain will drive change in higher education. Be sure to check out this article in the Winter issue of College and University Auditor.

About the Author

Sean Stein Smith

Sean Stein Smith is an assistant professor at Lehman College (CUNY), a member of the AICPA Leadership Academy class of 2017, was named a 40 under 40 by CPA Practice Advisor in 2017 and 2018, and is a member of the Advisory Board of the Wall Street Blockchain Alliance. Sean regularly appears as an expert contributor on blockchain, cryptocurrencies, and other emerging technologies for China Global TV’s live business programming. He contributes his research and analysis on blockchain applications for accounting and
business to the official IBM Blockchain site - Blockchain Unleashed. He is also an instructor with the Business Learning Institute and consults with the AICPA to develop and deliver blockchain and technology related content. Sean presents often on blockchain (and other emerging technologies) and its implications on the profession. His work and analysis of accounting, blockchain, emerging technologies, and the evolution of the accounting profession has been featured in dozens of practitioner and academic publications and presentations. Additionally, he is the author of numerous books focusing on accounting, technology, and how the profession will change moving forward. He can be reached at drseansteinsmith@gmail.com or @seansteinsmith.

Articles
Blockchain and Higher Education Applications: What Accountants and Auditors Need to Know (Part 2)
Blockchain Overview- What Auditors Need to Know (Part 1)