Is Blockchain About to Destroy a Centuries-Old Industry?

By Kimberly Cook |Email | Nov 4, 2018 | 7908 Views

Predictions abound about the myriad ways that blockchain will revolutionize the business world - from currency to transportation to banking to law. The most important effect that blockchain will have, however, is the one that gets the least attention. And the last time such a big change happened in the field, it led to the greatest global commercial, artistic, and intellectual expansion in the history of the world.

Double-entry bookkeeping and the birth of accounting
The field of accounting owes almost its entire existence to the creation of double-entry bookkeeping. It is believed that the double-entry system was invented by medieval Jewish merchants in the Middle East, and later picked up by Genoese merchants in the 14th century. From there it was popularized by the major trading families of the Italian city-states of Florence, Genoa, and Venice.

The system is deceptively simple but has major ramifications. For every intake of money in one account (credit), there must be an equivalent outflow in some other account (debit). The opposite is also true. For those who study accounting or even just general business in school, this is the root of the famous "Assets = Liabilities + Owners' Equity" formula.

The ramifications of this method pertain to the management of risk. The invention of double-entry bookkeeping allowed for the accurate reflection of financial health at a moment in time. By making two entries when a shipment of goods left the port of Venice, a merchant was able to understand that a) he could no longer count those goods as under his control, and b) the buyer owed him money. This allowed these merchants to keep track of many transactions at once. It allowed them, in other words, to scale up in a way that was previously very difficult or very expensive.

Merchants could now keep track of goods in transit, outstanding loans, lost items, and other regular business occurrences at an unprecedented rate. They could operate more easily with multiple currencies and account for the inflation of those currencies. They could better utilize interest rates and payment schedules to maximize the value of their accounts receivable.

Blockchain is not a double-entry bookkeeping system. I like to call it a "potentially infinite bookkeeping" system.
And to do all that, they had to create a niche group within their houses whose sole job it was to manage and oversee the accounts. Thus the accounting profession was born. They operated (and to a certain extent still operate) like a professional guild, a group of specialized workers with a certain training, skill set, and licensing that provide them with a special position within the global economy.

It is hard to overstate how much of an impact this has had. Many scholars on the history of capitalism agree with Werner Sombart's claim from the early 20th century that "capital, as a category, did not exist before double-entry bookkeeping." Accounting professionals, rejoice!

Accountants at their most basic level keep, manage and evaluate the accounts of companies. Blockchain technology, if widely implemented, will make those functions completely unnecessary to be done by humans, as I'll explain.

Blockchain and the death of accounting
How is blockchain different from double-entry bookkeeping?

To answer that question, consider the potential points in the double-entry system where mistakes or fraud might occur. They could happen at the first entry or the second entry. When they happen, they must be resolved (usually by accountants). In that resolution process, mistakes or fraud can occur yet again.

Blockchain is not a double-entry bookkeeping system. I like to call it a "potentially infinite bookkeeping" system. It is often described as a distributed and automated ledger with private keys.

If we take seriously the claims of some historians, double-entry bookkeeping birthed capitalism. Will blockchain spawn a new economic -ism?
For those who want a more in-depth primer, there are many resources available. At its core, and for the purposes of this article, blockchain technology can give every user in a system an automatically updated list (a "chain") of all transactions ("blocks") that have occurred within that system.

One of the most important components of any blockchain system is that it has validators: designated members of the system who come to "consensus" over a transaction. This means that transactions are automatically trusted once consensus is reached, which itself occurs automatically (though not instantly).

A copy of every transaction can be made by every participant in the blockchain system, not just on two ledgers controlled by one party. The ledger's only limitations are those posed by the number of users and the amount of computing power (thus, it's potentially infinite).

If I have a copy of every transaction in the system and no transaction can be amended without being verified, an instance of fraud or error at any point other than at input is virtually impossible.

And there's a great way to prevent fraud at the input. Public blockchains that anyone can join or leave at will are what we are used to hearing about, mostly because bitcoin uses this model. But permission blockchain is an alternative already in use. In permission blockchain systems, the participants have already been verified and can impose all sorts of limits on them - like who can read or add to the blockchain or how many users are allowed to be a part of the network.

So where does this leave the accounting profession? Why would we need anyone to check the accuracy of accounts, financial statements, or balance sheets? Why would we need anyone to calculate important ratios for financial decision makers or send an audit team to recognize books?

Essentially the only function in current accounting practice that would be necessary would be auditing to ensure that the inputs were done correctly. Then again, you could easily imagine a fraud-detection AI with better capabilities at pattern recognition to detect fraud-but that's another story entirely.

What does this mean for the future of capitalism?
If we take seriously the claims of some historians, double-entry bookkeeping birthed capitalism. Will blockchain spawn a new economic -ism, one that we are not wholly prepared for and don't yet have a grasp on? Maybe. Maybe not. But the last time we had such a tectonic shift in record keeping, it changed the world dramatically.

The article was originally published here 

Source: HOB