Back in the early 1990s, very few people had heard of the internet, let alone had any inkling as to just how much it would disrupt traditional ways of working and consumer habits. Now, should the hype be believed, we’re on the cusp of a similar development; this time in the form of blockchain.
The potential of blockchain lies in its ability to create a distributed ledger of transactions, of which all participants have an identical copy that can be accessed and viewed in real-time. There are huge implications for payments, and therefore accountants, but also for any industry or process relying on the sharing of information in a secure and timely fashion.
“Blockchain is distributed, decentralised database technology that maintains a growing list of transactions and, through encryption and other activity, verifies their permanence,” explains Hywel Ball, UK head of audit at EY. “It means every participant in the process can manipulate the ledger securely and without the need for a central authority, because they all see it simultaneously.”
Alex Shelkovnikov, corporate venturing and blockchain lead at Deloitte UK
It’s especially exciting for financial services and the securities processing industry, because it removes the need for central authorities
To date, the technology is best known as the basis for the cryptocurrency bitcoin, but its potential use goes far wider than this, suggests David Lyford-Smith, technical manager, IT and the profession, at ICAEW. “While it was created to be the platform for bitcoin, blockchain has applications anywhere where decentralised ledgers are appealing,” he says.
“The level of access and anonymity can be varied; for example, Bitcoin is 100% public but an implementation for inter-bank reconciliation would be private.” What is important, he adds, is not so much how the technology works but the broader understanding around its potential applications.
The link to bitcoin means most early attention has focused around the financial services sector, and payments in particular. “One of the most popular use cases that is starting to happen is international remittance, and that’s in both business-to-consumer and business-to-business applications,” says Alex Shelkovnikov, corporate venturing and blockchain lead at Deloitte UK.
From here, this could spread into clearing and settlement, he says, either interbank or within a bank’s own international network. “Then there are clearing and settlement use cases in the capital market space,” he adds. “We have seen applications by stock exchanges where blockchain technology allows them to reconcile, settle and pay out dividends based on the stock ownership by people and by organisation.”
Ball also highlights the potential for blockchain to revolutionise transactions. “It’s especially exciting for financial services and the securities processing industry, because it removes the need for central authorities,” he says. “If you’re doing a share-sale at the moment it’s got to be conformed, certified, the money has to be checked in place. With blockchain you can do all that in one transaction.” This is largely theoretical currently, he says, but estimates banks have invested around $1bn into the potential use over the last few years.
Technology company Redcloud is currently looking to make use of the concept to build a payment network in Africa, which would allow banks from different countries to transact with each other. “The African market is highly fragmented, so you have a lot of companies providing payment and financial solutions that are completely isolated from any kind of network,” says Soumaya Hamzaoui, chief product officer.
“They can’t connect to Swift because it’s too expensive and there are a lot of microfinance banks that don’t have access to any kind of international remittance or payments. We believe we can use this trusted network and this cryptocurrency solution to enable African remittances, for example, between banks in Egypt and South Africa.” The project is currently at proof-of-concept stage, he adds, and also needs the necessary regulatory and legal framework before it can become reality.
Nick Williamson is CEO and founder of blockchain infrastructure provider Credits. He argues that looking at payments is not the right place to start, as this part of the financial system generally works well. “It’s really not the payment itself that is the issue; it’s everything else that surrounds it from the Know Your Customer [KYC] considerations to the querying and settling of the transaction and the fees that are connected with communicating with these different intermediaries,” he says.
In fact, the principle of blockchain could be applied to a number of industries. Ball gives the example of music artists releasing new albums based on the technology, as well as particular sectors such as the oil industry and the diamond trade, where it could potentially help to overcome the issue of conflict diamonds. “You might have groups of suppliers and purchasers, especially overseas where they have high-risk jurisdictions, who want to know who is getting the money and what asset is being purchased,” he says.
There are also significant opportunities in the public sector, and the UK government is already exploring the possibilities. A recent report by
the UK’s Government Office for Science identified a number of ways in which distributed ledger technology could “revolutionise the citizen’s relationship with the state”, including helping governments to collect taxes, deliver benefits, issue passports, record land registries and assure the supply chain of goods, as well as sharing health records around disparate parts of the NHS. Such a system is already being used in Estonia, says Lyford-Smith, while a pilot scheme is being run in Honduras around land registry.
There are obvious applications for governments in the financial space, too, says William Garner, partner at the law firm Charles Russell Speechlys. “Various governmental agencies are likely to have access to the payment system and will be able to view transactions as they are proposed, validated, accepted and completed,” he says. “Blockchain technology should give governmental agencies the ability to detect financial instability, fraud, money laundering and financial crime at an early stage and act accordingly.”
Hywel Ball, UK head of audit at EY
Accountants do a lot of transaction processing, reconciliation and control, and that could change significantly if this technology gets adopted on a widespread basis
The concept also has significant implications for accounting, and the nature of the accounting and auditing profession. Essentially, says Williamson, blockchain is a better ledger. “If you work in the financial world every single use case boils down to being able to maintain and reconcile ledgers with each other,” he says. “There’s obviously a lot of operational and regulatory complexity around that but, at its core, that’s what we’re doing; adding entries to ledgers and having multiple ledgers that need to reconcile against each other.”
This has possible ramifications for internal finance functions, says Ball. “Accountants do a lot of transaction processing, reconciliation and control, and that could change significantly if this technology gets adopted on a widespread basis,” he says. “The cost savings that the banks are looking at are huge, and most of that saving is people who do the back office, so whether you view those as accountants or ledgers, there’s a degree of challenge to those in the accounting profession who work in finance functions.”
Lyford-Smith, however, remains to be convinced about the impact, even on book-keeping roles. “People have talked about some potentially very disruptive ideas to the way that businesses run,” he says. “You could just say we could put the whole of accounting in this one ledger of perfection, and take all those walls down, but that’s a very out-there and theoretical concept.” This is more likely to be used in certain areas such as inter-bank transfers, he suggests, rather than book-keeping more generally.
The implications for auditors are less clear. “Would we have to audit the chain itself or would we audit transactions?” asks Ball. “How much would we have to understand the advanced technology in the blockchain to audit the start and the end of the chain? Do we have to rely on the blockchain’s auditors? People are just starting to think about that now.”
One possibility is that this could change the nature of auditing, by removing some of the more transactional and checking parts of the role. “Essentially this provides that third validation point which didn’t exist before, and that’s where auditors have previously stepped in,” suggests Shelkovnikov.
“With blockchain technology that validation could be provided independently, potentially by an independent network validating transactions that have been recorded on the blockchain. The role of audit could move further up in the value chain, into providing more of a governance role around the various types of blockchains that are going to be used.”
This could even lead to the development of real-time audits, suggests Andrew Wingfield, corporate partner at King & Wood Mallesons. “One of the most compelling use-cases for blockchains is their ability to provide a live, indelible record of financial transactions, such as derivatives trades, which could give accountants the ability to perform, in effect, real-time, ‘smart’ audits of the capital and risk positions of banks and other financial services clients,” he says. “It’s likely that, on the other hand, in the medium-to-long-term, blockchain-driven solutions could reduce the need for many lower-quantum, high-volume manual audit processes.”
Yet there are issues that must be overcome. The government’s report suggests blockchain is inherently more secure than other data management systems as there are multiple copies, but distributed ledgers are not invulnerable to cyber-attacks (a $79m heist of cryptocurrency ether took place only in June). It also points out that its association with bitcoin, which has had its own security concerns, could make it harder to convince governments and consumers.
Regulators, too, need to become more comfortable with the technology before it can take off in mature markets, says Shelkovnikov. “We need to be able to evolve the current regulatory environment to be more friendly to the use of blockchain technology for payments. One of the things that needs to be thought of, together with regulators, is how to adopt regulation without stifling the innovation we have with blockchain.”
Achieving critical mass is also vital if it is to take off in any meaningful way, says Lyford-Smith. “The largest blockchain in existence by far is the one underpinning bitcoin, but that is nowhere near being able to support payments information on the scales required for a payments infrastructure like Visa,” he points out. “Currently there is a lot of talk about blockchain but very little concrete that’s actually being done.”
In fact, there is no guarantee that blockchain will succeed at all. “The likely future path forks,” says Lyford-Smith. “If blockchain becomes a respected fintech technology in its own right, with successful development and implementation in some high-complexity scenarios, then it could be a building block for a new option in the constellation of financial technologies, with some unique features and advantages.
“But if the technological barriers prove to be insurmountable, or better ways of meeting the same needs for transparency and trustworthiness are found, then it will likely die on the vine, having failed to live up to its hype and potential.”
The Isle of Man (IoM) government has sought to attract businesses operating in the blockchain space.
A lot of businesses wanted to come to the IoM because they saw there was a convergence going on between e-gaming and digital currency, and they also saw that the IoM did a good job on the regulatory side around e-gaming a decade ago, says Brian Donegan, head of operations, e-business, at the Department for Economic Development, IoM Government.
In 2015, the island was the first jurisdiction to recognise the value of digital currencies and blockchain, he adds, including putting in place a regulatory framework comprising anti-money laundering and Know Your Customer provisions.
It has amended the 2008 Proceeds of Crime Act to include digital currencies, and introduced the Designated Businesses Act 2015, which grants its financial regulator the power to inspect the books of all new registrants seeking to establish businesses in the blockchain and digital currency space. The island now has more than 25 businesses operating in the blockchain sector.