Blockchain In Finance: Why It Is Important To Keep An Eye On It

“I think I could, if only I knew how to begin ” – Alice in Wonderland

A lot has been written about blockchain, and it has followed its own hype cycle. Many applications have been prophesied but very few have been implemented, and even these, in limited industries. In Finance & Accounting, there has been a mixed response – hope mixed with skepticism. So why is there hope and why is there skepticism?

Fundamental premise: The double entry system of bookkeeping was created centuries ago in Venice to ensure that both sides of a transaction are recorded and validated. The entire bookkeeping currently done today is focused on recording data correctly, validating it, reconciling the data and minimizing errors and frauds. Audits are just another layer of again ensuring authenticity, accuracy and reliability of books of accounts, and are still not fully effective since they have to rely on samples.

Bookkeeping is also unilateral. Multiple parties maintain separate books of account to record the same information and transaction, which can lead to disputes and waste time, effort and increase the costs for each enterprise. Companies also spend significant time and money on validating every vendor and customer and are still prone to fraud. Further, record permanence is extremely tough to achieve and practically, never realized.

Promise of Blockchain: The reason for “hope” is that blockchain can solve many of these problems beautifully. Blockchain, in essence, is a database of transactions that are chronologically arranged, authenticated by all parties at every stage and sealed in a way that they cannot be changed. While the technology is complex, the logic is simple – one party initiates the transaction, the other parties “agree to it”, the transaction then gets locked and becomes a block that cannot be changed. Instead of two separate sets of records, there is one immutable accounting record shared among the firms. The data also cannot conflict with any other data in the system, ensuring consistency and serving as a control against errors.

The technology has also evolved to include “smart contracts”, where predefined actions get triggered automatically by certain events. Identity management and verification ensure authenticity, and all elements of the transaction are transparent to all parties.

Transactions, thus become authenticated and recorded in a way that negates the need for any validations, reconciliations or post mortem audits. Blockchain has the potential to challenge the entire current system of bookkeeping and audits and turn finance on its head for the first time in 600+ years.

While that scenario may be many years away, assuming blockchain technology and regulations ever mature to that extent, the current technology does offer some immediate applications.

Skepticism: Let’s move to the causes for skepticism.

Finance by its statutory and less flexible nature has never easily adopted technology except in the area of efficiency enhancement.

The regulatory future of blockchain is still unclear, making many organizations stay away from it.

The technology is not yet talking to standard ERP systems on which finance heavily relies. Blockchain by its nature is a threat to ERP, due to which it will take many years for the technology ecosystem to evolve in a seamless manner.

Blockchain needs all parties in a transaction to be on it for it to yield benefits, which requires huge transition and change management efforts.

Last of all, who bells the cat and adopts it first, for the hypothesis to get proven and others to follow?

Evolution: These are big obstacles to overcome and change will come gradually. The good news is that in the last year, there have been some big companies that have taken small but steady steps to adopt blockchain for finance. While most of these are with limited scope, such as intercompany, this is a promising start. Small to mid-size firms are experimenting with a larger scope, especially in the procure to pay and contract areas.

There is a reason for hope. The more companies that embrace the currently existing applications, higher the chance of technology and the ecosystem evolving to fulfill the larger promise that blockchain holds for finance in the future.