Blockchain technology is evolving accounting through cryptography by providing an immutable, tamper-proof record of the chain’s transaction history. In this article, we explore the history of accounting, define the concept of triple-entry accounting, and discuss how decentralised technology has proven to be the magic ingredient in creating a new accounting paradigm.
Blockchain as a catalyst for change in accounting practices
While a necessary evil in business, bookkeeping is hardly one of the most exciting topics to discuss. In times past, the practice was associated with unassuming, bespectacled individuals using a quill to make detailed entries on an oversized, black-leather bound ledger book. The world has long since stopped using quills, but the essential mechanics of bookkeeping have remained surprisingly unchanged for centuries.
Decentralised technology has infused bookkeeping with a new lease of life by adding cryptographic methodologies that add a much-needed layer of transparency and security.
A brief history of accounting
During the second half of the 15th century, Franciscan friar and mathematician Luca Pacioli enjoyed a life of traveling around his native Italy. He spent time teaching at the universities of Rome, Naples, and Perugia, sharing his knowledge and passion for education. In 1494, Pacioli published Summa, an influential book that compiled most of the mathematical knowledge of the era. But what cemented this wayward friar’s place in history was his seminal contribution to the accounting field. Pacioli was the first person to publish a paper on the double-entry system for bookkeeping. This work earned Pacioli the title of ‘Father of Accounting and Bookkeeping.
Pacioli’s work became a landmark moment in the field’s history. Businesses around Italy adopted double-entry accounting to improve their efficiency and bottom line. Soon, Pacioli’s knowledge was printed internationally and used as an accounting textbook well into the 16th century. Double-entry accountancy has endured the test of time, as it has changed very little since the time that Luca Pacioli put the principles to paper (likely using a quill) hundreds of years ago.
What is double-entry accounting?
The core principle of double-entry accounting (or double-entry bookkeeping, as it’s sometimes referred to) is relatively simple. In this system, each financial transaction requires three things:
- At least one debit and one credit
- The transaction affects at least two accounts
- The system must always balance, that is, the debits and credits must be equal
Archaeological data suggests that accounting methods were used as early as 300 BC in Mesopotamia (present-day Iraq, Kuwait, Turkey, and Syria). But double-entry accounting would not see widespread use until the introduction of Pacioli’s work in the late 15th century. Most businesses use this system today.
Double-entry accounting: the perfect measure against fraud?
The double-entry system is designed to prevent financial errors and fraud, though it’s far from ironclad.
The inherent problem with accountancy is its centralised nature. Historically and typically, a very reduced number of people would be involved in a firm’s accounting, at least in earlier times. Maybe one or two people would be in control of the books, which meant that, should these individuals decide to engage in fraudulent activities, it would be relatively easy to carry out, conceal, and perpetuate.
Fraudulent accounting is not limited to small firms though. The fall of the energy giant Enron is one of the best-known cases of financial malfeasance leading to complete collapse. Following years of financial mismanagement and fraudulent accounting practices, Enron filed for bankruptcy on December 2, 2001. Analysts estimated that the combined losses involved in Enron’s long collapse amounted to some $1.5tn and change.
From single-entry to triple-entry accounting
Fast forward to the present. More and more use cases are adopting blockchain technology and accounting is no exception. Decentralised technology facilitates triple-entry accounting by adding the inherent traits of transparency and immutability.
In earlier times, folk would use clay tablets to account for stuff. They would carve the amount on a piece of clay and leave it out in the sun to dry. Once dried, the clay tablet would become the immutable proof of the transaction. Some historians refer to this as ‘single-entry accounting.’ Then came Pacioli’s work, whose principles of double-entry bookkeeping have endured to the present day more or less unchanged.
Blockchain technology represents the next evolutionary step in the accounting industry.
In single- and double-entry systems, an accountant (or accounting team) must check and balance the books. In other words, a very small number of people get to decide whether or not the books are correct. This, in turn, poses obvious security risks. ‘Cooking’ the books is relatively easy, and can have devastating consequences, as the fall of Enron -and many others- starkly revealed.
Decentralised technology removes the need for a middleman (an accountant, or team of accountants), and therefore, the single point of failure. Now, it is the community itself that reaches a consensus on the correctness of the numbers. Falsifying this information is futile, as the community would know right away. Triple-entry accounting uses cryptographic signatures to validate the figures, independent of the consensus protocol used by the underlying chain.
Triple-entry accounting: redefining financial structures
There often are multiple reasons why a company goes bankrupt. Poor management, bad decision-making, and even natural disasters can hasten a firm’s collapse. But financial mismanagement, whether by poor decision making, incompetence, or outright fraud, tends to be one of the main culprits of a company’s untimely demise.
Triple-entry accounting presents a variety of use cases, both for private enterprises and governments. Because of blockchain’s inherent traits of transparency and immutability, it is no longer possible to ‘cook’ the books, so triple-entry bookkeeping renders fraud impossible. In other words, we can trust the numbers, so any ecosystem built on top of this principle of financial trust already stands on very solid ground. Such a trust environment also means that the identities on such a system can be trusted, so no fake social media accounts, for example.
Could triple-entry accounting have prevented the disaster that unfolded at Enron? One can only speculate. In hindsight, transparent accounting practices would certainly have revealed what was going on very early in the process. Had this occurred, and had corrective action been taken, Enron might still be in business today.
Blockchain technology wasn’t around back then, however. Even the internet was in its infancy, in comparative terms. Today, blockchain is available, and though it is also a relatively nascent technology, triple-entry accounting -and, by extension, blockchain- has the potential to revolutionize entire financial structures and become the next evolutionary step in accounting.
- Double-entry accounting has changed very little over the last 500 years
- Triple-entry accounting removes the need for a middleman (an accountant) to determine whether or not the numbers are correct
- In triple-entry accounting, the community reaches consensus on the numbers, so you can trust the figures
- Zaisan helps international clients to create a safe financial environment through blockchain consultancy