Traceable Accounting – Blockchain-Based Automated Real-Time Accounting

Faced with the immi­nent Wire­card account­ing scan­dal, and an appar­ent lack of dili­gence by audit firms, reg­u­la­to­ry bod­ies, and the gov­ern­ment have real­ized that finan­cial account­ing must be improved sig­nif­i­cant­ly. How­ev­er, pre­vi­ous improve­ments in finan­cial account­ing were aimed at an inten­si­fi­ca­tion of finan­cial con­trols that, in turn, led cor­po­ra­tions to inten­si­fy their inter­nal book­keep­ing cre­ativ­i­ty, and, con­se­quent­ly, to lim­it­ed pos­i­tive results. How­ev­er, we need some­thing dif­fer­ent: We need Trace­able Account­ing ‑Blockchain-based auto­mat­ed real-time accounting.

A new approach to finan­cial account­ing is need­ed: Fraud­u­lent behav­ior must be elim­i­nat­ed from the start. Trace­able, immutable finan­cial trans­ac­tions, processed on secure, trans­par­ent dis­trib­uted ledgers — this is what gov­ern­ments should require from all pub­licly list­ed companies.

Blockchain tech­nol­o­gy may rep­re­sent the next level of account­ing: Instead of keep­ing sep­a­rate records based on trans­ac­tion receipts, com­pa­nies can write their trans­ac­tions direct­ly into a shared ledger, cre­at­ing a sys­tem of his­tor­i­cal­ly con­sis­tent, endur­ing account­ing records. All entries are dis­trib­uted and cryp­to­graph­i­cal­ly sealed, there­fore fal­si­fy­ing or destroy­ing them to con­ceal activ­i­ty is prac­ti­cal­ly impossible. 

Com­pa­nies would ben­e­fit in many ways from the real-time trace­able account­ing we are devel­op­ing at Datarel­la as a key com­po­nent of our RAAY Dig­i­tal Oper­at­ing System: 

  • Automa­tion: A high degree of stan­dard­iza­tion enables audi­tors to ver­i­fy a large por­tion of the most crit­i­cal data behind the finan­cial state­ments automatically
  • Min­i­mized Costs: The cost and time nec­es­sary to con­duct an audit would decline considerably
  • Value Add: Com­pa­nies and audi­tors could spend freed-up time adding value to the company’s con­trol­ling: e.g. data analy­sis and algo­rith­mic pre­dic­tions on the future com­pa­ny (and mar­ket) development
  • Inclu­sion: The audi­tor and com­pli­ance offi­cer can be includ­ed in the entire account­ing process by run­ning a trust node

It is not fea­si­ble to start with a joint reg­is­ter for all account­ing entries. The Blockchain, as a source of trust, can also be ben­e­fi­cial in today’s account­ing struc­tures. It can be grad­u­al­ly inte­grat­ed with typ­i­cal account­ing pro­ce­dures: start­ing from secur­ing the integri­ty of records to com­plete­ly trace­able audit trails. At the end of the road, fully auto­mat­ed audits may be the reality.

Trust in Pub­lic and Pri­vate Blockchains
Where­as Pub­lic Blockchains are designed as truly decen­tral­ized, or ‘trust-less” sys­tems; i.e. net­works that don’t need a spe­cif­ic trust anchor since they come with inte­grat­ed trust through algorithm-based con­sen­sus mech­a­nisms, Pri­vate Blockchains are lack­ing this inte­gral trust. Pri­vate Blockchains are most­ly run as cen­tral­ized net­works, by com­pa­nies or orga­ni­za­tions, that have full con­trol of the data flow. Blockchain tech­nol­o­gy pro­vides his­tor­i­cal­ly con­sis­tent immutable data records — but under the sole respon­si­bil­i­ty and con­trol of the respec­tive com­pa­ny. Gov­er­nance Mod­els, in which rules and process­es of the Blockchain are defined, allow for a wide accep­tance of the sys­tem with all par­tic­i­pants. How­ev­er, third par­ties that are pre­vent­ed from par­tic­i­pat­ing in the per­mis­sioned net­work, can’t fal­si­fy or ver­i­fy the data output.

Step 1: Adding Trust With A Trust Node
Datarella’s Trace­able Account­ing con­cept adds trust to Pri­vate Blockchains by inte­grat­ing a ‘trust node’ run by a trust­ed third party, s.a. an audit firm or com­pli­ance offi­cer. Addi­tion­al­ly to the nodes run by the com­pa­ny itself, an audit firm runs a node with full access to the net­work, there­fore ser­vic­ing as a notary in the first place. The audi­tor con­ducts a real-time audit to ver­i­fy a large por­tion of the most crit­i­cal data. Through smart con­tracts, this audit can be auto­mat­ed to a high degree and save time and money. The audit engage­ment is mapped in a Gov­er­nance Model, which allows for full trans­paren­cy among the network’s par­tic­i­pants as well as towards exter­nal stake­hold­ers, s.a. stock­hold­ers, etc..

By adding trust to a Pri­vate Blockchain sys­tem through a trust node, a key inher­ent weak­ness of a partly-decentralized sys­tem is elim­i­nat­ed: Through the inte­gra­tion of audit firms in the company’s data flow, its account­ing becomes trust­wor­thy, and inno­v­a­tive at the same time: Trace­able Account­ing allows com­pa­nies to run AI-based data analy­ses that pro­vide valu­able data to the finance depart­ment for improved con­trol­ling capabilities.

Step 2: A Fully Trust­less Sys­tem
At a later stage, the Pri­vate Blockchain should be mor­phed into a Pub­lic Blockchain that pro­vides all inter­est­ed par­ties with access and audit oppor­tu­ni­ties. The archi­tec­ture and mech­a­nisms of a Pub­lic Blockchain allow for the par­tic­i­pa­tion of enti­ties in the net­work that do not have to trust each other — a Pub­lic Blockchain is designed as a ‘trust­less’ sys­tem: it works with­out the exis­tence of trust between the parties. 

A Pub­lic Blockchain can be designed as a per­mis­sioned or a per­mis­sion­less sys­tem. In a per­mis­sioned sys­tem, there is a reg­u­la­to­ry body that sets-up a gov­er­nance model defin­ing the rules for access and behav­ior in the net­work. In a per­mis­sion­less sys­tem, any­one can participate.

Trace­able Account­ing — Blockchain-Based Auto­mat­ed Real-time Accounting

Devel­op­ing a fully trust­less sys­tem must be the final goal for reg­u­la­to­ry and legal bod­ies when envi­sion­ing a new frame­work for finan­cial audit­ing. It meets all due dili­gence cri­te­ria, espe­cial­ly those that have fraud­u­lent­ly been bypassed in the Wire­card scan­dal. Fur­ther­more, trace­able account­ing will e required by future mod­u­lar­ized value chains; i.e. process­es of pro­vid­ing prod­ucts and ser­vices based on the col­lab­o­ra­tion of var­i­ous partners.

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