CPA Practice Advisor

AUG 2018

Today's Technology for Tomorrow's Firm.

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4 AUGUST 2018 ■ www.CPAPracticeAdvisor.com FROM THE TRENCHES RANDY JOHNSTON EVP & Partner K2 Enterprises & CEO of Network Management Group, Inc. randy.johnston@cpapracticeadvisor.com @RPJohnston WHY AND HOW: BLOCKCHAIN Blockchain seems to be everywhere in the press and conferences related to accounting. There is clear merit to this coverage and blockchain is a technology with long-term importance. Applications have only been developed in few pilot projects, and there is much work to be done before the applications have broad applicability. We are going to intentionally set aside more in-depth discussions of cryptocurrencies in this article and will cover that topic in a future column. The AICPA has been following and promoting blockchain in accounting, convening a symposium on the topic on May 1, 2018 and has follow-on observations and regulatory recommendations for auditing, accounting, tax and other application areas. The Wall Street Blockchain Alliance is involved with the AICPA and there are many powerful industry organizations involved with these efforts. There are also efforts all around the world, but the hotspot for blockchain and cryptocurrencies are in Zug, Switzerland because of the lack of regulations and restrictions on privacy. Another organization, AuditChain, is supporting a consortium known as DCARPE, and part of their strategy is to hook accounting products from QuickBooks to SAP to a blockchain technology that can be reported using XBRL techniques. The current blockchain leaders include Ethereum and HyperLedger, but we are sure there will be more competitors with additional features. Blockchain is a data technology that provides a secure, distributed database, that is created by hash algorithms run on a distributed set of computers. There are a number of blockchain algorithms available as well as many under development. The concepts have been clearly explained in columns earlier this year by columnist Brian Tankersley. The five fundamental concepts: Tokens, Transactions, Nodes, Hashes, and Blocks are all used in the developing the the major types of blockchains including public blockchains and private blockchains, and applications of the blockchain like smart contracts. Attributes of blockchain-based ledgers include, but don’t necessarily possess all of the following: • Shared ledgers, to get a single source of the truth • Secure, tamper proof (extra security) • Permissioned, with participants identity • Private, an unlinkable identity • Audit-able, to prove identity and ownership • Consensus, a modular protocol • Smart Contracts, with business logic • Digital Assets, as a record repository • Confidential, with permission control • Viable, should have a 100+ year architecture, just like archival paperless documents Like all of the emerging technologies we have covered in these emerging technology columns, blockchain has pros and cons. On the positive side: • Blockchain is simply a distributed, secure database • Five fundamental concepts need to be understood: Tokens, Transactions, Nodes, Hashes, Blocks • There are two major types: Public and private with a variety of uses including smart contracts, cryptocurrencies, shipping, medical records, more On the down side: • There can be audit control issues • Who controls the blockchain can be an issue • How do you validate signatures, timestamps and that the blockchain is complete? And there are clearly some risks: • Speculative Value. The valuation of most public blockchains (including cryptocurrencies) can vary widely and change quickly. The valuation of cryptocurrencies can easily change +/- 20% in a given day. • Regulatory & Compliance Risk. There is no regulation or consumer protection on blockchains. This might disqualify some organizations from embracing this technology. • New Technology. This cutting-edge tech does not have a decades-long proven track record of success. Users must accept and be comfortable with the risks. • Privacy. All transactions on a public blockchain are public. • Security. While the technology itself is secure, it heavily depends on the user to follow best practices. There are no institutional or regulatory safeguards in place like at a traditional financial institution. • Money Laundering. As transactions are anonymous and unregulated it can be used to launder funds around the world. • Tax Evasion. It is virtually impossible for taxing authorities to enforce local tax regulations. • Black Market. It is the currency of choice for black market goods. • Valuation. The instability of the cryptocurrency price makes it difficult to use in real world business transactions. At the end of the day, blockchain and cryptocurrency are cutting edge technology that are in their infancy. Compare your thoughts about the Internet in 1996 to your thoughts about it today. This is a long-term technology that will take 5+ years to gain mainstream adoption but has the possibility to truly change the world. It has the potential to change financial markets in the same way that the Internet changed communication and commerce in the last 20 years. It is highly speculative, volatile, changing constantly, but is constantly improving. There are measurable successes every year. Why? Blockchain can provide security and/or value for making business decisions. The following are characteristics of blockchain: • Large Variety. There are hundreds of existing different blockchain applications to suit a wide variety of specific needs. • Fast and Affordable. Conduct business with anybody in the world for next to nothing and almost immediately. • Secure & Transparent. All transactions are verified and available for examination.

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