What is Distributed Ledger Technology?
How does it impact auditors?
Why is DLT a game changer?
A distributed ledger is essentially an asset database that can be shared across a network of multiple sites, geographies, or institutions. All participants within a network can have their own identical copy of the ledger. Any changes to the ledger are reflected in all copies within minutes, or in some cases, seconds. The assets can be financial, legal, physical, or electronic. The security and accuracy of the assets stored in the ledger are maintained cryptographically through “keys” and signatures to control who can do what within the shared ledger. Entries can also be updated by one, some, or all of the participants, according to rules agreed to by the network.4 The UK Government Office of Science has produced a five-minute video, that sums it up effectively.
The transactions recorded with DLT have the following characteristics:
The technology underlying DLT is potentially disruptive because it solves a crucial problem that has faced the Internet since its inception: whether there is the capacity to trust others to execute transactions. So far, the solutions have always included third parties, with additional costs, delays, and inefficiencies.
Computers in a blockchain use an automated process to validate the format of the transaction record to be included in the next “block.” Once this “consensus” is reached, the information is recorded in a block. The full set of chained blocks forms a “ledger” referred to as the blockchain. Each computer in the blockchain network maintains a copy of the complete ledger, which is updated in real time as new blocks are created and validated.
As participants reach a consensus on the transaction, there is no need for facilitation by a trusted third-party intermediary. The blockchain-based “distributed trust” model stands in contrast to the centralized trust models used today to transact. For example, upon agreement, one participant could transfer digital currency (such as Bitcoin) to another participant across the blockchain network without using a bank.
Like all new promising technology, DLT has downsides and wrinkles that will have to be ironed out before it is ready for prime time. A recent example of DLT’s vulnerability was the June 2016 attack on the investor-directed venture capital fund The DAO that resulted in a loss of $70 million. Although not a failure of DLT per se, but rather of other software it was relying on, the attack showed that DLT is not foolproof if implemented without due diligence and prudence.5
Impact on the audit profession
The implications of DLT for audits are beginning to emerge. Everything we have learned about DLT indicates that it will be disruptive for auditors and will require some measure of adaptation.
For financial auditing, speculations range from the theoretical total removal of financial audit requirements due to the immutability of distributed ledgers to a complete integration of audit activities in the ongoing operation of blockchain-driven financial statements. The first scenario is contemplated in the paper disseminated by the Blockchain Supercluster (and sponsored by the Government of Canada):
“Consider the single impact of triple-entry accounting on government transparency and accountability. It’s entirely possible, for example, that the federal auditor general function could be replaced by real-time auditing on a new government blockchain platform. Rather than finding inappropriate expenses or waste a year later, such expenses could be nipped in the bud.” 6
On the other hand, the blockchain platform may present new business opportunities. The Big Four accounting firms have all formed working groups that are exploring the opportunities provided by DLT technologies.7
For performance auditing, possible implications include profound changes in the management of data and digital assets by audited organizations. This will necessitate a re-thinking of how and what evidence could be collected to reach conclusions at the level of assurance required by professional standards.
Opportunities for legislative auditorsOrganizations facing change must figure out how to adapt and be resilient. This is done in great part by identifying the new opportunities offered by the transformation they are facing. Legislative auditors could take advantage of the following:
Yves Genest, Vice-President, Products and Services, CAAF. You can send your questions and comments on this article to the author at firstname.lastname@example.org.
2 World Economic Forum, Realizing the Potential of Blockchain, June 2017, and World Economic Forum, Deep Shift – Technology Tipping Points and Societal Impacts: Survey Report, September 2015, available at: www3.weforum.org/docs/WEF_GAC15_Technological_Tipping_Points_report_2015.pdf
3 CPA Canada, Technological Disruption of Capital Markets and Reporting? An Introduction to Blockchain, 2016.
4 UK Government Office of Science, Distributed Ledger Technology: Beyond Block Chain: A Report by the UK Government Chief Scientific Adviser, 2015.
5 Ibid., p. 20.
6 The Tapscott Group, op. cit., p. 32.
7 Prableen Bajpai, “’Big 4' Accounting Firms Are Experimenting With Blockchain and Bitcoin,” available at: http://www.nasdaq.com/article/big-4-accounting-firms-are-experimenting-with-blockchain-and-bitcoin-cm812018
8 CPA Canada, op. cit., p. 16.