Advantages and Disadvantages of Blockchain in Accounting
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Blockchain technology has taken the fintech world to new heights. More than 50% of payment infrastructure firms have incorporated blockchains in their business operations. On top of this, blockchain has been projected to grow global GDP by nearly $2 billion in 2030.
But what makes blockchains attractive to modern organizations?
Essentially, blockchain technology is a form of accounting, but with several computers operating simultaneously in a network. In other words, blockchains work as distributed transaction ledgers. But don’t let the term ’ledger’ fool you. Blockchains have applications that go beyond financial accounting and conventional bookkeeping.
In fact, blockchains can be used to manage processes, and enterprises in many different sectors are finding new ways to harness their power. In this article, we will highlight the advantages and disadvantages of blockchain technology in accounting practices.
Advantages of Blockchains in Accounting
Blockchains can be useful for accounting. The practice of recording accounting transactions follows the double-entry system, where assets are equated with liabilities and expenses.
Each debit entry can be matched with a corresponding credit entry in the ledger. With blockchains, companies can manage double entries easily.
Here are a few more reasons why blockchains can be beneficial for accounting.
A joint ledger for everyone
Blockchains provide a way for every member in an organization to directly record entries in the ledger through their personal computers. Transactions can be recorded offline and can be updated later when required.
Using a distributed ledger also means that everyone can access the entire ledger without needing to keep any information in separate databases.
High levels of control and automation
In any accounting system, control levels are important in designating rights to operational team members. Blockchains allow automatic consensus for transaction entries, which can be controlled by different node levels.
This degree of automation allows organizations to set different control levels for staff members, which can then be used to distribute workloads across cross-functional teams.
Some reconciliation tasks can be completely automated to eliminate the need for manual entries, while other tasks can be approved only by active nodes that belong to members with higher authority.
Because blockchains are distributed systems, a blockchain accounting system ensures that accounting processes within a company can continue to operate with a few computers down.
This is a big advantage over a centralized accounting database that requires maintenance shutdowns, occasionally causing a break in operations.
Customized transaction protocols
Many second-generation blockchains like Ethereum have provisions for adding computer code into the network protocol that allows the network to execute tasks when specific conditions are met automatically. This feature has been the backbone for smart contracts, but its applications in accounting are not to be ignored.
Organizations can employ developers to write algorithms to automatically execute accounting functions. Tasks like periodic amortization, discounted cash flows, risk assessments, and inventory thresholds in designated ledgers can be easily automated. This can be vital for automating business processes and improving company efficiency.
Blockchain ledgers can be viewed by everyone in the organization. This transparency in blockchain works well for teams working in collaborative environments.
Entries made by executive staff can be viewed by board members (and vice-versa) in real-time. This, in turn, can help managers and their teams in making timely decisions.
Tamper-proof ledgers and secure backups
Blockchains keep records in blocks. Both blocks and the records contained within them are linked through timestamps. This makes the blockchain an immutable record of transactional or operational events.
Since the transaction record is also distributed across multiple computers, it is backed up, often with multiple copies stored across the network.
All of the blocks and transactions are encrypted, adding another layer of security to the blockchain data.
Therefore, it’s quite difficult for users to tamper with transaction records kept in the blockchain. Employers can worry less about employees making errors or unauthorized changes to accounting transactions. And they can feel confident about having backups of their entire accounting database.
Historical data for auditing and reporting
Accounting is almost synonymous with audits. After all, it’s what accounting firms do.
Timestamped data is the perfect ingredient for a historical look at transactions in an audit to check for unusual events. Auditors can look at exact dates for different incoming and outgoing payments with the help of blockchain ledgers.
Timestamps are also useful for creating different analytical reports based on time (and accounting) periods.
Central databases often require significant hardware investments when scaling up their capacity. That makes it very expensive to upgrade in order to meet high workloads.
Blockchains can be configured to distribute workloads across large networks, some of them which are accessible to the public. This is also known as horizontal scaling, allowing the network to optimize workloads with servers to process workloads efficiently.
The high scalability helps accounting teams to quickly record and close transactions while maintaining a good customer experience.
Native currency for cost accounting
Bitcoin’s Proof of Work scheme was the basis for modern blockchain-based digital currencies. Since then, many networks have sprung up with their own digital coins and tokens. These digital currencies are important in two ways.
- They help to assign a cost to transaction processes
- They help to compensate stakeholders with appropriate rewards
In accounting terms, native digital currencies automatically allocate operational costs into the ledger. They also give users a means to trade them for other assets like fiat currency or other digital currencies.
This results in a digital economy for your accounting transactions that drive organizations to conveniently develop products on a single platform. Companies and their partners can also diversify their digital asset portfolios to realize better returns on their investments in the long term.
Disadvantages of blockchains in accounting
While blockchains do have several advantages, they are not without some disadvantages. There’s always a trade-off with new technologies, and blockchains are no exception. Here are a few reasons why blockchains are disadvantageous for accounting processes.
A blockchain’s power consumption requirements are the real elephant in the room. Unlike a centralized system that can operate from literally one room, blockchains require many computers by default.
A blockchain infrastructure worth its weight in silicon needs stacks of powerful computers to quickly solve cryptographic tasks. That’s some extra overhead for power consumption expenses.
Power consumption can be distributed to public computers. But that puts your accounting data in the hands of potentially unauthorized users.
Blockchains have also been the subject of heated debates on their potential adverse effect on climate change. Companies and governments that account for environmental sustainability efforts feel that there is a need to look at how the power consumption and the procurement of computing resources affect their carbon footprint.
Therefore, blockchains may require firms to evaluate their ethical and compliance challenges concerning environmental action.
Lack of familiarity and standardization
Unlike traditional accounting systems and ERPs having well-established accounting modules, blockchains are still new to many users. Onboarding accountants onto a blockchain system to learn ledger entry processes and process codes requires intensive training by experts.
Accounting rules for blockchains are still in their infancy, as professional bodies are continuing to understand the specifics of administrative controls in distributed ledgers. With new technologies and algorithms being introduced yearly, accounting standards are revised accordingly.
Similarly, accounting companies need to invest in skilled programmers to configure and customize blockchains to their specific business requirements.
Cybersecurity and other technical challenges
Blockchains algorithms that have vulnerabilities can be targeted by hackers, especially if the servers are accessible to the public. It takes only one malicious individual or a small group to discover an exploit in the code, which can lead to a significant loss of data and funds.
Another potential issue that blockchain operators may face is the consensus problem. Upgrades to a transaction protocol may require a majority of network nodes to agree to a critical software (or hardware) update. Consensus to upgrade can be blocked if there is no majority in the network to vote for it.
For accounting firms, this can be the difference between implementing new accounting rules for the organization or sticking to existing ones. Conflicts can arise if different stakeholders are unwilling to agree to shift to a new version of the blockchain protocol.
Some blockchains like Ethereum have had to commit to creating hard forks that branch to a new version of the blockchains after a significant hack resulted in a major theft of crypto tokens.
This change is problematic for companies that work on legacy systems and requires significant allocations toward cybersecurity and technology budgets.
Blockchains are complex technologies that may not be suitable for every business. But they offer several benefits to accounting and auditing firms that can deal with their shortcomings.
Many accounting associations are now working with legal, financial, technical, and regulatory counterparts to work on acceptable standards for accounting through blockchain ledgers.
It is safe to say that distributed ledgers are going to be the accounting books of the future.
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