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Making sense of blockchain

Firms, such as the Big Four, are playing an active role in the global adoption of blockchain. Jemelyn Yadao finds out how they are exploring this nascent technology and asks, will it really disrupt the profession?

By Jemelyn Yadao

Many believe that we are in the midst of the biggest revolution since the invention of the Internet. Blockchain, a distributed ledger spread across a network of computers, that can record transactions in a verifiable way without any trusted central authority, promises to transform the way in which people and businesses cooperate, by streamlining processes, establishing trust and making it almost impossible to commit fraud.

The technology is full of promise, and also confusion. “The reality is that most people, when they are talking about it today, really don’t have the depth of understanding required to make a decision on how to use the technology, where to apply it or how it can benefit their organization, but I think we’ll start to see a shift later this year,” Peter Smith, Chief Executive Officer and Co-Founder of Blockchain, the London-based start-up that allows users to store and transact with digital currencies using blockchain technology, told CNBC in an interview earlier this year.

Consulting firms, particularly the Big Four and mid-tier accounting firms, have been actively helping organizations understand, implement and use the technology. “It is a nascent dialogue, but a vibrant one,” says Johnny Lee, Principal, Practice Leader Forensic Technology at Grant Thornton in the United States, adding the firm has been working on financial statement audits that have blockchain touch points for the last two years. For example, he notes, clients increasingly have accounts that they maintain in bitcoin – the virtual currency system, introduced in 2008, that eschews central authorities for issuing currency and confirming transactions. It is the first application of blockchain technology.

However, blockchain allows for much more than creating and transferring digital coins. “Our Spanish firm has a dedicated team of developers helping energy companies and telecom companies adopt this for inventory management and supply-chain uses. Our London firm is beginning to get serious enquiries to use this in court-related matters. We are certainly being brought more to the table in 2017 than any other prior year,” says Lee. “Our clients say, ‘We’d like to get your best thinking on this,’ and ask, ‘What are the risks? If we can make this work, what does that mean in terms of reduced audit fees or consulting needs or technology improvements?’”

Experimenting the possibilities

The Big Four currently advise clients on a range of blockchain-related issues – from the strategic approach and commercial deployment of blockchain-enabled solutions to providing assurance over a blockchain ecosystem. They are also known to be engaging in researching and developing blockchain applications.

In 2016, Deloitte created its first blockchain lab in Dublin, followed by the second lab in New York earlier this year. The third is being set up in Hong Kong to serve clients in Asia Pacific. In April, EY launched Ops Chain to help organizations commercialize the use of blockchain technology across an enterprise.

PwC in March announced that it was exploring blockchain solutions with Alibaba Group with the aim of building better trust in the supply chain of food products traded through the Alibaba platform. The e-commerce giant wants to address counterfeit and fraudulent food.

KPMG has been researching the digitization of trade and trade finance, and exploring its potential for streamlining compliance with Know Your Customer (KYC) requirements. At present, financial institutions must satisfy KYC regulations for each existing and new customer, even though that customer has most probably completed a KYC process somewhere else before. Financial institutions such as banks are spending on average US$60 million per year on compliance with KYC, according to a Thomson Reuters survey last year.

Explaining how blockchain can help, James McKeogh, Partner at KPMG China, points to digital identity services, such as those currently provided to some governments to help them manage their citizens’ identities. “It is one thing for the government to externalize information but the other thing is providing verification services on that information – that is what everyone is looking for,” he says. “If I am doing KYC on somebody and I want to know who they are, what their date of birth is, I can either store that information on my [blockchain] system and use it as needed or request validation. I can then get a confirmation that says on this date the information was valid and correct and there is the ‘hash’ – no risk of theft and violating privacy.”

The hash can be understood as a certification number that helps validate the “block” of records in the blockchain, explains Brian Chan, Partner at KPMG China. Each block is linked to the previous one with a hash, and the linked blocks form a chain, hence the name.

Understanding the drawbacks

While the technology’s potential seems to be huge, there are hurdles to overcome. The challenge of helping companies deploy blockchain is not at a technical level, says William Gee, Risk Assurance Partner at PwC China. “A blockchain ecosystem is about sharing and consensus, and often the challenge is to agreeing what the participants within a blockchain ecosystem are willing to share, and the rules upon which to achieve consensus.”

Uncertain regulatory status is another challenge to implementation. “There are virtually zero experimental business models being converted into commercial operations using blockchain currently. When you look at the pilots and the proof-of-concept such as identity management and KYC, they have proven conceptually that it works, however the business models and legal frameworks have not been established,” explains McKeogh at KPMG. “Building legal contracts into code to establish certain requirements around different transactions – that’s extremely difficult. How do you convert years of legal precedents into a computer program that everyone is going to agree with?”

Other constraints include the lack of interoperability and international standards for the technology, according to Paul Sin, Consulting Partner at Deloitte Hong Kong, making ecosystems incompatible with each other. This year, it was announced that Deloitte and a consortium of banks were working with the Hong Kong Monetary Authority to develop a proof-of-concept blockchain-based platform for trade finance. “This is only Hong Kong. But if the seller is in Hong Kong, and the buyer is in Singapore or Dubai, those countries will need to use the same underlying technology in order to share invoices. People using different technologies and different standards cannot talk to each other,” says Sin, who is closely involved in the HKMA project. “There are a lot of people working on the interoperability issue, like MIT labs, but it is still not completely resolved.”

The disintermediation aspect of blockchains is considered a big advantage. Two parties are able to conduct an exchange without the need of a third party acting as an intermediary, which helps to speed up the exchange. However, this aspect also “terrifies a lot of participants,” notes Lee at Grant Thornton. “In many transactions, there is a reliance on third-party verification for many different aspects of the transaction, such as valuation-related aspects. But third parties are used to also address hidden liabilities that are not self-evident, and the promise of blockchain will reduce or eliminate the need for such third-party verification,” he says.

McKeogh at KPMG agrees, following conversations with clients. “People are uncomfortable with the distributed nature. When you have a trusted third party providing a specific answer, you know who to sue when it comes to legal liability perspective. You can’t sue the entire ecosystem,” he says.

Real-time audits

Only 4 percent of accountants identified blockchain as the disruptor that will have a great impact on their business 25 years from now, according to a recent survey conducted jointly by Thomson Reuters and the Chartered Institute of Management Accountants. This contrasts with the much-written-about idea of how blockchain is poised to eliminate traditional methods of invoicing and documentation for businesses, as well as the need for audits in the future.

Some experts say it is too soon for the doom and gloom talk. “The technology has the potential to significantly enhance the efficiency of processes surrounding routine transactions, but less so in areas requiring professional judgment,” says Gee at PwC. “Blockchain is but a collection of facts, and in itself is not an auditing or accounting system. Availability of facts kept in a blockchain solution can, of course, help auditors and accountants, but the extent to which the process can be streamlined would depend on the design and operation of the blockchain ecosystem, as well as any related aspects, such as applicable accounting standards.”

Others say that in the long term, audit firms could be able to do audits in real-time thanks to the technology, because all unchangeable transaction data is recorded to the distributed ledger. According to a EY report, “Blockchain might also be able to replace random sampling by auditors, by making it easier and more effective to check every single transaction using code. This would also make it easier to investigate fraud, since real-time systems could highlight and investigate anomalies.”

In the meantime, CPAs are encouraged to keep themselves informed about this new technology and embrace changes on the horizon. “In jurisdictions where the standards are very set, and there are policymakers that are amenable to this trend – which is very hard to ignore – I think there will be attempts to integrate blockchain technology over time into the audit. Certain assets held in bitcoin, for example,” says Lee at Grant Thornton. “We see it in isolated incidents now in the U.S. but I predict in six to 12 months we will see more clients demanding a larger component or at least contemplate blockchain as a potential avenue for conducting audits of various kinds.”

With the potential of new technologies, such as blockchain applications, still unraveling, firms are forced to rethink their future talent needs. “Talking about blockchain, we will need accountants with multi-disciplinary capabilities. There is a lot of repetitive procedures that can now be done by AI. A lot of manual work will be minimized,” says Peter Koo, Partner of Advisory in Audit and National Leader of IT Advisory at Deloitte. “We need CPAs no matter what, but we need ones who are open to IT and have good business sense plus strong soft skills. The future of accountants is that they’ll become half accountants and half advisors specialized in different businesses or industry domains. This will be the new generation of accountants.”

This article was originally published in the August 2017 issue of A Plus.