Greetings from my lounge chair on Miami Beach. Sorry for the miss yesterday; MailChimp is on my poop list. It’s mind blowing that a company with millions of corporate paying customers doesn’t give users the ability to make edits to its campaigns from a mobile device. Thankfully, AT is updating the campaign and sending it out a day late.
Today, a guest post from Richard @gendal Brown from IBM on bitcoin’s real killer corporate app: accounting. File this one under boring, but massively important.
Enjoy, and hope to see some of you tonight!
“Could decentralized ledgers change the face of accounting?” | By Richard Brown, IBM
When I speak to people about decentralised ledgers, some of them are interested in the “distributed trust” aspects of the technology. But, more often, they bring up the question of cost.
This confused me at first. Think back to where this all started: with Bitcoin. Bitcoin is deliberately less efficient than a centralized ledger! Its design adds really difficult engineering constraints to what we already had. How could this technology possibly be cheaper than what we already have?
And yet the claims keep coming. So perhaps this “cost” claim deserves closer consideration. Perhaps there are some scenarios where the “cost” camp might be right?
Ledgers
So much comment in this space talks about “distributed ledgers” or “decentralized ledgers”. But there is very little reflection on what we actually mean by “ledger”.
Investopedia has a good definition of a General Ledger:
A company’s main accounting records. A general ledger is a complete record of financial transactions over the life of a company. The ledger holds account information that is needed to prepare financial statements, and includes accounts for assets, liabilities, owners’ equity, revenues and expenses.
There are some key points here: “complete record of financial transactions”… “information that is needed to prepare financial statements”. I find this a useful definition because it captures two insights that will become important.
first, we use ledgers to record facts… things that the company has done, transactions it has entered in to.
second, the ledger is not an end-product; rather, it’s something from which we prepare other documents — our balance sheet, for example.
So let’s work through an example of a balance sheet to test the “cost” argument.
In what follows, I’ll work through a really simple and not-representative example that constructs a balance sheet for a small firm — and asks if there are any opportunities to apply decentralized consensus technology to the problem. (And, as will become painfully clear, I’m not an accountant…)
A worked example: the world’s smallest and most naïve investment bank…
Imagine you had a fetish for being regulated and decided to start your own TINY investment bank. You persuaded your friends and family to invest £1m and opened the company. You haven’t started trading yet so your accounts are really simple: you have put the £1m you raised in the bank (let’s say Barclays) and, since your friends and family own the firm, you also have £1m of equity — which represents their ownership of the firm. Let’s call it RichardCo.
Hang On — What’s a Balance Sheet?
In my mental model, a Balance Sheet is the financial statement you use as a snapshot of the firm’s financial position at a point in time:
What are all the things you owned at that point (your assets)?
And what are all the things you owe (your liabilities?).
If the difference is positive, great: this is your shareholders’ equity in the business. If it’s negative, it’s game over: you’re insolvent.
So the “balance sheet” for RichardCo on day one might look like this:
RichardCo’s simple balance sheet. There’s £1m in the bank and you record your shareholders’ funds on the liability side of the balance sheet. The “scroll” is the ledger.
By convention, we put the assets (the things you own) on the left and the liabilities (the things you owe) on the right. And we’ve captured a couple of likely entries from various ledgers that explain where the entries on the balance sheet came from.
Notice how we put the shareholders’ funds (the equity) on the “liabilities” side of the balance sheet. This is because the shareholders’ funds can be thought of as a “residual claim” on the company. If you shut it down (or were shut down), you’d have to sell the assets, use the proceeds to pay off everybody you owed money to and, whatever was left, would be the shareholders’. You’d be liable to pay it to them. So we think of the equity as a liability.
Now, like I say, we haven’t done any business yet. But, already, there’s some complexity here
Think about that £1m in cash. It appears on your balance sheet as an asset and you’ll have a record somewhere recording its receipt from your shareholders and another recording the fact that you paid it into the bank. (Actually, you’ll be using double-entry book-keeping and so you will have four entries in the ledger but let’s leave that to one side for now)
Now think about it from the bank’s perspective. They will also have a record. After all, they took it in as a deposit. So it will also appear on their balance sheet — but this time as a liability. They owe it to you.
So there are multiple ledgers in two different organisations all recording the same pieces of information and two balance sheets that reflect the position:
Your balance sheet, recording the claim against Barclays: an asset
Barclays’ balance sheet, recording their obligation to you: a liability
Your £1m asset in the bank also appears on the bank’s balance sheet, as a liability.
Great — this is as it should be and it makes it possible for us to keep an eye on things. When it’s time to get your accounts audited, the auditor doesn’t just have to trust your ledgers. They can phone up the bank and get them to verify that their recording of the position matches yours. The fact you know this can happen acts as a disincentive to cheat in the first place.
If only banks really were this simple. But, in reality, it’s far more complex than this; banks aren’t funded primarily by equity… they also have a HUGE amount of debt…
So let’s imagine you have gone to some pension funds and borrowed £2m — you want to be prudent for now.
You decide to build out your broker-dealer arm first so you use the money you borrowed to buy some shares for inventory: £2m of IBM stock. That gets you about 20,000 shares, which you deposit at a custodian bank for safekeeping.
Let’s also imagine that you enter into some interest rate swaps with some other banks. Perhaps LCH.Clearnet, acts as central counterparty for all these trades. And, brilliant news! Your derivatives positions have moved in your favour and it looks like you’re up £1m on them!
Great. So your balance sheet now looks like this.
Your balance sheet after borrowing £2m, entering into some derivatives contracts that move in your favour (£1m mark-to-market — MTM) and buying some IBM shares. Notice how Shareholders’ Funds (equity) has increased by £1m as your assets (the money owed to you by LCH) have increased in value, whilst your debt has stayed the same.
Now think about all the book-keeping at all the other firms
For every position on your ledgers that goes into creating this balance sheet, at least one other entity will also have a ledger that records the same position (from their perspective).
So you might end up with a picture like this:
Your (still very simple!) balance sheet will be reflected on ledgers and balance sheets all across the financial system.
And this picture isn’t the full story. Remember we said the clearing house stepped in and became your counterparty? So the other participants will, in turn, have their own ledgers on the other side of the clearing house. And your shareholders presumably have their own records. And so on.
Making sure all these ledgers are kept in sync: reconciliation
One of the many important control functions in a bank is to check regularly that all these ledgers line up — that your counterparties agree with you on what it is that each of you own or owe to each other.
But, interestingly, you only really need to agree your positions — not the valuations. You could, quite legitimately, come to different conclusions about the value of some positions. For example, let’s imagine that the pension fund thinks there’s a chance you’ll default on your loan. They will still have a record that you borrowed £2m but they may only value the position on their balance sheet as a £1.9m asset.
This is an interesting subtlety: the fact, as shown on the ledger, is that you owe £2m but the pension fund’s balance sheet may reflect their opinion that they’ll likely only recover £1.9m
Similarly, the fact of your derivatives positions is recorded on your (and LCH’s) ledgers. And you’ve probably agreed to pay (or receive) whatever cashflows their systems calculate. But how you value your overall position on the balance sheet could depend on a whole other set of factors.
So perhaps the picture actually looks like the one below: the “facts” that we need to reconcile between firms are those contained on the underlying ledgers, not the subjective valuations on the balance sheets:
In principle, we need to reconcile our ledgers to keep everybody accurate and honest. But it’s perfectly OK for the subjective valuations of some of the positions (as reflected on the balance sheets) to be different — such as with the pension fund here.
So, to simplify hugely, we could say that our problem is one of keeping all these disparate ledgers in sync:
The same picture as before but with the other firms’ balance sheets removed for clarity. Our problem is to make sure these ledgers always agree with each other when they record information about the same transactions.
So we see in the picture above that the facts that underpin my view of the world need occasionally to be checked against at least four other ledgers in other organisations and, in reality, many more.
Enter Decentralised Ledgers
So now let’s turn attention back to the world of decentralized consensus.
I said earlier that it’s hard to argue a decentralised ledger system like Bitcoin that replicates ledger data thousands of times can be more efficient. But perhaps it (or something like it) can.
Imagine we’re living five or ten years in the future. Perhaps we have a securities block chain that records ownership of all securities in the world. Perhaps we have a derivatives smart contract platform that records (and enforces?) all derivatives contracts? Maybe, even, there will be a single, universal platform of this sort.
If so, perhaps all participants would have a full copy of this ledger. And so now maybe we can redraw the picture.
A possible future: all firms record their external obligations and claims on a single shared, massively replicated ledger. Would this reduce (remove?) the need for systems duplication and reconciliation?
Sure — everybody still has a copy of the data locally… but the consensus system ensures that we know the local copy is the same as the copy everywhere else because it is the shared consensus system that is maintaining the ledger. And so we know we’re producing our financial statements using the same facts as all the other participants in the industry.
Does this mean we no longer need audit? No longer need reconciliations? Obviously not, but perhaps this approach is what is driving some of the interest in this space?
But notice: this is just a way of ensuring we agree on the facts: who owns what? Who has agreed to what? We can still run our own valuation algorithms over the top and we could even forward the results to the regulator (who could also, of course, have a copy of the ledger) so they can identify situations where two parties have very different valuations for the same position, which is probably a sign of trouble.
Of course, this is a very simplified example and the real-world is considerably more complex. In particular, some really difficult problems stand in the way of making this a reality:
Scale — think about how many transactions would be recorded
Security — imagine what would happen if somebody managed to subvert the ledger. This also has implications for who controls it, runs it and is allowed to connect to it. Bitcoin’s pseudonymous consensus system is unlikely to be appropriate here?
Privacy — do you really want everybody being able to see all your positions?
… and so on.
So I’m really not saying this is how things will pan out but I think it’s a useful thought experiment: it shows a potential use for replicated ledgers that might have utility but which doesn’t depend on being “trust-free” or “censorship-resistant”.
Perhaps this is what some of the other commentators in this space have in mind?
[ Note: This post originally appeared on @gendal’s blog. Apologies that the images weren’t copying over correctly. Check out the original (and all of Richard’s excellent posts here: http://gendal.me/2015/01/15/cost-trust-something-else-whats-the-killer-app-for-block-chain-technology/]
Events
Inside Bitcoins Conference and Expo — Singapore (Jan. 27–28), Berlin (Mar. 3–4), and New York (Apr. 15–17)
Inside Bitcoins is the largest bitcoin and blockchain technology focused event series worldwide. At each event you’ll hear about the latest challenges, trends, and opportunities in the industry from experts including Steve Beauregard of GoCoin.com, Marco Santori of Pillsbury Winthrop Shaw Pittman, Brian Kelly of CNBC’s Fast Money, Barry Silbert of Digital Currency Group, Marco Santori of Pillsbury Winthrop Shaw Pittman, and more. Plus, TBI Daily readers get 10% off the Singapore, Berlin, and New York events with code TBIDAILY.
Bitcoin Conference, Miami, FL (January 16–18)
Winter doesn’t have to suck. It’s not too late to escape down to Florida for the second annual Miami Bitcoin conference this MLK weekend. Tickets are just $200, and this is the best Bitcoin or fintech conference you’ll be able to go to for months. The Chamber of Digital Commerce is also hosting a “Regulatory Hackathon” at the Miami event, an AML compliance bootcamp focused on how to establish and keep banking relationships as a digital currency venture. Hope to see you there!
http://btcmiami.com/
Jobs, Jobs, Jobs
Bitnet, San Francisco, Belfast, London (VC-backed)
-Leading digital commerce platform & former Visa team.
-Open positions: Engineering (Customer Success, Lead UI, Product, DevOps), Sales Director (EMEA), Sales Engineer (San Francisco)
-Check out Bitnet (https://bitnet.io/careers.html) and email jobs@bitnet.io
Coinbase, San Francisco (VC-backed)
-Largest “universal services” bitcoin company.
-Open positions: Security Engineer, Software Engineer (2–3 years mobile product development), Regulatory Compliance Investigator, (1 year conducting SAR investigations)
-Check out Coinbase (https://www.coinbase.com/careers/)
BitGo, Palo Alto (VC-backed)
-The leading Bitcoin multi-sig security company
-Open positions: Back-end / Front-End / iOS / Security Engineers, UX Designer
-Check out BitGo (www.bitgoinc.com/jobs) and email jobs@bitgo.com
Bolt, San Francisco (VC-backed)
-Stealth startup focused on consumer applications of Bitcoin.
-Open positions: Security Engineer, Ruby Engineer, UI/UX Designer, Executive Assistant.
-Check out Bolt (bolt.com) and email jobs@bolt.com.
Elliptic, London (VC-backed)
-Vault and enterprise digital currency services.
-Open positions: Software engineers and business development gurus.
-Learn more and apply at elliptic.workable.com
Today’s Tid Bits
Forget Everything You Didn’t Understand About Bitcoin
http://www.businessweek.com/articles/2015-01-15/bitcoin-may-succeed-as-software-not-medium-of-exchange
Circle Internet Financial, which has pulled in $26m in venture capital over the past two years, with the promise to help “make Bitcoin mainstream” by providing an outlet for you to move your money, quickly, securely, and for free. This past year, Bitcoin has received some publicity, its price has declined, and the use of bitcoin for ordinary purchases has stagnated, but the underlying technology, “the blockchain” remains. This trusted intermediary, the blockchain, is what companies like Circle are using to carry out their services, without fees. Thus the future of Bitcoin may rest with entrepreneurs seeking to make one aspect of the global markets easier: moving money.
Why Bitcoin’s Astonishing Price Collapse Doesn’t Matter
http://www.businessinsider.com/why-bitcoins-astonshing-price-collapse-doesnt-matter-2015-1
Fred Wilson, major VC, recently said on Twitter that the best thing to come from Bitcoin’s price decline is that it will “get people to stop focusing on and talking about the price.” Barry Silbert also said he’s seen “no impact” from the price of bitcoin falling. The heavyweights of the bitcoin industry understand the blockchain, the underlying technology of bitcoin, is what really matters. Not the price.
DHS Witness Suggests Karpeles was the Mastermind Behind Silk Road
http://newsbtc.com/2015/01/16/dhs-witness-suggests-karpeles-mastermind-behind-silk-road/
On the third day of Ross Ulbricht’s case, Ulbricht’s defense team interviewed a Department of Homeland Security witness who testified that Mt Gox founder Mark Karpeles was the driving force behind the illegal marketplace. He also claimed that UIbricht gave up control of the site to Karpeles in its early days. The DHS employee pointed to evidence such as the domainsilkroadmarket.org being registered to Karpeles’ company, to support his claim. Karpeles has denied the connection.
As Price Surges, Bitcoin’s Wild West Days Come Alive Again
http://blogs.wsj.com/moneybeat/2015/01/15/bitbeat-as-price-surges-bitcoins-wild-west-days-come-alive-again/
Volatility is back and some believe it is a result of a messy transition of bitcoin’s trading market from a rudimentary, limited market structure to a more developed market with more options, but without any safeguards in place to protect traditional investors. The total number of active bitcoin swaps, trading instruments that can be used to bet on price swings, has jumped to 25,000 from 5,000 in December. Bitcoin’s trading market is unregulated, it’s highly automated, shorting has appeared to enter the market, and automated sell orders have been flooding the market driving the price down. Bitcoin’s Wild West Days have not left.
Bitcoin Exchange Processor EgoPay Freezes Funds, Disables API
http://www.coindesk.com/bitcoin-exchange-egopay-freeze-client-funds/
EgoPay, electronic payment processor and gateway, has frozen accounts to a number of its clients, including cryptocurrency exchanges BTC-e and Bitmarket.pl. Additionally, EgoPay’s core technical features have also stopped functioning correctly, according to some customers. EgoPay claims it is conducting a “system migration” leading to delays with withdrawals and deposits, but the company has not commented on the frozen funds or disabled API.
Ciphrex Raises $500k in Advance Multisig Wallet Offering
http://www.coindesk.com/ciphrex-raises-500k-advance-multisig-wallet-offering/
Ciphrex, a cryptocurrency security firm, has completed a successful Series A funding round, raising $500,000. Ciphrex’s main products are a multisig wallet, mSIGNA and an application development platform that allows the secure management of multisig account for businesses, CoinSocket. Six accredited investors took part in the funding round, but their names will remain private.
The Price of Bitcoin Doesn’t Matter Right Now
http://www.wired.com/2015/01/price-bitcoin-doesnt-matter-right-now/
The price of bitcoin has fallen over 20% in the past 24 hours, the sell-off has drawn lots of media attention, but it doesn’t really matter. Jerry Brito ofWired argues that bitcoin should be viewed as a 5 to 10 year project, just like the early Web, and there is a still a lot to be built on. The blockchain was created in 2009, thus we are still in the early stages of bitcoin, and short-term drops and rallies in the price of Bitcoin should be put in perspective.
Next US Marshals Bitcoin Auction Could Be Held in Q1
http://www.coindesk.com/us-marshals-bitcoin-auction-q1/
The US Marshals Service (USMS) has revealed that the next bitcoin auction will most likely take place in the first quarter of this year. After seizing the assets of the online black market Silk Road, the USMS has been auctioning off the bitcoin they seized in stages. As of now, the USMS has auctioned off nearly 80,000 BTC. As the USMS works to liquidate its remaining bitcoins, the USMS is expected to sell 94,366 BTC, worth around $17.5m in the upcoming months.
Tim Draper, Nas Back Bitcoin API Maker BlockCypher in $3 Million Round
http://www.coindesk.com/tim-draper-nas-back-bitcoin-api-maker-blockcypher-3-million-round/
BlockCypher, a bitcoin web services that allows users to easily build block chain applications, has raised $3m in seed funding. The round will allow the company to expand its operations in Europe and Asia and will work to provide customers with deeper analytics while continuing to build services and invest in scaling and security. Tim Draper, Jerry Yang’s Cloud Ventures, Boost VC, 500 Startups, and hip-hop artist Nasir Jones aka Nas led the seed funding round.
CoinTerra CEO: Company ‘Frozen’ Amid Lawsuits and Default
http://www.coindesk.com/cointerra-ceo-lawsuits-default/
Cointerra, a major bitcoin mining firm, has recently been under fire from consumers who believe the firm is insolvent. CEO Ravi Iyenger has now confirmed that the firm is in default, and is currently awaiting a decision from its secured note holders, which are worth roughly $4.25m. Additionally, C7 Data Centers has filed a lawsuit targeted at the bitcoin mining company for unpaid services. As of now, all of CoinTerra’s services are “frozen.”
Coinbase Expands USD Wallets to 7 New States
http://newsbtc.com/2015/01/14/coinbase-expands-usd-wallets-to-7-new-states/
Coinbase, bitcoin wallet and platform, has added USD wallets for seven more states. When the
USD wallets originally launched at the end of 2014, only 16 states were eligible for the wallets. USD wallets also allow verified users to purchase bitcoin instantly, previously Coinbase users had to wait up to 5 days for bank transfers to clear. Alabama, Iowa, Kansas, Mississippi, New Hampshire, New York, and North Dakota now have access USD wallets on Coinbase.
PayPal Expresses its Thoughts on Bitcoin Regulation
http://newsbtc.com/2015/01/14/paypal-expresses-thoughts-bitcoin-regulation/
PayPal made a submission to the Australian Senate committee, which is investigating the regulation of digital currencies, where the company called for the recognition of differences between digital currencies, and the companies that facilitate digital currency transactions. Although PayPal still believes, “the currency itself should not be regulated,” nor should the transactions. PayPal also asked the Senate committee to recognize digital currencies as full financial instruments.
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