Blockchain

www2.deloitte.com/in/en/pages/finance-transformation/articles/blockchain-influencing-finance.html

January 18,
2017

Blockchain is believed to have the similar disruptive potential that the internet had in the
1990s. Just like the internet revolutionized the exchange of information, Blockchain is
being said to revolutionize the exchange of value. Clearly, Chartered Accountants, CFOs
and business leaders are intrigued by the promise of the Blockchain technology.

Blockchain is a protocol for exchanging value over the internet without an intermediary,
such as a central bank. It is the technology allows for the secure management of a public
ledger or database (also referred to as a ‘distributed ledger’), where transactions are
verified and securely stored on a network without a physical governing central authority.
Blockchain technology is the backbone that supports crypto currencies such as Bitcoins.

In a marked difference from the prevailing systems of exchange of value, where two or
more parties need to agree on the value and other commercial considerations for a
transaction to happen, Blockchain allows for transactions within a closed group
underpinned by a crypto currency. Blockchain offers the storage of records of
transaction data through distributed networks. It retains the full history of transactions,
which makes them verifiable and independently auditable. It also enables peer-to-peer
transfer of value, potentially eliminating the need for intermediaries. In addition, event
triggered programmable contracts, also known as smart contracts, can be stored and
executed on Blockchain.

There are several intrinsic features of a Blockchain that lend it its power and allows it to
record and transfer value over the internet in a peer-to-peer manner:

1. Near real time: It enables near real time settlement of recorded transactions,
removing friction, and reducing risk
2. No intermediary: It is based on cryptographic proof, allowing any two parties to
transact directly with each other, without the need for a trusted third party.
3. Distributed ledger: The peer-to-peer distributed network records a public history
of transactions, making Blockchain distributed and highly available.
4. Irreversibility: It contains certain and verifiable record of every single transaction
ever made that cannot be altered without altering the entire chain. This prevents
double spending, fraud, abuse, and manipulation of transactions.
5. Censorship resistant: Crypto economics ensures that Blockchain continues
pumping out new blocks and that blocks are not being reverted or altered.

The Gartner hype cycle puts Blockchain technology just below the peak of expectations,
which means that experts still see another 18-24 months before this technology
becomes main stream. Most industry experts and pundits concur, but would rather see it
moving quickly beyond proof of concepts (POCs) into production sooner rather than
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later. While significant investments have already been made into the Blockchain
ecosystem, a lot still needs to be seen. Several companies have done POCs globally, with
financial services industry leading the way. The leading global banks have been actively
working together in the Global Blockchain consortium R3, which is a consortium
partnership of over 80 of leading financial institutions and regulators led by R3, a
distributed ledger technology firm. There are several uses cases around global money
movements (payments and remittances), trade finance, digital identity, smart contracts,
and several others that have been established and leading firms are investigating into.

The key question facing CFOs is how to evaluate the potential and the business case for
Blockchain for their respective businesses and help the C-suite make the right level of
investments in the technology before it is too late. The global economy is quickly moving
towards platform-based shared business model driven by technologies, such as
Blockchain. Therefore, it is not just the CIO who alone should be leading the discussion
at the C-suite for Blockchain, the CEO and the CFO, should also jointly participate in the
conversation of investing in new platform based technologies, such as Blockchain, that
have the power to disrupt entire business models.

There are several specific use cases where the Blockchain technology can prove to be
useful for the Finance Function. Some of these are listed below:

1. Budgeting and Forecasting

2. Inter-company reconciliations
3. Financial Audit
4. Vendor Management
5. Shareholder Voting

Budgeting and expense management: Conducting the budgeting and expenses on a

Blockchain involves placing the entire budget data on the Blockchain and allowing the
transfer of value (i.e. money) on the Blockchain to the various parties connected with the
Blockchain. It will create an audit trail for each and every dollar/rupee spend, providing
greater transparency and internal accountability.

Consolidations and inter-company eliminations: With the record keeping and

transaction management features of Blockchain, it can easily hold the financial
transactions for the group companies and aid consolidation of the financials for the
group and eliminating inter-company entries. The Blockchain does not work on the
double entry book keeping system, instead, it maintains a single records ledger for all
transactions. The immutable nature and the historical record maintenance will facilitate
the accurate consolidation of financials, enforce documentation of intercompany
transactions, and promote intercompany synergies.

Financial audit: With a company using the Blockchain to post every transaction on the
Blockchain in real-time, the nature of financial audit will change completely. Instead of
having quarterly or annual audits, the company could look to audit its financials on a

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daily basis. Financial audits on a Blockchain may eliminate the need for third party
validators, reduce audit expense and costs for books maintenance, and provide better
governance and transparency.

Requisition and vendor management: Blockchain’s ability to hold assets, transfer titles
and value, and execute smart contracts will make it possible to create requisitions and
manage vendors. Vendor data and identity can be easily held and verified using the
digital identify feature and smart contracts can execute automated remittances and
payments, reduce vendor cash conversion cycle, eliminate need for reconciliation, and
promote efficient Vendor management.

Accounts payable process: Upon addition of a vendor’s digital identity to the

Blockchain and the negotiated terms on a Blockchain smart contract, using shared sub-
ledgers, vendors can see the requisition requests in real-time. Smart contracts can track
individual assets to document their provenance, track their ownership, combat frauds,
and initiate automated payments. As a result processing time will be reduced and
security can be enhanced. The system will also eliminate the need for reconciliation of
PO and invoices, and drive better vendor relations.

Shareholder voting: Shareholder voting system can deploy the Blockchain to record the
ownership of securities; and issue voting right assets and voting token assets for each
shareholder. In order to exercise the vote, a user may spend voting tokens to cast votes
on each meeting agenda item if they also own the voting right asset. This system has
been tested by NASDAQ in a trial conducted in Estonia. Clear benefits of such a system
include increased transparency due to reduced manual intervention, greater trust in the
corporate decision making, and better investor relations and shareholder participation.

Case 1: A global e-commerce company is offering a different approach to online retail, by

connecting buyers and sellers directly. The open-source project is creating a
decentralized network for peer-to-peer commerce. Instead of visiting a website, users
download and install a program that directly connects them to other people looking to
buy and sell goods and services, removing the middlemen altogether.

Case 2: A bank in Japan has completed a three-month trial on the application of mijin (a
platform for creating Blockchains) to its accounting systems in a real-world environment.
In the demonstration, 2.5 million virtual bank accounts and an environment with capacity
to process 90,000 transactions every hour were created, with significantly reduced risk of
failure and fraud.

Case 3: A leading consumer equipment manufacturing company in India has started

using Blockchain to make payments to their suppliers. Earlier, the payment process was
cumbersome and involved several steps that included confirmation of delivery by the
company, raising of a physical bill of exchange by the supplier and submission of invoice
and transport documents to one of India’s leading bank, for payment. After the
implementation of Blockchain, the details of invoices processed in the company’s ERP
system get transferred to the bank on Blockchain, and then are discounted and funds
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are disbursed to the vendors of the company. On the due date, the solution facilitates an
automated debit from the company’s account maintained with the bank. The entire
process cycle for bill discounting has come down from four-five days to almost real time;
entire audit trail is maintained and transactions have become completely paperless.

Recently Reserve Bank of India (RBI) has published a white paper on the potential use of
Blockchain in India, based on a proof of concept testing the end to end technology play
in the interbank remittance process. The white paper concluded that the overall proof of
concept provided a good demonstration of the use-cases and helped broaden the
understanding of the technology and its potential to other real-
life applicationsThe Whitepaper concluded that the proof of concept provided an overall
good demonstration of the use cases and helped broaden the understanding of the
technology and potential end uses. It is expected that RBI will stay in step with the global
adoption of Blockchain for accepted mainstream usage by monetary authorities around
the world and this technology will gain credence and usage soon. For the finance
leaders, this is a profound transformation in the horizon upending the traditional double
entry accounting protocols and driving significant efficiencies and economies. There are
many unanswered questions still – such as revenue recognition principles for a
Blockchain transaction. It is only expected that the ecosystem supporting Blockchain will
gradually fall in place as the regulatory framework evolves.

Authored by: Soumen Mukerji, Partner; and Pankaj Arjunwadkar, Director, Deloitte
India.
This article first appeared in The Chartered Accountant Journal, July 2017.

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