Understanding Digital Distributed Ledgers
Thursday, December 3, 2015 at 08:05AM

In a post a few days ago, I mentioned that someone was creating a "triple-entry accounting system". They point out three key pieces to that system:

Those three things might be "technologies" or "implementations of technologies". But I don't think that those are the pieces of the puzzle.  Or, there may be more than three pieces.  For example, Ethereum is one of many blockchain and other supporting technology implementations.

One of the fundamental pieces though is the idea of a digital mutual distributed ledger.  (I have heard "distributed ledger" and "mutual distributed ledger" and "digital ledger" used interchangeably. I will use the term digital distributed ledger.)

So what is a digital distributed ledger?  A digital distributed ledger is an indestructible and uneditable decentralized computer record, or ledger.  It provides a full and complete history of transactions in that ledger.  Ledgers can be as public and open or private and limited as the use case demands. Ledgers can be permissioned or permission-less in determining who can add new transactions. Different approaches can be used to determine how new transactions are authorized (proof-of-stake, proof-of-work, consensus, identity mechanisms) before they can update the ledger. Ledgers can be interlinked with one or more other ledgers.

The key innovation that enables computerized digital distributed ledgers is the blockchain technology.  Blockchain technology is used to maintain what amounts to a continuously growing list of translational data records hardened against tampering and revision, even by operators, using advanced cryptography (basically, cryptographic mathematics). As Gabriel Tumlos of KPMG put it in his paper Blockchains, Distributed Ledgers in Finance and Accounting, "Blockchains introduced a trust-minimizing transactional platform that all but eliminates the need for a vulnerable third party and allows accounting systems to take their logical next step."

What can digital distributed ledgers be used for?  This video mentions the following use cases:

Don't limit yourself by thinking that a "transaction" is an accounting transaction such as an invoice.  While transactions can be recorded, so can events, circumstances, and other phenomenon that affect, say, a business during a period.  That sounds a lot like the sort of information from a financial report.  A report is a transaction.  The "payload" of the transaction is the information in the report itself.  XBRL-based digital general purpose financial reports, say to a regulator like the Securities and Exchange Commission, are really transactions that hold complex information structures about the financial condition and financial position of an economic entity.

What XBRL brings to the table is an ability to agree on and document the relations between the reported facts in the complex transactions we refer to as financial reports.  But XBRL can also be used to make sure that smaller transactions that go into these ledgers adhere to agreed upon business rules.  This keeps information within those digital distributed ledgers correct.

If digital distributed ledgers are used to their full potential, it could enable a fundamental shift in the way economic entities transact business with one another.  How will this impact the role of accountants and auditors?  Time will tell.

Here are some additional resources useful in understanding computerized digital distributed ledgers: 


Article originally appeared on Intelligent XBRL-based structured digital financial reporting using US GAAP and IFRS (http://xbrl.squarespace.com/).
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