Many people use Blockchain and Distributed Ledger Technology (DLT) as synonyms. But they are not! Blockchain is a form of DLT, which has a rich past of its own. Exploring DLT history will help you understand blockchain and DLT even better. Let’s go back a few hundred years in time to a small island in the South Pacific called Yap. The way the Yapese were dealing with transactions resembles an early implementation of a distributed ledger.
The Yapese people had a very particular form of currency: Rai stones. The largest could be up to 3.6 meters and weigh 4 tonnes. Consequently, these stones owners could not keep them in their purse when they wandered around looking for a trade. They had to find an alternative way to use the stones as part of a transaction.
The Yapese decided to leave each stone where it was on the island. They applied a system that maintained who was the owner of each particular stone. As long as you could prove you were the owner of that stone, you could complete a transaction. In short, proofing ownership was more important than possessing the Rai stone. So, how did they do it? What system did they apply to capture who the owner of which Rai stone is? One can find the answer in their community.
Let’s assume person A owned a Rai stone located close to the giant tree on the island. And that person A wanted to exchange it for food with person B. These two people then announced their intended transaction to the tribe. In case more than half of the tribe members present confirmed person A owned the stone, person A and person B could complete the transaction. And every tribe member present made a mental note that person B was the new owner of the Rai stone located close to the giant tree. Tribe members who were not present were updated later on.
The Yapese could have appointed a dedicated person to keep account of all transactions and corresponding ownership changes. Instead, they chose to keep track collectively of ownership changes. This approach has some benefits in terms of:
We will now look at a modern implementation of a Distributed Ledger. The steps we will take are as follows. First, we will provide a brief, somewhat technical description of blockchain. Next, we will compare that description to the Rai stones implementation example. We can then look at the similarities between the two that stems from the fact that both are DLT implementations. But then, what’s modern about the blockchain implementation? To understand that, we will dive into a few centuries of accounting innovations.
Blockchain is a peer-to-peer distributed network of nodes (computers). Each node has a copy of the ledger, and they all maintain that copy. Nodes broadcast transactions to the network. Based on a consensus mechanism, the nodes decide which transactions are valid and which are not. Nodes offline for a while will receive the latest version of the ledger once they are back online. The Bitcoin chain, in this manner, keeps track of who owns which Bitcoin.
Let’s take a look at the text we used in the previous paragraph. We will list some words and activities and link them to those we used in the Rai stone example.
Even though the terms are somewhat different, the concepts behind both implementations are equal. It’s all about validating transactions based on a correct registration of ownership. A group, rather than a central authority, determines which transactions are valid. They do so based on a method called group consensus.
Despite the similarities, there are a few reasons why the Yapese system would not work today. Privacy and scalability are amongst them. In today’s society, it’s not acceptable that everybody knows who owns what. Privacy is highly appreciated. Furthermore, the human brain is just incapable of remembering today’s volume of transactions entirely and correctly.
Blockchain is a modern solution to modern problems. So, let’s look at a few centuries of accounting innovations and recent challenges to understand better how blockchain adds value. The main innovations introduced in that period are the ledger, a double-entry ledger, and the triple-entry ledger.
The birth of accounting is closely related to the introduction of counting, money, and writing. As such, the history of accounting is thousands of years old and often linked to ancient Mesopotamia. The Mesopotamians started to record items and quantities on clay tablets. The introduction of the ledger capturing ownership and transactions enabled humans to trade outside their community. The ledger incentivized trade to develop and communities to grow into villages, cities, countries, and so on.
The second major innovation, the double-entry ledger, introduced the concepts of debit and credit. Lucia Pacioli published a book in 1494 in Venice, containing a section called ‘Particularis de Computis et Scripturis’ (Latin for: ‘Details of Calculation and Recording.’) meticulously explaining the double-entry ledger standards. Banks applied these standards by creating a central ledger keeping track of all debits and credits. They also figured out how to intermediate between savers and borrowers while earning a fee. Over time banks expanded their wealth and cemented their centralized role as trusted third parties to enable monetary transactions.
A transaction is supposed to always appear equally on the ledgers of transacting parties. In reality, with global trade and accounting becoming more complex, this is not true. And fraudsters have a considerable interest in finding their way around that. As such, there is a growing interest in finding an efficient method that prevents errors and fraud. One that ensures that a single transaction gets recorded in an immutable manner, with the same data, in the respective ledgers. This method is called ‘Triple Entry Ledger.’
The missing component in a double-entry system is an immutable distributed record of transactions. Blockchain provides this component. Why immutable? To ensure no one can alter the data after the transaction took place. Why distributed? Because it’s much harder to manipulate entries if you do not control the books. So, what is it that blockchain provides? A digital time-stamped receipt of each transaction recorded on a distributed ledger.
Let’s focus on the word Technology in DLT for a moment. Blockchain uses cryptography to create blocks of transactions and to link these blocks together in an immutable manner. Its network consists of enormous amounts of nodes collectively maintaining the distributed ledger. The processing power of all participating nodes is also a very relevant technology component. Imagine for a moment using the Yapese method to solve the challenges faced by double-entry bookkeeping. Pretty infeasible, right? The nodes and the Yapese tribe members apply similar principles. But adding cryptography and decentralized global processing power into the mix makes blockchain a very powerful Distributed Ledger Technology.
At the end of this article, we would like to share a compact summary of our conclusions so far. And provide you with a brief outlook into the future of DLT.
We started on the island of Yap in the South Pacific. We ended by mentioning cryptography as a core technology to create digital time-stamped receipts of transactions. Let’s look at what we concluded along the way.
What does the future have in store when it comes to DLT? Two factors play a role here: 1) Blockchain technology got introduced only recently (2008), meaning there’s plenty of room for improvements, 2) Any blockchain is a distributed ledger, but not any distributed ledger is a blockchain. Many people are working on blockchain innovations, which in effect, are also DLT innovations. Finding an efficient, effective, fast, secure, and affordable alternative for Bitcoin’s consensus mechanism Proof of Work is just one innovation example. New and promising other forms of DLT are Directed Acyclic Graphs (DAG) and Hashgraph. For instance, Hedera’s Hashgraph delivers tremendous improvements in ‘Transactions per Second’ and ‘Transaction confirmation times.’
Accounting, like supply chain, construction, and energy, is a domain that may experience a significant impact in a decentralized future. This article referred to Triple Entry as a decentral component providing an immutable link between a series of transactions. In theory, all companies are honest and don’t make mistakes, so any transaction has an equal representation in each ledger. In reality, we have accounting firms checking annual reports. Now imagine for a moment what it would mean if there’s a decentralized ledger that provides an immutable link for all transactions in all ledgers. Would we still need accountants in their current role?
The Pacio company (yes, based on Lucia Pacioli, famous for writing a masterpiece on double-entry accounting) is working hard to deliver Triple Entry Accounting services. This type of service will meet its real potential if a significant number of companies participate. Or, as Pacio CEO David Hartley states in a blog on the Pacio site: “It’s the same problem as the first telephone. It only makes sense if there are enough others.”