The impact of blockchain on audit & assurance
Blockchain technology has been characterised as the ‘fifth pillar of the IT revolution’, and it has many benefits for use in accounting, particularly in audit and assurance. Kris Cooper, trainee reporter, GlobalData reports.
The Big Four have been gradually integrating blockchain technology into their services, but progress has been somewhat slow. Since 2017, there has been discussion about how blockchain can benefit auditing and assurance processes by quickening the methods, improving transparency, and verifying transactions. Simultaneously, as cryptocurrencies have increased in use and circulation, there has been a demand for auditing of blockchain environments, which companies such as Deloitte have been working to facilitate.
A McKinsey and Company report has estimated that by 2027, “up to 10% of global GDP could be associated with blockchain-enabled transactions”, signalling the imminent need for accounting firms to be well acquainted with blockchain environments and utilise the technology. While blockchain technology could speed up the auditing process significantly, it has transformative implications for assurance with its inherent immutable and transparent qualities.
How is blockchain relevant?
As a digital distributed ledger, blockchain has the potential to generate more trust and transparency in accounting practices as it is resistant to modification and can verify transactions quicker than traditional accounting practices.
The ICAEW report about the technology and the future of accountancy states, “The name blockchain is inherently descriptive of how the technology works – new transactions are gathered together into a block and added to a chain of all previous transactions, by a cryptographic process that is complex to perform, but which makes it easy to confirm that the history of all transactions is genuine.”
Crucially it is a shared, digital record of transactions, meaning all parties have equal access to identical records. Blockchain’s immutability is very helpful for auditing as it reduces the risks of fraudulent transactions and human error.
Corroborating the strength of blockchain’s immutability for accounting, Nicholas Newman, partner at accounting firm Harris & Trotter explains, “Everything is there for anyone to see and it's immutable and can't be changed and there is huge value in that,” adding that this is “the complete opposite of what the press normally states”.
Newman contests that the popular view of blockchain, “is that it's this dark, murky place where fraud goes on”.
"There is fraud within this industry as there is with every industry,” he says. "If you look at banking fraud, it's probably 10 times that of crypto fraud, and that's a much more mature industry, but it is transparent.”
Nicholas Newman, partner at accounting firm Harris & Trotter
How does blockchain technology generate immutability?
There are various features of the technology which make it immutable, transparent, and secure. As a distributed ledger, a new owner or auditing firm can trace and verify all previous transfers of ownership.
The transactions are also irreversible and hard to tamper with, due to the utilisation of cryptographic hashes. As per the name, when a chain of blocks is connected, they include the hash function which uniquely represents the input data. Each chain added to the block includes the pre-existing hashes, thus, data from previous transactions cannot be altered or deleted as they are dependent on the pre-existing data. If someone tried to amend the data, it would produce a different hash and therefore not link the blocks, invalidating it.
Another core element of blockchain protocols is the use of private keys and digital signatures. Digital signatures are needed when transferring assets and can be protected through private keys, ensuring they are encrypted and can only be decrypted by those who have been sent the key.
The most relevant application of blockchains is the capacity for continuous auditing. As real-time transactions can be almost instantaneously verified, this can overcome the labour-intensive data entry that slows down auditing processes.
Accounting and auditing with blockchain technology and artificial Intelligence: A literature review claims that, “traditional auditing methods have now become inadequate to support current and future business needs,” signalling the welcome advances that blockchain brings. Audit activities can be ongoing, and AI can analyse anomalies and patterns continually, providing better information to accountants and clients.
A major criticism of financial reporting is the lag between transaction and verification times. The CPA has identified that this lag time could be significantly reduced, in turn increasing efficiency, “Enabling management and auditors to focus on riskier and more complex transactions whilst conducting routine auditing in near real-time.”
Harris & Trotter claim to be revolutionising auditing, “Rather than doing an audit, once a year, which is the traditional way, we're doing this every second now.”
Implications for assurance
In providing third-party attestations for Proof of Reserve for stablecoins for decentralised oracle network Chainlink, Harris & Trotter are using blockchain to raise the level of assurance, delivering it more quickly and with fewer gaps in information. They do not just report the total value of an asset but also detail: the number of custodians of a reserve, what percentage is in commodities, government bonds or liquid, who the statutory auditors are and when the last audit was. This reduces asymmetries in financial reporting and allows potential stakeholders to make informed judgments on how stable stablecoins are.
How H&T’s attestation process works with Chainlink for stablecoins to ensure not too many are minted. Credit: Harris & Trotter”
Auditing blockchain environments
As blockchain and cryptocurrency become increasingly entrenched in our financial system, accounting firms must evolve to have the expertise to audit these environments. The Big Four have been making steps toward this since 2017. Earlier this year, EY announced the fourth generation of its Blockchain Analyzer: Reconciler. It supports Bitcoin, Bitcoin Cash, Litecoin, Ethereum, Ethereum Classic and Dogecoin blockchains. This allows EY’s clients to use the software to reconcile off-chain records to the public ledger and analyse anomalies in transactions or signatures.
KPMG offers ‘Chain Fusion’ which supports generating financial statements for crypto-native companies or individuals with a small number of crypto investments. PwC also supports the auditing of cryptocurrency with their tool Halo which evidences, “private key and public address paring[s]” to verify ownership of crypto assets. Additionally, Deloitte’s COINA has been developed to reconcile clients’ records with crypto assets and other digital assets.
Business acceptance, trends and talent gaps
The transparency of blockchain still has many sceptics. A recent CIPFA report on blockchain technology, stated, “A respondent from the public sector (central government) expressed the lack of an accountability mechanism: This technology remains too opaque to be considered for anything useful outside of gambling. The complete lack of effective ownership and accountability renders it untrustworthy.”
This sentiment, and a lack of knowledge on how the technology works, has led to slow uptake in the utilisation of blockchain technology despite its potential benefits. Newman foresees the next step toward the mass adoption of blockchain technology to be institutional adoption, and for that stable stablecoins are essential.
Although there have been some moves towards considering the potential of blockchain for audit and assurance by the Big Four, their focuses remain elsewhere, meaning smaller businesses have more scope to become market leaders if they can deliver what the market is demanding.
Commenting on the position of the Big Four in the digital asset space, Newman says: “The reality is, you've got a huge amount of power within the accounting auditing space with the Big Four, but, for the most part, they're unwilling to do any work. You're starting to see them hire advocates that talk about crypto but, in terms of their risk appetite or ability or technical expertise to do that work, they're years behind where they should be. So, there is this huge vacuum within the community where there aren't traditional people doing that work.”
Moreover, there appears to be a significant talent gap in the industry to fulfil these new demands. Newman continues, “You cannot really find people with experience in the space. There are quite crypto native people who want to be accountants, but you have to train them, or there are really good, qualified accountants and auditors who don't have professional crypto experience… that's one of the big issues you see within the workforce. They just don't have the expertise today”.