565 Research Paper
Introduction to blockchain
H-1
©McGraw-Hill Education
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What are blockchains? Familiar elements, combined in an elegant new way
Shared ledger
immutable database
transacting and recording data and value
securely
and
for
very
A shared database of records, in which data transactions are recorded, replicated, shared and synchronized among the members of a decentralized network
Information that has been translated into a form that is more convenient to move or process (e.g., bits)
Preventing unauthorized access, use, disclosure, disruption, modification, inspection, recording or destruction of information/value
A collection of information that is organized so that it can easily be accessed managed, updated, and virtually impossible to alter without detection
Database
Single elegant design
Traditional elements
Network
Public key infrastructure
Blockchain
Introduction to blockchain
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Cryptocurrencies have experienced high growth and volatility
Funding for companies with blockchain applications has grown exponentially
Blockchain is one of the fastest-growing disruptive technologies of the last decade
Investment in crypto-economy ($MM, end of June 2018)
Source: Autonomous NEXT, Various for ICO, Pitchbook for VC, EOS Scan
$255b
as of June 2019
219
exchanges that deal in cryptocurrency
$65.8b
total daily trading volume as of June 10, 2019
55.6%
of total market cap accounted for by bitcoin, as of June 2019
Introduction to blockchain
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Coinbase, whose users primarily deal in bitcoin and ethereum, reported that its revenue soared 847% in the first quarter to $1.8 billion, and that it now has 56 million verified users in 2021.
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Life cycle of a transaction on the blockchain
A
B
A wants to send tokens to B from its address in the ledger.
The tokens then move to B‘s address in the ledger.
The transaction is broadcast to every node on the network.
?
?
?
?
All or a subset of nodes in the network approve the transaction from A to B is valid.
✓
✓
✓
✓
The approved transactions are bundled into blocks, which then are added to the chain – this provides an immutable and transparent record.
Introduction to blockchain
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A cryptographic hash function creates a unique digital output from any digital input by applying an algorithm: creates unique digital ID # for each block.
Blocks are hashed to create a tamper-evident trail that spans the entire blockchain.
Each block added to the blockchain contains the evidence (hash) of the previous block adding further security to previously validated transactions.
Cryptography brings security and immutability to the blockchain
Transactions require a digital signature, which is generated by using a private key. A valid digital signature authorizes a transaction and unlocks cryptocurrency from its associated public address to be sent to the recipient’s public address.
Public addresses are derived from the related private key using cryptographic methods.
The public keys are used by network nodes to validate authenticity of signature to the associated private key.
All completed transactions are visible on the distributed ledger.
Private/public keys
Hashing
Text
(abc)
Function f(X)
Hash
(0bee89b07a248e27c83fc3d5951213c1)
Text
(abC)
Function f(X)
Hash
(2217c53a2f88ebadd9b3c1a79cde2638)
Introduction to blockchain
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Consensus ensures all nodes have the same ledger
Nodes on the blockchain independently maintain their own version of the current ledger state. Consensus is the process by which each node checks with other nodes on the network (peers) to reconcile their version of the ledger with the rest of the network.
When a miner successfully mines a block, they append the newly mined block of transactions to their local copy of the ledger. They then broadcast to their peers that their version of the ledger is at a higher block.
The peers then check to see if the update is valid per the consensus rule set, before downloading the block and reconciling their own local copies of the ledger. There are two primary consensus rule sets:
Proof of work:
The model used by bitcoin, for example, which requires computational work to be performed by miner nodes; first miner to solve the problem on their proposed block with ‘proof of work’ gets to create the next block and is rewarded.
Proof of stake:
The greater the amount of tokens ‘staked’ by a node, the greater its chances of successfully creating a block and obtaining transaction fees.
Introduction to blockchain
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Copies for verification via consensus rule set
Ledger of successful miner updated with a new block(s)
Synchronization of ledgers to reflect the update with a ‘winning’ block
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So what can a blockchain be?
The blockchain provides a number of benefits:
Connects peer-to-peer parties
Supplements trust with mathematics (cryptography)
Removes need for central intermediaries
Many practical use cases exist:
Supply chain management
Shipping and logistics
Registries of legal title
Fractional asset ownership
Digital rights and royalties management
Food and pharmaceutical provenance and safety
Introduction to blockchain
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Distributed ledgers can be public, private or hybrid
Public - permissionless
Hybrid
Private - permissioned
The blockchain provides a number of benefits: transparency, no central intermediary
Read/write access open to everyone
>90% of all blockchain application developers work in this space
Challenges:
Regulatory/legal status
Scalability/processing speed
Risk of cyber attack
Elements of both ledger versions
Public yet permissioned
Challenges:
Shared challenges from private/public
Read/write access permissioned to involved parties only
Complex business processes being managed for companies
Challenges:
Replicates Central Authority
Slow to stand up and costly to maintain
Adoption and onboarding challenges
Introduction to blockchain
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More and more blockchain solutions incorporate smart contracts
For additional reading: https://scientifist.com/ethereum-smart-contracts/
Autonomous
Secure
Accurate
Execution and settlement are faster and cheaper, and can help parties avoid errors
Your terms and conditions are encrypted on a shared ledger
You control programmed terms of this digital agreement; no need for a broker or lawyer
Smart contracts
Contracts with predefined conditions that need to be met by specified parties to automatically trigger a predefined transaction on the blockchain
Code posted on blockchain
Once posted, code cannot be changed due to consensus-driven immutability of the blockchain
Introduction to blockchain
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Bitcoin was the first payment coin and the first blockchain use case
Bitcoin is a cryptocurrency:
Cryptocurrency is a digital asset in which cryptographic techniques are used to regulate the generation of units and verify the transfer of units, operating independently of a central bank.
Crypto-exchanges serve as a platform to transact in digital currency
Some exchanges are cryptocurrency only; some incorporate fiat-denominated purchases and redemptions of cryptocurrencies.
Most exchange-related ‘hacks’ you hear about are due to poor custody and cybersecurity practices by crypto-exchanges.
Bitcoin does not equal blockchain!
Introduction to blockchain
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What is an initial coin offering? Method of raising funds by issuing tokens
Process flow
Purchasers
Tokens
Blockchain
Issuer
Token transactions are recorded on blockchain, often Ethereum.
Purchasers subscribe to buy tokens typically with cryptocurrency.
Purchasers receive tokens that can be used to transact on the issuer’s blockchain solution, which is yet to be developed.
Tokens are recorded on the blockchain.
Issuer generates tokens using a smart contract.
A white paper describes the features and functionality of the proposed blockchain solution.
Introduction to blockchain
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Where Can Blockchain Be Applied?
CPA Canada and AICPA 2017
©McGraw-Hill Education.
Why is Blockchain a Game Changer?
Blockchain & Cybersecurity Webinar , Wiley
©McGraw-Hill Education.
How will blockchain disrupt the accounting profession?
Double entry accounting to triple entry accounting
Impact of blockchain on the financial statement auditing process
Real-time remittances of sales, payroll and ultimately income taxes with no intermediary (CPA) involved
Blockchain & Cybersecurity Webinar , Wiley
©McGraw-Hill Education.
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Triple Entry Accounting
Blockchain & Cybersecurity Webinar , Wiley
©McGraw-Hill Education.
What does blockchain do for accounting ?
Blockchain & Cybersecurity Webinar , Wiley
©McGraw-Hill Education.
The Potential Impact of Blockchain on the Financial Statement Audit and the Assurance Profession
Financial Statement Auditing
The occurrence of the transaction-The acceptance of a transaction into a reliable blockchain
Management’s estimates- many transactions recorded in the financial statements reflect estimated values that differ from historical cost.
Considering general information technology controls (GITCs) related to the blockchain environment.
CPA auditors understanding and assessing the reliability of the consensus protocol for the specific blockchain
Evaluating management’s accounting policies for digital assets and liabilities
CPA Canada and AICPA 2017
©McGraw-Hill Education.
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The Potential Impact of Blockchain on the Financial Statement Audit and the Assurance Profession
How Audit and Assurance Might Evolve with Blockchain
Real-time data access via read-only nodes on blockchain
Accessing information in the blockchain will likely become more efficient
Reducing the lag between the transaction and verification dates
Deploying more automation, analytics and machine-learning capabilities
CPA Canada and AICPA 2017
©McGraw-Hill Education.
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The Potential Impact of Blockchain on the Financial Statement Audit and the Assurance Profession
Opportunities for Future Roles of the CPA
Auditor of Smart Contracts and Oracles: a new skill set, including understanding technical programming language and the functions of a blockchain.
Service Auditor of Consortium Blockchains: to provide assurance as to the effectiveness of controls over a private blockchain
Administrator Function: a trusted, independent and unbiased third party
CPA Canada and AICPA 2017
©McGraw-Hill Education.
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Blockchain and Internal Control
COSO & Deloitte 2020
©McGraw-Hill Education.
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Blockchain and Internal Control
Implications of Blockchain on Five Components
Control Environment: help facilitate an effective control environment
Risk Assessment: new risks and simultaneously helps to mitigate extant risks
Control Activities: help facilitate control activities
Information & Communication : promote enhanced visibility of transactions and availability of data
Monitoring Activities: monitoring more often, on more topics, in more detail
COSO & Deloitte 2020
©McGraw-Hill Education.
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Blockchain and Internal Control
COSO & Deloitte 2020
©McGraw-Hill Education.
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Blockchain and Internal Control
Implications of Blockchain on Types of Controls
Blockchain can be coupled with the analytical abilities of other emerging technologies – such as AI, IoT, and data analytics – may be used as a means of detecting anomalies.
COSO & Deloitte 2020
| Type of Control | Implications of blockchain |
| Preventive controls | Recognizing the immutable nature of transactions recorded on the blockchain, there is a premium on recording transactions correctly the first time. |
| Detective controls | The visibility of transactions in a blockchain world provides new avenues for detective controls, when the necessary information is either available on-chain or discoverable off-chain from the on-chain record. |
©McGraw-Hill Education.
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Blockchain and Internal Control
COSO & Deloitte 2020
©McGraw-Hill Education.
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Blockchain Financial Reporting Assertion
COSO & Deloitte 2020
©McGraw-Hill Education.
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Blockchain and Internal Control
COSO & Deloitte 2020
©McGraw-Hill Education.
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