Blockchain & accounting
What is the accounting challenge and how to solve it?
Is there only one accounting issue? An accountant would say that there are so many challenges with accounting that it’s hard to synthesize them. That’s the challenge that we are taking with this article.
In a few words, there is an accounting issue due to old systems running in the current industry, leading to daily manual tasks by accountants. And there is an accounting issue due to cryptocurrencies because the rules are not ready for them yet, leading to many questions.
We will list the main actors involved. Then take a look at issues from the 2 different angles mentioned above.
There are workarounds and quick wins in our current context. With emerging projects, some initiatives aim to make the most out of new technologies. Last but not least, we will look at worldwide changes coming with blockchain technology. The cryptos’ underlying technology has the potential to solve many issues. The future of accounting looks promising.
Companies and individuals are facing an accounting issue but that’s not it. There are also future actors who will face issues if we keep the same system.
Different kinds of companies and projects have issues coming from accounting
Decentralized projects allow anyone to develop the code and have a part in decisions. Blockchain protocols such as Bitcoin itself are not making yearly financial statements. Indeed there is no entity. That’s an interesting issue for regulators. It makes Bitcoin close to a currency.
On top of the cryptocurrencies which work with proof of work, there are mining operations. Some companies and individuals mining cryptocurrencies are guaranteeing the functioning of the blockchain. They get regular rewards for doing so. The individuals performing that kind of activity with their servers are subject to taxes.
Freelancers, entrepreneurs, SMBs and crypto companies (dealing with cryptocurrencies or not) usually build their bookkeeping on spreadsheets. It leads to various issues that we will tackle later. Moreover, crypto assets get used for payments or other operations by crypto executives. There are questions for both the companies and the executives who have some responsibility. For example, CFOs must be careful with KYC, KYB and AML, and they also need to be tech-friendly to understand, track and manage crypto. Accounting firms, small and big, have issues dealing with companies’ issues. And auditing firms, small and big, have issues dealing with accounting firms’ issues. In most cases, it takes a lot of time for auditors to manually verify manual inputs from companies or accountants, and it costs money. CPAs & accountants are the ones advising the CFOs and they also need to embrace technology. They need to get more knowledge on the matter and be able to apply the rules. Same for auditors.
Among the actors having challenges with accounting, there are asset managers, VCs and crypto funds. They invest in projects and companies and get to follow some more or less international laws.
Big corporations usually have costly ERPs to manage their operations and accounting. They also have to manage the transactions between subsidiaries and the resulting bookkeeping in different countries.
Last but not least, governments and tax offices are not able to have a clear overview of the economy or even to verify that taxes have been correctly paid. This lack of control is an important topic for them.
Individuals are also touched
There are not only companies facing accounting challenges. All individuals do.
Let’s look at tax rules for companies versus individuals. Most governments ask companies to build yearly financial statements. In parallel, the individuals must submit a tax report for revenues earned for one year.
Companies can deduct most charges from their revenues and pay profit taxes, while on the other side individuals pay taxes on revenues only. One of the explanations is the complexity today to have an overview of individuals’ charges.
Future entrants and technologies compatibility with current accounting model will be challenging
- Robotics, AI and the Internet of things are not only interconnected technologically but they can also interact financially. Robotics, AI and IoT devices are already able to exchange information which fits the characteristics of an invoice or a payment. Price algorithms can determine the value of transfer between 2 objects for example. Invoices and payments can be made. This evolution poses questions to accounting responsibility and principles.
- Moreover, Decentralized Autonomous Organizations (DAO) are organizations supported by thousands of actors, potentially. Those organizations are autonomous, they do not belong to a single owner and there is no direct control from anyone. It could become as big as if 2 million persons owned an SP500 company, with no chief on board and no legal entity. The question there is also about who handles the accounting?
Some issues are happening in the current accounting system. Some others are resulting from organizations’ involvement with crypto. They are of different nature.
Issues for the current system are about manual tasks, taxes, interoperability and analysis
Technical loopholes and manual issues are interconnected
There are two ways to store bookkeeping data: on internal servers or in the cloud. Internal server outages or mistakes have huge consequences. Cloud usage means that there are some costs to take into account and often software to trust. Security is challenging.
Additionally, we receive most invoices by mail or by email. This is sad and sometimes it results in loss of data or discrepancies. Technologies that SMBs use today for invoices are not adapted. If an email can be used to convey any kind of information, it does not make it a scalable financial information network. It does not even make it efficient, only the speed and costs of transfers are removed, not the transmission’s ones. Only some public sector suppliers use a kind of automated electronic invoicing.
Among the consequences of technical imperfections, there are manual tasks. It usually costs USD 5 to USD 15 to process an invoice because of some manual tasks such as:
- For the supplier: entering the invoice in the system, then sending it by email to the client. Then later verifying that he received the payment, and linking it to the invoice.
- For the client: downloading the invoice from an email, then entering it to the software, manually.
- For the client: receiving the invoice per mail, then scanning it to attach it to the software.
- Building a spreadsheet to manage amortizations and entering them for every month in the software.
This lack of automation results in inaccuracies and time-wasting. It also prevents organizations from getting an accurate analysis on time. Businesses’ main goal is not to do a proper accounting.
Governments suffer from tax issues, and executives get anxious
It’s better to avoid frauds but sometimes tempting to play within boundaries. CFOs need to feel safe about the accounting principles used, and need to be sure to be in line with the rules. Calculating taxes can be so complex that it becomes hard to sleep at night. We are in a need for a simpler way.
For governments and tax offices, it’s also hard to get control, especially over international operations. Some technologies are getting ready though, more on that later.
One of the foundations of concerns in the field is the lack of Interoperability
Invoice data is often duplicated. Obtaining data is often asynchronous. Knowing about data is often reserved for accountants. Those are some of the results of the usage of non-interoperable systems. Isn’t it a matter of worry that most SMBs take 6 months to power yearly financial statements?
The interoperability challenge is not only about systems. There are no universal accounting principles, standards or procedures. They tend to vary from country to country, or have regional-only guidance.
Financial analysis complexity restrains businesses from understanding more about their finances
Businesses need to manage and forecast charges and avoid unforeseen expenses. Getting asynchronous analysis slows down the discoveries and is a vital risk for projects.
Same for the management of cash flows. It’s one of the top reasons why businesses fail. With correct reporting, the economy could behave better.
Organizations involved with crypto suffer
Technical knowledge is lacking in the industry
Crowdfunding was already an interesting topic for professional accountants (CPAs). Now that the creations of new tokens are becoming frequent, the discussion is evolving. There are more complexities about identification, geography, and rules. Auditors also struggle to get accustomed to crypto transactions. They get unusual proofs when they need bank statements, for example. Sometimes it’s even impossible to provide something which fits their needs, according to their profession. We can admit that there is room for progress about proof of ownership with blockchain.
Additionally, there are concepts that exist with crypto and didn’t exist in the accountant’s world before. For example, forks are hard to manage for professionals. It’s the duplication of one cryptocurrency into 2 cryptocurrencies (the former one remains and an extra one gets created). To their credit, it never happened before that USD gets transformed into USD plus USD2.
And finally, it’s a new technical environment that successful accounting professionals will have to know and master. They don’t have to know what a database is but they will have to know more about smart contracts. They will have to replace bank statements with good certainty, and to master the extreme cases of pending transactions, internal transactions and airdrops. There is a lot to answer, but first, a lot to learn.
Tax offices need to become tech-friendly
There are frauds. There are also inaction and mistakes when people don’t know how to do the job in a proper way.
For crypto accounting, companies have a choice. They can make things as clean as possible with the help of external accountants – who most of the time don’t know more. Or they can decide to focus on their product and spend the minimum time on it. It’s better to make things clean but it takes a lot of time & energy.
As a result, governments have a hard time to receive taxes out of crypto transactions. Indeed the technology environment is not ready because the guidance is unclear.
Sometimes the guidance does not make sense. In some countries, we need to pay taxes on capital gains on the 31st December of the year (as evaluated by the local currency), while 2 days later there could be no more gain because of volatility. Sometimes the rules are clear but it feels like you need to have a Ph.D. to properly calculate taxes.
Compliance is challenging because traditional rules don’t apply anymore
We evoked the subject earlier, it’s hard to follow rules when the rules don’t seem to apply. Indeed experts wrote rules without the current technological progress in mind.
Two important organizations are defining international standards for accounting. The International Accounting Standards Board (IASB) is developing the International Financial Reporting Standards (IFRS). The Financial Accounting Standards Board (FASB) is developing the Generally Accepted Accounting Principles (GAAP). They allow comparing international companies with the same principles.
Despite those standards, there is limited accounting guidance about crypto assets specificities.
According to KPMG crypto assets are intangible assets, under the GAAP principles. California CPAs consider that they “can be reported as anything from a commodity to an investment or even be counted as working capital”.
The classification process is confusing for companies dealing with crypto, for CPAs, and for auditors. Not to mention fast-changing legal and political specificities for cryptocurrencies.
One of the consequences is the lack of compliance. Individuals and companies neglect accounting practices.
Additionally, banks refuse basic banking services to crypto companies. Similar stories can be read all over the world, except for some countries. Many crypto projects don’t have a bank and still survive this way. It’s hard for them to get a loan from a bank, but also to be compliant with local rules.
Most banks decided not to onboard companies dealing with cryptocurrencies. Indeed this is a headache for their own compliance. Also because they consider crypto as a disruptive force against their business, or because they don’t believe in its potential.
As a consequence regulatory compliance is lacking from companies. For example, a Foundation in Switzerland needs to provide the CHF capital to a Swiss bank account within weeks after the company’s creation. And it’s impossible without an account.
Regulatory authorities such as Swiss ones tend to become flexible but all countries don’t show the same understanding. A first solution is in the hands of those regulatory organs.
Financial analysis is currently hard despite promises
The basis of accounting is first to get data. Getting data is not user-friendly yet, even when done in an asynchronous way. Individuals and businesses struggle to have an overview of their finances when there is crypto involved.
Indeed, the number of wallets and tools is challenging. Here are examples of tools a company can use:
- A few exchanges such as Kyber, Coinbase, Kraken, Wyre and Binance
- Browser wallets such as Metamask and Portis
- Mobile wallets such as Jaxx
- A crypto bank such as Multis.co
- A decentralized lending platform such as MarkerDAO and Compound
- An invoicing system such as Gilded.finance
- A multi-signature wallet like Gnosis team safe
- A physical wallet such as Ledger
The challenge is to use decentralized tools in a centralized business process framework.
Moreover, bookkeeping software doesn’t allow custom currencies, even though they announce being innovative with blockchain technology. For example, hundreds of Xero users are asking Xero for crypto flexibility here. And currently, those users tend to use some FIAT currencies they don’t expect to use, and manually input exchange rates every time there is an invoice or payment.
It’s paradoxical to have difficulties at the particular point where it will become easier in the future. Indeed blockchain technology aims to allow real-time dashboards. Timing-wise, it looks like current software providers and blockchain technologies are not aligned yet.
Existing solutions for individuals and businesses to tackle current problems
On the tax issue
Determining the fair value of crypto assets is possible. There is enough guidance to find a few possible approaches. The individuals or businesses usually interpret the options themselves, and choose the one which makes more sense. Most countries apply different tax rates on cryptocurrency gains, depending on whether there has been a trading activity or not. If there has been one trade in the year, it’s not a trading activity. When there are 1000 trades in the year we could say it is. People interpret themselves.
For accounting under GAAP or IFRS, the guidance gives a few different options. We can consider the crypto as a commodity, as an investment, as inventory or as intangible assets. Based on the past and expected usages the persons apply to the one which makes sense.
On the banking issue
Crypto companies become creative to live without banks. There are solutions that allow running a business anyway. It takes more time but it’s also fun to take part in the development of innovative solutions. For example, there are decentralized loan solutions open for anyone on the blockchain. MakerDao and Compound have been working well.
It’s also possible to pay lawyers, accountants and employees in crypto assets. With volatility, there are more challenges, that’s why stable coins such as DAI are getting traction. The DAI’s value always remains close to USD 1. Businesses can transfer USD value in seconds, all over the world, for a few cents.
Last but not least, getting paid in crypto is easy. Many websites & businesses get paid in crypto. Among them, dozens of merchants use Wooreq and Reqify to create invoices and also receive cryptocurrencies as payment.
On the compliance issue
Over the last few years, a few crypto companies have established or have moved their legal structures to Isle of Man, Switzerland, Gibraltar, Caimans Islands. There, regulations give more clarity and more sense of being within the law. That’s a paradox. Other governments have reacted since. Guidance is getting clearer for the setting up of companies.
The holders of crypto assets need to interpret the rules and apply the ones which make the most sense. In most cases, the CFOs will get in touch with specialists. Together they will look at options and interact so that there is a good understanding of the asset’s properties, and they will choose between a few options. This is more a decision to take than a rule to follow. In other terms, we apply an approach based on principles that we choose.
On the knowledge issue
Accounting professionals tend to become friendly with smart contracts. First, the accountant needs a bank statement, and he can get a view on the blockchain via etherscan.io for example for Ethereum transactions. This could be ok for him but that’s unusual. Second, he can see on the website that there are ETH transactions, ERC20 transactions and internal transactions. ETH is about Ether movements, ERC20 corresponds to the currencies built on top of Ethereum, and internal transactions correspond to interactions with smart contracts. Sometimes they mean that there has been a movement in a multi-signature wallet. Sometimes they mean that there is a movement with a decentralized application, like a decentralized loan service, or an invoicing tool. The accounting schools did not teach them how to interpret this technology. Getting accustomed to online tools is a good way to start mastering the environment.
Those tax, banking, compliance and knowledge problems are opportunities for businesses to catch.
Initiatives from startups and big corporations
Many startups already have traction working on accounting technologies for cryptocurrencies:
Blox.io, Softledger.com, lukka.tech, cryptio.co, lumina.app and cointracking.info are providing crypto assets tracking and accounting.
Big actors also try to provide solutions, such as PwC which built a way to centralize information about funds. Their tool uses APIs to get information on different blockchains and exchanges.
It’s not always the technology that makes the users shift their needs. Sometimes it’s the users shifting their needs which drives tech changes.
Positive changes are happening thanks to technology
- Blockchain technology: By nature, blockchain is an accounting technology. As said by Deloitte: “Blockchain technology is fundamentally an accounting technology”.
- E-invoicing and Peppol network: E-invoicing is an exchange network where we replace the exchange of financial documents with the direct exchange of financial data. Thus automating most following steps. Peppol is an e-procurement platform with standards that aim to help EU countries exchange financial information.
- The Request network is a technology to have invoices’ data on the blockchain. It’s one of the long term solutions, scalable and working today, but only with a few currencies. In concrete details, there is already a library and an API allowing startups to build on top of this technology. Gilded.finance uses the Request network technology to allow tracking and transaction reports for the accounting of (crypto) invoices. This set up also allows interoperability with bookkeeping software such as Quickbooks and Xero. It’s possible to synchronize wallets and exchanges to build real-time dashboards.
Such technologies are ways to allow automated transactions, real-time accounting and real-time audits. Entrepreneurs and executives will be able to automate and watch their finances in real-time. Same for industries and governments.
Parallel changes are happening in mindset
There is a kind of spiritual change in favor of interoperability with a common underlying technology.
The move from competition to cooperation can benefit users thanks to:
- Interoperability between systems (different proprietary systems)
- Interoperability between companies (invoices on the blockchain)
- Interoperability between countries
And interoperability will simplify reconciliation processes, thus avoiding mistakes.
Additionally, a change in transparency is happening. Governments, cities, NGOs and companies are starting to become transparent. The current technology trends are of great help and it just started.
The future of accounting is going to be automated. Real-time dashboards and real-time accounting already start to pop up. Real-time audits are expected by 2020 according to ACCA. And real-time predictions would empower the businesses.
One of the reasons why accounting exists is because of taxes. The type of fraud existing today will decrease. Tax calculation and payments will happen in real-time. Their automation could drive the rates down.
The internet of things, DAOs, Robotics, AI, VR, and AR will power objects which send each other invoices and payments. Blockchain-based technology will automate their accounting.
In summary, the accounting issues are numerous, there are promising solutions but the transition brings a great load of new problems. We need to remain careful anyway. The technology is evolving, we are only able to imagine a small fraction of the solutions it will bring and questions it will ask.