Electronic copy available at: https://ssrn.com/abstract=2897645

Maria Karajovicmkarajovic18@schulich.yorku.ca

Harleen Narula hnarula18@schulich.yorku.ca

Kartiki Pandya kpandya18@schulich.yorku.ca

Janvi Patel jspatel18@schulich.yorku.ca

Ibnoor Warring iwarring18@schulich.yorku.ca

Blockchain: A Manager's Guide

A Report for OMIS 3710Schulich School of BusinessYork UniversityToronto Ontario Canada

We would like to acknowledge "Information Systems: A Manager's Guide to Harnessing Technology" by John Gallaugher and published by Flat World Publishing as the source of the look and feel of this document. The content of the document is, however, completely original.

Electronic copy available at: https://ssrn.com/abstract=2897645

1. NEW KIDS ON THE BLOCK…CHAIN

Blockchain – or what used to be known as “block chain” prior to the demise of the dreaded extra keyboard click – is a peer-to-peer (P2P) public ledger maintained by a distributed network of computers that consists of three components: a transaction, a transaction record and a system that verifies and stores the transaction. [1] The cloud concept of blockchain is what the name implies – it contains blocks that hold valid transactions together. When an individual requests a transaction in real-time, it gets broadcasted P2P-style in the network through a series of nodes. [2] Blockchain’s most popular application is its validation of Bitcoin transactions. This is made possible via a set of algorithms successfully solved by the administrator (a user of the system). The incentive to be a so-called “miner” that solves these computational problems? The opportunity to get more bitcoins added to your wallet! The blockchain is combined with other similar transactions to create a new block of data for the general ledger. Keep in mind that the new blocks will be added to the hash of the prior blocks that are already in the blockchain. [3] This makes transactions permanent and immutable. The transaction is then deemed complete and the other party receives their payment. The blockchain is always added in a linear chronological order. About every 10 minutes, a newly generated block is created and attached to the blockchain through mining. This, however, raises the question about the database’s capacity to synchronize and store data in the system as it grows. [4]

Given its disruptive nature, blockchain has ignited an international buzz.

1. Understanding blockchain, its history, its disruptive nature and its future. 2. Develop a comfortable understanding of blockchain’s many applications.3. Recognize the advantages and disadvantages associated with blockchain.

L E A R N I N G O B J E C T I V E S

hash Any function that can be used to map data of arbitrary size to data of fixed size, often used in computer software for rapid data lookups.

node Gets a copy of the blockchain via the computer of the client completing the transaction validation.

FIGURE 1.1 The blockchain process.

Source: "What Is Blockchain Technology? A Step-by-Step Guide For Beginners." Blockgeeks. N.p., n.d. Web. 29 Oct. 2016.

<http://blockgeeks.com/guides/what-is-blockchain-technology-a-step-by-step-guide-than-anyone-can-understand/>

1.1 Why it Matters

Blockchain has the potential to be incredibly useful in a variety of fields. See for yourself!

Accounting

Perhaps blockchain’s greatest accomplishment is its potential to prevent trusted professionals from “cooking the books.” Manual deterrence measures, such as segregation of duties, internal controls and third-party audits may be insufficient in thwarting bad apples from colluding. Enter blockchain. Retrospective changes to its data are practically impossible; once data has entered a blockchain, it cannot be changed – not even by system administrators. Thus, the transactions are immutable. For accountants, this means that the paper trail would be greatly reduced, if not outright eliminated. Although an economically-friendly decision, it has been met with the contempt of paper-loving skeptics. Certain original documents are hard to forge and are prized for their degree of authenticity, while modifications to electronic files may go unnoticed due to their digitized nature. However, from a technical perspective, the blockchain hash string solves this problem by creating a “physical fingerprint of a particular file,” preventing criminals from extracting these transactions and replacing them with cover-ups. [5] To maliciously alter a blockchain, one would have to hypothetically alter thousands of preceding and subsequent blocks to ensure the chain is chronological. Standardization of this process means that auditors will spend less time verifying data and more time managing complex tasks like assessing ambiguous or unethical transactions, hence focusing their time on value-adding activities. In fact, companies may no longer need auditors, since the integrity of financial transactions would be controlled by a blockchain system internal to the organization. The system also allows for smart contracts to reconcile transactions and automatically trigger audits. [6] For a profession founded on faithful representation and accuracy of information, blockchain presents a valuable opportunity for further improvements in the field of accounting.

Finance

Blockchain has proven to be a reliable instrument, which is likely why it has been endorsed by financial powerhouses like Wall Street, Pricewaterhouse Coopers and Barclays. Firms wishing to cultivate the trust of present and potential customers while simultaneously fostering a first mover advantage may adopt this technology in their quest for transparency. A blockchain available to the public cultivates a culture of openness and ensures “data consistency and integrity across a computer network.” [7] Blockchain’s high quality data is guaranteed to be “complete, consistent, timely, accurate and widely available.” [8] Innovation in industries where intermediaries were previously imperative will experience faster and cheaper services from these advances. [9] Where transactions previously took days to clear, users now only need to wait minutes and can have 24/7 access to the service. This empowers users, in a sense, since they are “in control of all their information and transactions.” [10] Disintermediation brings with it lower transaction fees as a result of lower overhead costs.

The existing capital market is often criticized for its slow, dependent, and expensive infrastructure. Blockchain, however can ameliorate this problem by providing an independent, single location for investments to be traded.[11] Blockchain provides a safe and convenient location to trade stocks, bonds, and digital currencies. Specifically, instead of companies trading publicly through a stock exchange like the TSX or NYSE, they would issue stocks using coloured coins. This would make it easier to track these investments and offers particular potential for the regulation of intellectual property. One final benefit of blockchain is that it provides a platform to send and receive other cryptocurrencies through an exchange called ShapeShift. This creates a gateway for more companies to reach out to a wider pool of consumers.[12]

Today, the blockchain platform has the potential to completely reshape global trade. The blockchain and bitcoin duo create a standardized unit of account that avoids the need for conversion. This simplifies trade and also makes valuing transactions more consistent because it overrides the need to convert to the currency of another country. Naturally, this also reduces the demand for paper-based currencies and the intermediaries responsible for issuing them. Despite this, bitcoin prices are still fairly volatile but are nevertheless expected to stabilize overtime as the pool of users increases. [13] The promising crowdsourced technology that powers bitcoin is secure enough that it does not need to be centrally controlled. This means that even a financial crisis, such as the 2007/2008 crisis, would not have as detrimental of an impact on taxpayers and their wallets.

smart contract Computerized procedures that enforce and verify the performance and negotiation of a contract.

coloured coins Open source bitcoin protocols that allow for the creation and management of digital assets in blockchain.

Previous crises may have broken people’s confidence in the financial markets, but decentralization of the blockchain minimizes these effects because it does not have a central point of failure.

Real Estate

On average, a homeowner places his or her house on the market every five to seven years. Purchasing a home is usually the biggest investment an individual makes in their lifetime. Yet, there have not been many developments to enhance the process of home buying. Blockchain’s application in the real estate sector could signal multiple benefits, including disintermediation, transparency, and fraud prevention. The process of purchasing a home often requires going through a number of middlemen, such as brokers, appraisers, banks, and insurance companies. Blockchain, however, makes it possible to store all required information about a property, including past transactions, digital addresses and financial, legal, performance, and physical attributes, in a secure database that is universally accessible. This reduces costs and increases efficiency by providing increased transparency of information to the average homebuyer. It provides easy and quick verification of a property and links it to its real owners, thus reducing the likelihood of a property scam.[14]

FIGURE 1.2Illustrates the speediness and simplicity of trade grâce à blockchain.

In the bag, or hitting the Sach?

Goldman Sachs, the investment banking giant of our time, issued a research report on the technology of blockchain in May 2016. In the report, it outlined the benefits and disruptions to certain industries caused by blockchain’s ever-growing presence. The investment bank projects that up to $90 million from cost reductions and $700 million from IT Improvements could be saved from adopting the blockchain. Not only has it issued research reports, but the company is even looking to apply blockchain technology to its own operations. Specifically, as of mid-September 2016, it filed a patent for foreign exchange trading on blockchain. In its application, it identified the challenges of adopting the new technology, mainly concerns of technical transition, scalability involving costly initial investments in infrastructure, and potential breaches in privacy and anonymity. Fundamentally, in its patent, it proposes a blockchain system that identifies information and performs the know-your-customer (KYC) and anti-money laundering (AML) checks which it claims will address some of the former issues. [15]

know-your-customer The process of verifying and identifying the identity of a client.

anti-money laundering Laws, regulations, or procedures created to stop income generation through illicit activities.

Source: James McLean, “Banking on Blockchain” Putting the Progress of Distributed Ledger Technology In Financial Services,” IBM, January 2016

1.2 Hype or Reality?

Blockchain enthusiasts would agree that the future of blockchain looks bright. Nevertheless, there are also a fair number of naysayers who argue against its success during this relatively early stage of blossoming (and perhaps eventual domination). As blockchain penetrates various facets of commerce, we are left to determine whether this emerging technology is really as promising as it seems.

Looking back at the applications of blockchain in accounting and finance, it may seem like an ethical saviour. However, it’s important to remember that every rose has its thorns. Although bitcoin’s blockchain technology offers great value, it does not completely eliminate fraud. If malicious transactions are initially recorded, integrity is diminished right away. Therefore, validated transactions are not necessarily “true.” Although the code that governs the technology cannot be hacked, humans are still corrupt and one error – intentional or otherwise – can make the entire blockchain futile. Moreover, blockchain technology does not attempt to verify the reliability or accuracy of its content. [16]

Users’ trust is paramount in determining the success of this electronic ledger. If skepticism on security issues and ethical concerns remains high, society may never buy into a promising system. For some, although the future looks hopeful, the initial capital investment is simply too costly, despite the future savings in transaction costs and time. Data control problems also arise in cases where multiple entities have access to the blockchain data, thereby making control of data much more complex. Although blockchain is deemed an enabler of change, strategy-related issues may atrophy its momentum. [17]

As an emerging technology, blockchain still has many areas of improvement, including transaction speeds, its verification process and data limits. [18] Since modern currencies have always been created and regulated by national governments, uncertain regulatory status may hinder institutions from adopting this technology. [19] With this phenomenon also comes large energy consumption, as miners attempt to validate trillions of transactions per second. This computing power does not come cheap, especially considering its attractiveness to regulation.

Alas, even the most well-intended technologies are met with drawbacks. Thus far, the blockchain has been able to offer a “novel solution to a number of complex computational and cryptographic problems” and surpass every security risk, attack, evolution crisis and PR nightmare which would have otherwise destroyed new technologies. [20] Whether blockchain is the future of bookkeeping still remains uncertain, but reports indicate professionals in all industries should keep an eye on this revolutionary disruptor.

1.3 Looking to the Future

According to Accenture, the law of diffusion of innovation curve projects blockchain will reach

law of diffusion of innovation curve Theory that every market has groups of customers who differ in their readiness and willingness to adopt a new product.

Source : James Schneider, “Profiles Innovation Blockchain” Putting Theory into Practice.” Goldman Sachs, May 2014

its “tipping point” in 2018 after the majority of financial services begin to reap the benefits of early adopters and new emerging models. Blockchain is expected to accomplish the innovative phase in 2016 along with the 13.5% threshold of early adopters amidst financial services. This development pattern is forecasted to persist until the year 2025, at which point it will become accepted and widespread.[21]

According to PwC, three trends are highlighted in 2016 pertaining to the blockchain technology: (1) Potential users’ increasing emphasis on preserving their intellectual property while discovering new opportunities to interact with stakeholders; (2) Strategic thinking further guiding technological risk taking in large financial organizations; and (3) Increasing transactional processes created by market incumbents. [22]

To stay at pace with these trends, blockchain must overcome numerous obstacles if it hopes to eventually become mainstream. The most notable of these - creating a shift in public perception towards adopting widespread use of its database. Primarily, it must attain approval from regulatory committees. Another key issue presents itself in relation to employing blockchain, specifically the proof of existence. Private organizations might be hesitant to display their monetary figures and financial data onto a generally accessible and decentralized system so companies are attempting to innovate and develop their own networks. In response, the permission-based blockchain was developed, which enabled the technology to only be accessed by the selected authority chosen by the company rather than being an openly distributed source. However, some say this secrecy goes against blockchain’s core purpose of decentralization. [23]

So far, numerous companies have attempted to replicate blockchain’s progress. The most successful competitors of bitcoin’s blockchain include Ethereum Labs and the Eris Industries. While

permission-based blockchain Blockchain technology that can only be accessed by the selected authority chosen by the company.

FIGURE 1.3A look at the law of diffusion of innovation curve.

proof of existence Anonymously stores any proof of existence for any document without being stored in the database.

Source: "The Future of Blockchain in 8 Charts - Raconteur.net." Raconteur. N.p., 27 June 2016. Web. 07 Nov. 2016.

Ethereum’s smart contracts are notable, the system failed for being overly-ambitious. It had many plans for new features but failed to live up to its own expectations. As a result, this gave blockchain an opportunity to replicate the smart contract technology before forcing Ethereums out of the market.[24] While the Eris Industries provides users with the resources and software to build their own blockchain, it failed to offer an incentive for data miners to perform their complex duties. [25]

Similar to the internet, in order for blockchain to succeed, it must be a generally-accessible and easy-to-use resource.

3.4 Concluding Remarks

We have seen the diverse perspectives and trends influencing the future rise or fall of this powerfully emerging database. It is evident that blockchain represents the start of a new digital era and technological turning point. This “internet of value” has opened up a new world of possibilities through a peer-to-peer platform that enables personal economic empowerment, financial reporting accuracy and information sharing freedom. Only time will tell whether this electronic ledger will truly gain momentum.

K E Y T A K E A W A Y S

Q U E S T I O N S A N D E X E R C I S E S

Blockchain is a public ledger containing bitcoin transactions. Blockchain ledgers bypass centralized infrastructure. It has potential applications in numerous fields, including accounting, finance, and real

estate. Blockchain can make processes more democratic, secure, transparent and efficient.

However, regulatory, control, privacy and security issues may thwart users from recognizing its full potential.

There are numerous obstacles that blockchain must overcome if it wishes to be successful. Examples include gaining public trust and staying ahead of competitors and industry trends.

Although economic theory dictates a promising future for blockchain, it must stay aggressive and constantly innovate in order to be achieve sustained prosperity.

1. Define blockchain. How is it used with bitcoin?2. What is a hash? Why is it important?3. Name one way that blockchain is reshaping the accounting profession. 4. Give an example of how blockchain and bitcoin are working together to redefine financial

markets.5. Illustrate how home buyers would be affected by the use of blockchain. 6. What are some criticisms that downplay blockchain’s future success?7. What do economic trends suggest about blockchain’s future growth? What must

blockchain do in order to remain competitive? Defend your answer.

ENDNOTES

[1] "What Is Blockchain Technology? A Step-by-Step Guide For Beginners." Blockgeeks. [2] Watters, Audrey. "The Blockchain for Education: An Introduction." Hack Education. 07 Apr. 2016. [3] Berger, Carola F. "Bitcoin Part 3 – Hashes, Public Key Cryptography “for Dummies” and the Block Chain." CFB Scientific Translations and Consulting. 29 June 2015. [4] "Blockchain." Investopedia. N.p., n.d. Web. 22 Oct. 2016. [5] A. Lewis, “A Gentle Introduction to Immutability of Blockchains,” Bits on Blocks, February 29, 2016. [6] Nicolai Andersen, “Blockchain Technology: A Game Changer in Accounting?,” Deloitte, March 2016 [7] A. Morrison, “What Are the Limitations of Blockchain and Where Does the Technology Break?,” Quora, June 3, 2016. [8] Stefan Thomas, “Potential Uses of Blockchain Technology,” WeUseCoins [9] Nick Caes, Robard Williams, Elena H. Duggar, Gregory W. Bauer, “Robust, Cost-effective Applications Key to Unlocking Blockchain’s Potential Credit Benefits,” Moody’s Investor Service, July 21, 2016[10] E. Hinchliffe, “The World’s Financial Elite Just Gave Bitcoin a Huge Endorsement,” Mashable, August 12, 2016. [11] James McLean, “Banking on Blockchain” Putting the Progress of Distributed Ledger Technology In Financial Services,” IBM, January 2016 [12] J. Boersma and Jeroen Bulters, “Blockchain Technology: 9 Benefits & 7 Challenges,” Deloitte Nederland, accessed November 5, 2016. [13] J. Condos, William H. Sorrell, and Susan L. Donegan, “Blockchain Technology: Opportunities and Risks,” Vermont, January 15, 2016.

[14] Stefan Thomas, “Potential Uses of Blockchain Technology,” WeUseCoins [15] Ian Kar, “Goldman Sachs wants to put Foreign Exchange Trades on Blockchain,” The Quarts, September 13, 2016 [16] P. Manasse, “What Is the Major Limitation of Blockchain Technology?,” Quora, January 20, 2016. [17] A. Morrison, “What Are the Limitations of Blockchain and Where Does the Technology Break?” [18] J. Boersma and Jeroen Bulters, “Blockchain Technology: 9 Benefits & 7 Challenges,” Deloitte Nederland, accessed November 5, 2016. [19] A. Morrison, “What Are the Limitations of Blockchain and Where Does the Technology Break?,” Quora, June 3, 2016 [20] "The Future of Blockchain in 8 Charts - Raconteur.net." Raconteur. N.p., 27 June 2016. Web. 07 Nov. 2016. [21] Garfinkel, Haskell, Jeremy Drane, and Cathryn Marsh. "What’s next for Blockchain in 2016?" PwC FinTech Jan. 2016: n. pag. Web. [22] Niloy, Mainul Alam. "Blockchain Technology; How Does the Future Look Like?" 99 Bitcoins. N.p., 19 Nov. 2015. Web. 03 Nov. 2016. [23] J. Condos, William H. Sorrell, and Susan L. Donegan, “Blockchain Technology: Opportunities and Risks,” Vermont, January 15, [24] DeRose, Chris. "Why the Bitcoin Blockchain Beats Out Competitors." American Banker RSS. N.p., 2015. Web. 04 Nov. 2016. [25] DeRose, Chris. "Why the Bitcoin Blockchain Beats Out Competitors." American Banker RSS. N.p., 2015. Web. 04 Nov. 2016.