Every new technology, that has the potential to disrupt, causes fear. In the 1970s, the electronic calculator was made popular. If you know of accountants who practiced at the time, they’ll tell you how easy it made their lives. Before the calculator was introduced, all calculations were done manually on paper.
The calculator changed the whole landscape. It made long calculations accurate and it did so in a fraction of the time that it took a human. This was a major disruption in the accounting industry. Not surprisingly, there were people who looked at it with fear and distrust thinking their skills would no longer be required.
A similar event happened in the 1990s and early 2000s. When MS Excel became popular, many accountants were fearful their work would then be done by computers. MS Excel made auditing a two-hour process from an earlier two-day long ordeal. This was another major disruption that created fear and anxiety in the accounting community.
But we can see today that accounting is a growing and thriving industry. No disrupting technologies have put the accountant out of work. In fact, these technologies have made the lives of all accountants much easier and they are able to complete more work in less time.
Interestingly, there is yet another disrupting force in the accounting arena. Blockchain, you’ve probably heard, is the next cog in the wheel of tech evolution.
Accountants, however, should not be afraid of this new technology. Just like the calculator and MS Excel, blockchain has the potential to radically transform the way we perform accounting tasks and create greater efficiencies in this sphere.
A brief history
We will try and understand the concept of a blockchain using the example of bitcoin. The blockchain concept has been around since the 1980s, but it was only in 2008 that it really came to life. The introduction of bitcoin by an anonymous figure called Satoshi Nakamoto was truly an inflection point. Nakamoto’s identity remains unknown but his work is now considered revolutionary.
Nakamoto used blockchain technology as a publicly available ledger of accounts for his cryptocurrency called bitcoin. He created a ledger of all transactions and distributed it with all participants in the network. Every person interested in bitcoin can view all transaction records from beginning to finish.
As people buy and sell bitcoins or pay for goods or services using them, they are creating transactions that are stored in this public ledger. This public ledger is made up of groups of transactions called blocks that are created roughly every 10 minutes in real time. This means the number of transactions can change from one block to another. So, one block can have a list of 100 transactions, and the next block can have 10,000 transactions.
These two blocks are linked with each other through something called the hash value. These hash values are generated by people called miners. They run very high powered computers to perform complex mathematical puzzle solving. And this is used to validate transactions.
Understanding blockchain basics
Hash or hashing function. A hash is created by a computer programme called the hash function or the hashing function. A function is a computer programme that takes any input, and delivers an output. For example, say we have a function called addition. We give it two inputs, say two plus five. It then gives us an output of seven (the sum of two plus five). This function adds the two inputs and yields one output.
Similarly, a hash function is a computer programme that takes in an input of any length, and delivers an output of a fixed length. This output is now called the hash.
You can take any input and put it into this programme and it will generate a hash of a fixed length, each time. In the bitcoin blockchain, the hash function used is called SHA-256. This is because it yields a 256-bit long hash.
Now, this hash has a few characteristics. First, it cannot be reversed easily. If we take the hash and put it in some reverse hash function, we cannot regenerate the input again.
Second, each input has its own unique hash. Even if you change a single item in an input, it will come up with a completely different hash. This means you are guaranteed a unique hash for every input. In addition, even small changes in the input deliver very different hashes.
Mining. Mining is how new blocks are validated and added onto the chain. This requires huge computing power and miners use graphics cards to perform their calculations.
A miner takes all transactions that are to be put onto a block along with the previous block’s hash and a nonce value.
The nonce value is a random number that can be chosen by the miner. They combine these to create the input which they insert into the hash function. This generates an output called the hash. When a hash is successfully created, it is termed validation.
The three inputs are now called a block and added onto the blockchain as a new block. The newly created hash will be used as the input for the next block.
In bitcoin, roughly every 10 minutes, a new block is created.
I told you earlier that even if you change an input even slightly, it will come up with a completely different hash. What this means is that if someone tries to edit transactions of previous blocks in the chain, the new hash generated will be completely different from the old hash. It will conflict with the hash that is already stored in the next block.
Hashing and mining are the two fundamental blockchain concepts. If you can understand these, you will not have any problem in understanding blockchain and its applications.
(This is Roheen’s first article on blockchain and accounting. The second article can be read here.)