Bitcoin and the Accounting Revolution that Shook the World
Daniel Jeffries, zvg.

Bitcoin and the Accounting
Revolution that Shook the World

The last major innovation in accounting happened 500 years ago during the Renaissance. Then came Bitcoin.

 

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We don’t think much about accounting. It’s not the sexiest subject, to say the least.

But without it, you wouldn’t be reading this article on your smartphone, driving a new car, or listening to music on Spotify. Without accounting there’s no commerce, no trade. Without commerce there’d be no planes, no trains, no tractors, no steam engines, no skyscrapers or computers. There’d be no nation states, no boats, no shipping containers traveling all over the world ferrying goods from near and far.

Without accounting you’d still be running around the forest hunting deer or eking out a living by working a small plot of land as a subsistence farmer.

The reason is simple. There’s only been two accounting breakthroughs in the entire history of the world before now and both of them preceded a massive uptick in human societal level complexity and innovation.

Our ability to keep track of who owes what, who paid who, and what people have or don’t have, led directly to humans’ ability to build greater and more dynamic civilizations. It took us from tribes to gigantic nations of 100s of millions of people. Instead of everyone having the same few jobs, hunter, gather, or farmer, it allowed for specialization and the division of labor. Division of labor let people focus on smaller and smaller problems that led to bigger and bigger gains. Once someone figured out large scale ship building and someone else figured out writing, it wasn’t long before ships surged around the high seas, bringing spices and exotic animals and silks from the far corners of the Earth.

Single entry accounting: written with blood

The first breakthrough was single-entry accounting. It let kings and queens build great kingdoms out of formerly warring tribes. It let them establish professional armies and build great castles and wonders filled with gold and jewels. I’m writing this from a road trip through beautiful Bavaria. The castle I toured yesterday, filled with paintings of battles, solid silver chandeliers with stately stags, and grand cherry wood furniture was built with single-entry accounting and a lot of blood. The romantic style of the paintings left out the inconvenient detail of the blood but didn’t hide the fact that early wealth came from open war.

But what does accounting have to do with castles?

It was single-entry accounting that kept track of what kings like crazy dreamer Ludwig II borrowed to build his lavish palace, the Neuschwanstein Castle, that draws millions of tourists today but had the peasants ready to rise up and kill him for running Bavaria into the deep red of debt. With single-entry accounting you have a single column in a ledger. You write down what someone owes or paid. Daniel paid 50 euros. Daniel owes 50 euros.

It was effective enough to take us into the feudal age of dukes and clans and powerful families with their own personal armies. But single-entry accounting is incredibly limited and prone to fraud. All a bookkeeper has to do is wipe away a line in the ledger and that money debit or credit no longer exists. There was no way to verify, no way to audit, no way for two people to agree. In the time of feudal lords, the only accountants were the king’s brother because you really had to trust that guy and no random tradesman would do. That meant trade was a family affair. The kings and queens traded with the dukes and mostly they kept all the money for themselves and left the rest of us to starve. Powerful clans dominated the Earth.

A monk made it possible

The second big breakthrough in accounting changed all that and made the world as we know it today. By the 1400’s, single-entry accounting really started to show its age. For the first time you had big boats traveling from all over the Earth. That meant people could trade with people they’d never met, people who weren’t part of a vast, extended family. With boats the center of economic life, port cities like Venice became the center of the ancient world.

But with so much trade going on, single-entry accounting made it super easy to make data entry errors. People’s books were soon a hopeless mess of conjecture and lost money. The more trades that stacked up, the more errors.

Multiple civilizations from the Italians in the 1300’s, to the ancient Koreans, to the second Muslim Caliphate all developed versions of a double-entry system. The systems never caught on though because they lacked one more incredible invention that’s more important than anything else ever invented: the printing press. Without the press, knowledge remained siloed. People would develop a breakthrough in one area of the world, only to die off and leave no trace because they couldn’t write it down and share it with others. The press allowed people to make hundreds of thousands of copies and that meant knowledge survived and circulated, instead of dying with its creator.

There were two things that people wanted to write down and share right away, religious beliefs and who owed what, aka accounting ledgers. It was someone versed in both religion and money that changed the world. In the 1400’s, a Franciscan friar, Luca Pacioli, finally codified the double-entry system and it swiftly became the standard with Venetian merchants. This opened up world trade in powerful new ways. Now goods could flow easily to all the empires of the old world over the oceans and along the silk roads.

No more tricks

Fast forward to today and we still mostly use a double-entry system. If you keep your books in Quickbooks you’re using a double-entry system. But now those systems are starting to show their age badly too. Take a company like Enron. They found all the loopholes in double-entry systems to hide billions in debt and disguise fraudulent transactions. With double-entry systems, the corporate side of the accounting stack becomes a black box, hidden from everyone else besides the few corporate accountants whose job depends on covering up that fraud.

Of course, Enron had «independent» auditors to peel open the black box, but those auditors had a conflict of interest because they’re paid by the company and who wants to expose someone if you lose your meal ticket? In the end, their independent auditors helped them cook the books too. That’s where triple-entry accounting comes into the picture, a brand new breakthrough that gives us only the third revolution in history.

We had two theoretical designs of triple-entry systems, one called momentum accounting by Professor Yuji Ijiri and a second by cryptographer Ian Grigg. But both of those systems remained on paper, not widely used until a young programmer or programming team likely discovered the systems, as he, she or they worked in secret on a project in 2007-2008 that would revolutionize the way we think about money: Bitcoin.

Bitcoin is the world’s first working example of a triple-entry accounting system. It uses a third, global entry that everyone can see in a global, shared, digital ledger that gets shared across the entire system.

Even if you don’t believe in Bitcoin, you’ll want to understand it because the breakthrough of triple-entry accounting paves the way for a brand new wave of innovation and complexity in human civilizations.Triple-entry accounting and by extension blockchains are a way of agreeing on objective reality. It’s not the objective reality. That’s a philosophical black hole we’ll ignore for now, but it’s an objective reality. It’s two parties agreeing on a version of past events with a third entry recording that objective reality for the entire world to review and verify. The third entry in the system, entered into the blockchain, is both a receipt and a transaction. It’s proof that something happened between those two parties, which goes beyond the receipts that each party holds in a double-entry system.

Corporate firewalls: Soon to be a thing of the past

What else can you do with triple-entry accounting? A million things, but one of the simplest and most promising use cases is for issuing stock. Let’s say you have a little company that we’ll call Enron. It’s doing tremendously well. You’ve got a million shares of stock, something like 10% of the total shares. At least you think you’ve got 10% of the stock. You’ve got an official looking piece of paper that says you own a million shares. That’s all you need, right? The paper has a stamp and everything so it must be accurate.

Except you don’t really, because as we saw with the Enron scandal, they were cooking the books. Cooking the books in this case with stock would mean issuing double shares. With today’s double-entry systems, it’s a security problem to give you access to their books so you can’t audit them as a small share-holder. They live behind the corporate firewall. You have to trust they’re telling the truth, even though you can’t really trust them. But triple-entry changes all that. A company can issue stock and you can check your stock against the third entry in the ledger, the blockchain. Now you don’t need access to their books to verify that you actually have 10%. You can look at the chain, see that there were 10 million shares issued and that you have a million, so you have 10% for real and you know it, all without ever needing to get behind the corporate firewall and audit Enron’s books yourself.

That might not stop them from completely cooking the books, but it goes a long way towards stopping lots of financial fraud that’s possible today with outdated double-entry systems that corporate entities know how to game with ease. When you get stock, you’ll know you didn’t get double-issued stock or short changed your rightful shares. While we’ve seen a lot of hype and hope and false promises in the crypto world, don’t pay too much attention to it. In any early system, there’s all kinds of fraud and growing pains. Today, cryptocurrency is like a banana republic economy, small and filled with fiefdoms and lots of crazy ideas that won’t work as people try out new things. But tomorrow it will grow into a massive powerhouse that revolutionizes the world.

Blockchains and triple-entry systems will change the way we track goods and services. Today, you don’t really know where that shrimp on your dinner table came from at all. Did it come from a sustainable farm that followed all the rules or did it come from a corrupt country that doesn’t care about those rules at all?

Today, food that doesn’t follow the rules makes it into our food chain through graft and bribes and broken economies. It gets routed through smaller countries with little rule of law and overworked inspectors who happily take a bribe to change the sticker on those shrimps to say they came from Thailand instead of China. Now you’re eating shrimp stuffed with antibiotics and fed on feces run off from pig farms. In the future, when farmers around the world use a universal system that connects to every part of the food chain, food will get checked and scanned into a blockchain that keeps track of every step in the chain. You won’t be able to bribe an inspector and when someone cheats we can go back and look at the global ledger to understand where things went wrong and punish the people responsible for cheating us all and poisoning the system with sick food.

Be aware of the traps new technologies brings

Beyond Bitcoin, we’ve seen second and third generation decentralized currencies and blockchains focused on privacy. Coins like Zcash and Monero look to replicate the anonymity of physical, folding paper cash. Hyperledger, a Linux foundation project, builds private transactions into the system that will keep the details of the transaction secret, but still allow a third-party audit to see goods and services changed hands.

Of course, not everything is good with these triple-entry systems. Many people in the crypto community see Bitcoin and decentralized cryptocurrencies as a universal good that can’t be corrupted or taken over by governments or hostile actors but they’re not paying close enough attention. Governments that once looked at Bitcoin and cryptocurrency with fear and loathing are now eyeing it with understanding. They see the power of triple-entry and digital ledgers and they already know how to warp them to their own needs and desires. Unlike the privacy focused dreams of leaders of the crypto revolution, they’re looking at it as a way to track everyone and everything. If you buy something from a bake sale they’ll want to know about it and their panopticon money will know it.

It’s no surprise then that China is the first to turn blockchains into a tool of the state. They’ve already built a Central Bank Digital Currency (CBDC) that they rolled out in beta to multiple provinces and that they’ll soon make into their own national currency, one intimately tied to social credit scores that rate citizens on how well they adhere to party guidelines. That would let them cut off the money to people who don’t march to the ever shifting whims of the party line.

It won’t be long before China eliminates untraceable physical cash all together. Other countries will follow. Many have already tried and failed, like India. But those failures are just short-term setbacks. Blockchains will make it possible for them to succeed in successfully making cash illegal and replacing it with cash that can peer into every aspect of your life.

Like every revolution in technology, it’s never black or white. It creates both good and evil and everything in between.

Blockchains and digital currencies will deliver nightmares and tremendous breakthroughs in technology and culture as new kinds of societies we can barely dream of now will flourish. They’ll allow panopticon money and spying in ruthless dictatorships but they’ll allow open democracies the ability to track the fair trade of goods and services. In the future, we’ll see a massive battle between privacy focused, decentralized currencies and the state sponsored alternatives that focus on command and control.

Who wins in the end remains to be written in the pages of tomorrow.

But whoever wins and whatever happens, remember that it’s the quiet, unnoticed discipline of accounting that made it all possible. Triple-entry accounting marks the beginning of a brand-new age of commerce and civilization.

And only tomorrow’s children can see what wonders it brings to the world.

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