Pub. 1 2019 Issue 3

M A Y / J U N E 2 0 1 9 26 nebraska cpas AUDITING DISTRIBUTED LEDGERS & BLOCKCHAINS BY MARK ECKERLE, CPA, WITHUMSMITH+BROWN, PC Theauditinglandscapehasremained relatively unchanged over the past few decades with similar procedures being used to gain assurance that the financial statements are free ofmaterial misstatement. But distributed ledger technology offers a significant opportunity to increase efficiency in the auditing process. A dist r ibuted ledger, or dist r ibuted ledger technology, is often referred to as blockchain technology. It is a consensus of replicated, shared, and synchronized digital data, which is geographically spread across multiple sites, countries, or institutions with no administrator or centralized data storage. A distributed ledger is essentially an immutable database maintained among a set of nodes or computing devices. Blockchains are one form of distributed ledger technology and are distributed across and managed by peer-to-peer networks. The major difference between most other distributed ledgers and a blockchain is that other distributed ledgers do not usually employ a chain of blocks to provide a securely distributed consensus. Distributed ledgers have taken central stage in technology innovation in the business world as this technology can disrupt current best practices. Utilizing distributed ledgers and blockchains within accounting, specifically auditing, can improve audit efficiency and audit quality. Major accounting firms are devoting sign i f icant resources to blockchai n development by establishing research labs; however, the full extent to which blockcha i n and d i s t r i but ed ledge r technology will impact the auditing industry remains uncertain. Public v. Private Blockchains There a re two t ypes of blockchai n technology: public blockchains and private, or permissioned, blockchains. The main distinction between the two is related to who is allowed to participate within the network and maintain the shared ledger. A public blockchain network is an open- source software program where anyone can join and participate. This type of network, or protocol, typically has a built- in incentive mechanism to encourage network participants to join and use the network. An example of a current public blockchain is the Bitcoin blockchain, which is publicly accessible and can be used by any participant to transact with Bitcoin. A private blockchain network requires an invitation andmust be validated by either the creator of the network or by a programmed set of rules that are built into the network by its creator. Aprivate blockchain typicallywill have a permissioned network which places restrictions on its participants and the types of transactions. Records on a private blockchain are synchronized on all of the nodes to ensure immutability. Privately distributed ledgers offer more privacy, energy-efficiency, and scalability as the network sizes are generally smaller than publicly distributed ledgers. An example of a private blockchain inproduction today is J.P. Morgan’s Quorum™. In order for distributed ledger technology to provide audit efficiency and audit quality, accountantsmust understand how to use and audit the technology. Auditing distributed ledger technology will vary depending on whether it is a public or private network. Auditing a Public Blockchain Auditing a public blockchain focuses not so muchontheprocessofauditing theblockchain itself, but rather obtaining assurance that the blockchain is working effectively and a third party can independently verify a transaction. The Bitcoin blockchain, for example, offers three key technological characteristics