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How blockchain can help SMEs build trust

Erich Schnoeckel, manager accountancy program ecosystems, Exact

Businesses must be able to build trust if they’re to thrive. You can’t entice a new customer or a finance deal if the company you’re dealing with doesn’t trust you. But in the digital age, there are far fewer physical items that can be used to establish that trustworthiness – most companies’ paperwork exists solely in digital form, and as we all know, just because it’s on the internet doesn’t mean it’s true.

We used to use paper trails and trading histories to show that companies had real goods and cash on hand, but most of those documents have now moved online. It’s hard to prove that a Word document or a PDF are the genuine article – particularly when they’re being used to secure financial transactions where trust is used instead of securitisation. How do you prove you’re a sound investment with a screenshot? Demonstrating that the business has a real pipeline of work and invoiced revenue based on digital records is challenging, or at least inefficient. In this environment, today’s businesses need a different way to access the liquidity and vendor trust that they need to thrive.

One such solution is triple entry accountancy. A notion first explored in the late 1980s, technology has now caught up to enable the idea of an accountancy model where all accounting entries involving outside parties are cryptographically sealed and verified by a third entry. This approach can be used to confirm that a logged transaction – such as an invoice or order – is a genuine transaction with a real expectation of payment.

An introduction to triple-entry accounting

Triple entry accounting uses blockchain to provide a means by which trading entries can be verified by all parties involved in a transaction. Put simply, blockchain is a tamper-proof, distributed digital ledger. Born out of the bitcoin cryptocurrency, blockchain was the underlying ledgering system that allowed all users of the bitcoin currency to record and keep track of transactions. However, blockchain is useful in far more ways than just to keep bitcoin honest.

With a blockchain, multiple parties (such as banks, accountants and traders) can write entries into a record of information, and a community of users can control how the record of information is amended and updated. No one body, like a central bank, controls it, so a single point of failure won’t cripple the whole system. Entries can’t be hacked or surreptitiously altered without breaking the chain, as each record is authenticated by the transaction before and after it – interlinking every entry. Blockchain-based triple entry accountancy therefore provides a single shared version of the truth, backed up by the incorruptible technology of a ledger that can’t be tampered with.

It is a way for SMEs to gain quick access to funding, as well as provide financial information to lenders and other creditors that can be verified as accurate and truthful. Triple entry accounting uses blockchain technology to create an audit trail of transactions that can be verified by the host company, the company being invoiced, and by third parties such as banks and credit insurers looking to confirm the financial health of a business.

The key benefits

Companies using triple entry bookkeeping gain two immediate benefits. First, auditing is simplified, as more of the verification work normally done in an annual audit is already there – reducing the time and cost of the process as external auditors can quickly and easily verify financial statements. Triple entry accounting won’t do away with the process of an annual audit, but it will reduce its complexity and criticality, as verification of accounts is continuous via the blockchain rather than annual.

Second, it can help reduce internal fraud. Income and expenses cannot be falsified if they require the encrypted signature of a counterpart in order to be accepted as valid. Blockchain ledgering has its origins in bitcoin, where transactions only occur and exist when verified bitcoin currency is transferred between parties. Only at that point is the entry signed and inserted into the ledger.

There is simply no incentive to undertake the immense work needed to fraudulently tamper with existing entries. The unique cypher used to sign each transaction and interlink with the transaction before and afterwards means any tampering immediately shows up as it breaks the chain of transactions. Taken together, these factors make it easier to borrow money and access bridging loans, invoice factoring and so on. Essentially, it becomes simpler to get up-front payment on invoices based on trust rather than having to secure money against physical assets.

By allowing all parties to verify and confirm a transaction, the accounts can serve as a trusted and independently-verified record of a business’s trading – something that can be trusted by a lender or credit insurer. It also supports the ability of the seller and buyer on a wholesale level to stagger their payments, building trust along the way.

For example: say Company A in the UK orders goods from Company B in China, an action that would normally involve paying up-front for the goods, often before they’ve even been made. Company A then waits anxiously for the shipping container to arrive from Company B, not certain that what was ordered is what is in the box. With a blockchain-based transaction system like triple entry accounting, Company A can do staggered, verified payments to Company B. Company A reduces its risk, but Company B can be increasingly sure that payments are being made as the order reaches fulfilment, instilling trust in the transaction and using the blockchain-based accountancy system as a transparent record.

Staying safe

Even with triple entry accounting, there is a risk that one half of the transaction might try to defraud the other. A blockchain ledger won’t stop this, but it will create a fixed trail of events and of the break in trust and reputation, meaning that the defaulting party will not be able to walk away from the black mark on their record. It will also show that the defrauded party entered into the transaction in good faith, and represented the validity of the transaction to lenders, insurers and suppliers genuinely.

Blockchain provides a trust element that allows debt to be traded as a commodity more reliably, without the need for third party credit assessment. It means that small business debt can be sold on or traded on open exchanges, with more transparency than we have seen with things like mortgage-backed securities.

The use of blockchain in the business world will allow companies to improve their access to funding, as well as developing closer, more informed relationships with those they are working alongside. Underneath all the hype and media frenzy, blockchain is simply a mechanism for restricting the endless copyability of digital artefacts, which thereby enables insurers and banks to extend credit to companies with greater confidence. Companies should take the initiative now and look to incorporate triple-entry accounting into their systems – it’s likely to become essential in the years to come.

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