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Blockchain and Its Coming

Impact on Financial Services

Editorial Review

Kurt Fanning and David P. Centers

itcoin and its

of these transacThis article provides insight into how Blockcryptocurrency
tions. Information
chains work. A block chain or Blockchain is a
alternatives
that was written
such as Litecoin and
within the block
distributed database that maintains a continuously
Primecoin, have been
consisted of items
growing list of data records that are hardened
affecting financial
such as amount of
against tampering and revision, even by operaservices for nearly a
the transaction, who
tors of the data stores nodes. One can view a
decade. However, it
it was paid to, and
Blockchain as a public ledger of all transactions
is likely that Blockby whom. This was
that have ever been executed. It is constantly
chain, a supporting
added to prior inforgrowing as completed blocks are added to previtool, will have the
mation about past
ous blocks forming a chain. Importantly, blocks are
largest impact on
transactions. The
added to the Blockchain in a linear, chronological
financial services
protocol surroundorder. Each miner gets a copy of the Blockchain
and other industries.
ing the Blockchain
when joining the Bitcoin network. The Blockchain
Blockchain has a
and the stored inforthey receive has complete and accurate informachance to be a transmation within the
formative technolblock was now able
tion about the addresses and their balances right
ogy. It will change,
to serve as the trust
fromthe genesis block to the most recently comat the minimum, the
element. This trust
2016 Wiley Periodicals, Inc.
pleted block.
way financial firms
element meant that
perform many of
the parties involved
their activities. It will
were able to make
also impact other industries
to record and validate transacthe transaction with confidence
such as gambling, contracts,
tions. This need was met by the that it would be validated.
auditing, and product validadevelopment of Blockchain.
Since this function is normally
tion. Inaddition, several existTosimplify, a Blockchain was a provided by financial instituing long-standing businesses
collection of validated pieces of tions, a Blockchain effectively
and professions will probably
information, blocks, linked to
severs the need for a centralno longer exist. These losses
the others by adding the newized agent. This trust element
will be a result of structural
est blocks to the existing chain. inherent in Blockchain was the
changes caused by firms using
With Blockchain, users could
important reason for Bitcoins
Blockchain or a similar system. validate and track their bitcoin success.
During the development of transactions, as it maintained
In addition to making
Bitcoin, a method was needed
a permanently secure record
the Bitcoin system work, the

2016 Wiley Periodicals, Inc.

Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22179

53

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The Journal of Corporate Accounting & Finance / July/August 2016

development of Blockchain
also met many of the desires of
individuals who were involved
in the early stages of making
bitcoin transactions. Many of
these early individuals involved
with Bitcoin strongly wished to
avoid dealing with third-party
intermediaries such as financial
institutions. This desire was
partly driven by the users wish
to achieve cost savings and
ensure their privacy. However,
it was largely driven by their
dislike of government, with a
decided libertarian perspective
on need for the development of
Bitcoin. Bitcoin was to be the
answer to the financial crisis
of 20072008.
In any case, Blockchain
turned out to be extremely
effective in maintaining a
secure ledger of bitcoin transactions. As with any new project, there have been some
miscues along the way. Since
the protocol and code was
and currently is open-source
software it has benefited from
the efforts of many interested
coders who wanted Bitcoin
and Blockchain to work.
Thus, many of the problematic aspects of the design and
coding errors have been short
lived. Currently, Blockchain
has proven successful enough
that many are trying to apply
it to their firm. The success
of Blockchain has financial
services firms moving quickly
to utilize the benefits of
Blockchain and similar systems within their firms. The
financial services firms see this
as appropriating Blockchain
technology within their own
settlement transactions. These
could include items such as
remittance settlements and
mortgage settlements. There
are many nonfinancial service
related opportunities where
DOI 10.1002/jcaf

Blockchain may prove viable

and beneficial. This includes
other industries such as auditing, gambling, and authentication for event tickets and luxury goods. These opportunities
are just a few possibilities for
Blockchain. Thus, Blockchain
is a transforming technology
that chief financial officers
(CFOs) need to be aware of,
especially since its impact is
right around the corner.

CRYPTOCURRENCY
There are two basic kinds
of cyber or digital currencies.
Both are virtual currencies
but serve different purposes.
One is a pure virtual currency
normally restricted to controlled environments such as
inside of a social network or
an online game. This type of
digital currency is subject to a
centralized authority that controls the supply of the digital
currency. It can still be used to
purchase items, but normally
only within the confines of the
centralized authority. Amazon
Coins is an example of this
digital currency. This type of
digital currency does not use
a Blockchain system since the
validation is derived from
the issuing entity.
More relevant to Blockchain is cryptocurrency. This
form of digital currency is also
used to purchase items, but its
acceptance is not restricted or
controlled by a central authority. This lack of a controlling
central authority makes the currency appealing to those wishing to avoid the problems faced
by current financial institutions.
Its ability to be used as a currency is based on peer-to-peer
protocols making it secure and
virtually impossible to steal.
The most popular of these

cryptocurrencies is Bitcoin,
with over 80% of the market
capitalization and even more of
the number and value of transactions. Two others of some
interest to the topic are Litecoin
and Primecoin. However, the
one with most importance to
our topic is Bitcoin. The history
and issues around Bitcoin are
well beyond the scope of this
paper. However, it was in creating a system to make Bitcoin
trustworthy that developers created the Blockchain encryption
method that does interest us.
Bitcoin is still using the original
Blockchain to record transactions. Currently, bitcoin is still
the most used cryptocurrency
used to purchase a myriad of
goods and services with choices
of these products and services
ever expanding.
Two other cryptocurrencies that may prove relevant
for the issues within this paper
are Litecoin and Primecoin.
Litecoin is probably the second
most widely known cryptocurrency. While Litecoin is based
on the same protocol as Bitcoin, its method of validation
is designed to be much easier
to use since it uses a simpler
algorithm designed for Linux
backup systems. This simplified
approach enhances the users
ability to maintain the validation process. It also generates
a richer reward in a shorter
period, while requiring the use
of simpler resources. Most
importantly, it is able to generate blocks at a faster rate than
the system behind Bitcoin. The
simpler and quicker method for
generating a Blockchain may
make their system more valuable to others seeking to apply
Blockchains.
Primecoin also has a different protocol for proving
the validity of transactions.
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The Journal of Corporate Accounting & Finance / July/August 2016 55

Primecoin validates its transactions by finding long chains of

prime numbers, known as Cunningham chains. It also has the
advantage of generating blocks
faster than Bitcoin. Both alternative cryptocurrencies may
have Blockchain protocols that
could potentially benefit firms
trying to use Blockchain for
their endeavors more than the
Bitcoin protocols.

BLOCKS
The fundamental storage
space for information about
Bitcoin transactions is called a
block. Each block stores data
about the Bitcoin network. In
addition, each block contains
information about some or
all of the most recent Bitcoin
transactions not previously
entered in prior blocks. Thus,
a block works like a real-time
general ledger or record book.
Within each block is a permanent store of records of past
Bitcoin transactions. Once a
block is completed, it gives
way to the next block. These
blocks are joined together in a
linked chain. This relationship
led to the name Blockchain.
Importantly, a Blockchain has
the important strength that,
once written, the blocks within
the chain cannot be altered or
removed.
A Blockchain works similar
to the recording of bank transactions, with a block representing the transaction confirmations such as a deposit slip.
However, within the Bitcoin
protocol, the block not only
contains information about
the transaction but information about past transactions.
The information on the block
needs to be validated, which
in the Bitcoin protocol is done
through a process known as
2016 Wiley Periodicals, Inc.

mining. Once the block is validated, it is added to the prior

blocks. The block is a now
part of a permanent record
of transactions and now new
transactions are recorded in the
current block. Thus, the whole
system works in a cycle and the
data are permanently stored.

MINING
Bitcoin mining is the process by which transactions
are verified and added to the
public ledger, known as the
Blockchain, and the means
through which additional bitcoins are released. In essence,
it is a bookkeeping service. The
system involves individuals,
known as miners, working in a
peer-to-peer network consisting of individual nodes. Their
task is to solve a mathematical
problem associated with information on the block. Once the
winning miner solves the problem, the solution is shared with
other mining nodes as a proof
of work. The other miners then
accept this proof of work, and
the block is added to the Blockchain. This process validates
the information on the block.
The winning miner gains a
reward of additional bitcoins,
with their reward being the first
record in the next block.
Anyone with access to the
Internet and suitable hardware
can participate in mining. However, the process has evolved to
where specialized instruments
are needed to be successful
in mining at a profitable rate.
Graphics cards turned out to
be more effective at mining and
replaced standard computers.
Eventually, hardware known
as an application-specific
integrated circuit (ASIC) was
designed specifically for mining bitcoins. Mining is very

competitive, and today, it can

only be done profitably with
the latest ASICs. In fact, much
of the mining is now accomplished by organized mining
pools, where the rewards are
split proportionally.
Several important considerations about the mining process are relevant to our topic.
The number of new bitcoins
is controlled by the difficulty
of the mathematical problem.
Since new blocks are not added
to the chain until the solution
is found, there is a waiting
period for transactions to be
finally recorded. Also, due to
the Bitcoin protocol, there is a
limit of how many transactions
can be handled within a certain period. There will also be
a slowdown of the number of
bitcoins awarded in the future.
This could potentially reduce
any miners incentive to solve
these problems. These limitations will probably mean that
a necessary adjustment of the
mining process may be needed
for Blockchain to fulfill its
promise.

BLOCKCHAIN
The Wikipedia definition
of a Blockchain is: a block
chain or Blockchain is a distributed database that maintains a continuously growing
list of data records that are
hardened against tampering
and revision, even by operators of the data stores nodes.
One can view a Blockchain as a
public ledger of all transactions
that have ever been executed.
It is constantly growing as
completed blocks are added
to previous blocks, forming a
chain. Importantly, blocks are
added to the Blockchain in
a linear, chronological order.
Each miner gets a copy of the
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The Journal of Corporate Accounting & Finance / July/August 2016

Blockchain when joining the

Bitcoin network. The Blockchain they receive has complete
and accurate information about
the addresses and their balances right from the genesis
block to the most recently completed block.
Blockchain has several
advantages. First, it currently
exists as a peer-to-peer network
that has no single point of
failure. If there is a failure in
any node, the other nodes will
continue to operate, maintaining the systems availability.
Second, almost the entire documentation is digital and can be
easily applied to many different
applications. Third, all transactions on the Blockchain are visible to all its participants, with
the corresponding increase in
auditability and trust. Fourth,
changes to the Blockchain are
extremely difficult and in the
very rare case such a change
occurred, it would be visible to
the other users. These advantages of Blockchain technology will eliminate third parties,
lower transaction costs, and
cause transformation in many
industries. Clearly, Blockchain
is the crown jewel of the
Bitcoin protocol.

Blockchains Impact on
Financial Services
The area where many see
Blockchain first changing the
current financial services is the
back-office handling of transactions. When a financial institution sells a syndicated loan
or derivative, the recording of
the transaction is time consuming and involves burdensome
back-office processes. These
processes rely on negotiated
contracts with the numerous
associated lawyers and contact
between the parties to finish
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the transaction. On average,

it can take 20 days to settle a
syndicated loan trade. These
back-end activities are also
costly to the financial institutions. This is in contrast to the
front-end systems at financial
institutions, where millions are
spent to achieve a nanosecond
of competitive advantage. In
addition, financial institutions,
due to regulatory requirements
such as Dodd-Frank, are dealing with greater requirements
for reporting, transparency,
and dissemination of data.
They need a technological
breakthrough to help solve
these problems. Blockchain can
be the breakthrough that can
streamline these financial transactions. There are estimates
that Blockchain could save
financial institutions at least
$20 billion annually in settlement, regulatory, and crossborder payment costs.
Given this opportunity to
replace the back-end systems,
there are many firms and organizations using Blockchain
hoping to be the one to solve
these problems. For example,
R3, a Blockchain start-up,
is offering a Blockchain as a
Service (BaaS) that already
involves such members as
Barclays, BMO Financial
Group, Credit Suisse, Commonwealth Bank of Australia,
HSBC, Natixis, Royal Bank
of Scotland, TD Bank, UBS,
UniCredit, and Wells Fargo.
R3 hopes to execute financial
transactions instantaneously
across the global private network. The banks will simulate the financial transaction
exchange values by using
tokenized assets on the distributed ledger, using Blockchain
protocols. As another example,
Coinbase, a major firm dealing with bitcoin transactions,

has created a bitcoin debit

card. Using the Blockchain
protocols, the debit card will
be the first step in recoding
the transactions straight to a
Blockchain, avoiding most of
the back-end costs. Further,
Goldman Sachs is investing
in the start-up Circle Internet
Financial, which it hopes will
provide a better back-end system based on Blockchain. This
system should provide greater
ease of use in online and inperson payments, along with
enhanced security and privacy
for consumers. They are also in
the process of creating a digital
currency for their own needs.
UBS is using its London-based
Level39 to develop means to
use Blockchain to improve
their financial service needs.
Sand Hill Road, a start-up
dedicated to becoming the new
Wall Street, is creating several
Blockchain initiatives dedicated
to take advantage of the benefits of Blockchain. Probably
the most developed financial
service using a Blockchain system is Ripple. It offers a means
to make simpler and faster
cross-border payments using
a distributed approach to the
global network. Thus, financial
institutions now have real-time
delivery with certainty for every
settlement, resulting in the lowest total cost for any transaction. These are just a few of the
many firms involved in making
changes to the financial markets using Blockchain. Venture
capitalists have eagerly invested
over 500 billion in over 100
start-ups in the past year, and
projections are even higher for
this year. Clearly, using Blockchain to change the financial
system will only grow.
At the organizational level,
there are several ventures building on the Blockchain. Nasdaq
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The Journal of Corporate Accounting & Finance / July/August 2016 57

is working with private companies such as Chain to use

the Blockchain to issue and
transfer the equity shares of
closely held companies on the
exchanges private marketplace.
Their plan is for Blockchain to
replace the current paper certificates system, with a lowering
of cost and a gain in speed of
having the initial public offering. Clearly, there will be many
beneficial outcomes from all
these efforts. CFOs and financial executives need to be following these firms efforts to
stay competitive.

BLOCKCHAIN 2.0
Within this category are the
many ideas that firms are developing to utilize the benefits of
Blockchain outside of financial
services. Since many are only
nominally connected to Bitcoin
protocol, the term Blockchain
2.0 is used to group these ideas
together. IBM has introduced
a protocol for smart contracts

that is based on the underlying

Blockchain technology. IBM is
also trying to get the same technology to work with currencies
besides Bitcoin. Another area
that stands to benefit from
Blockchains is the auditing
profession. Using a Blockchain
the accounting entries between
two trading partners can easily
be compared while maintaining data privacy. This solution
could significantly reduce the
reliance on auditors for testing
financial transactions.
Blockchains are being
examined as a means for handling loyalty-points programs.
Others are examining Blockchains as being an effective
way to validate information
about luxury goods. Similarly,
vendors of tickets to events are
looking at using Blockchains
to help prevent fraud. The
health care sector will be a big
user of Blockchains. Storing
patient data securely and accurately is a major concern of
all health care providers. It is

strongly possible that the public sector will become a large

user of Blockchains. Several
municipalities are looking at
Blockchains for recoding
property transactions. Other
municipalities are examining
using Blockchains for tamperproof voting records and vehicle registries.
There are so many others
that this short discussion
about possible Blockchain
applications is just a starting
point. In this article, we
have tried to provide some
information about a technology that will soon have major
impacts on your firm. Two
suggested places for additional
information are a paper from
Deloitte (http://deloitte.wsj
.com/cfo/2016/02/26/beyondbitcoin-blockchain-is-comingto-disrupt-your-industryweekend-reading/tab/print/)
and the book The Age of Cryptocurrency by Paul Viga and
Michael J. Casey (St. Martins
Press, 2015).

Kurt Fanning, PhD, CPA, CMA, CIA, CISA, is a Professor at Grand Valley State University. Kurt has
written articles for publication in scholarly journals such as the International Journal of Intelligent Systems in Accounting, Finance and Management, Accounting, Journal of Corporate Accounting & Finance,
New Review of Applied Expert Systems and Emerging Technologies, and Financial Studies Journal. His
primary teaching and research interests are in management fraud and accounting information systems.
David P. Centers, MBA, is an Accounting Instructor at Grand Valley State University. Previously, he worked
in governmental, industrial, and not-for-profit companies as an auditor, plant controller, and controller.

2016 Wiley Periodicals, Inc.

DOI 10.1002/jcaf