In this article, we explain the problems that managing financial data face and how blockchain is improving the world of finance.
Keeping financial records is a messy, complicated, and expensive nightmare. However, it is essential to keep these financial records in order for a global economy to function as they explain the value and success of the business.
The bulk of financial records are, nevertheless, redundant but still require onerous paperwork. Not only is this tedious, but it is also expensive human labor, and those costs often end up being the customer’s responsibility.
Blockchain technology is offering solutions to many of these problems. The technology that was originally designed for Bitcoin is now being put into use in the traditional financial world.
Inefficiencies Inherent in Financial Systems
The central problems that traditional financial systems face, which are problems that blockchain technology is able to fix are as follows:
- Antiquated: Financial records are still primarily physical paper. One reason is the current laws regarding confidentiality. However, this is a cumbersome and expensive process.
- Solution: Blockchain is an encrypted public ledger that keeps track of all changes made to contracts and transactions.
- Centralized: Financial systems are primarily centralized, as they are large banks and government factions. The reason for this is because when it comes to making deals and lending money, we rely on trusted third-party intermediaries. The problem is that centralized systems are insular, which means transparency is low, and these groups are slow to change.
- Solution: Blockchains are built on decentralized or partially decentralized networks of computers.
- Blockchains are also built to store any kind of document. That means records are public and encrypted, so they cannot be surreptitiously changed. All changes are recorded on the blockchain.
- Moreover, because blockchain uses consensus mechanisms and encryption, peer-to-peer operations are now perfectly safe.
- Exclusionary: Banks and governments are exclusionary, in fact, there are billions of unbanked people in the world. The reasons for this vary, but for many, it is an issue of wealth and physical access. If you do not have enough money some banks will not let you open an account. Or if you are too far from the physical bank, you may not be able to access it at all.
- Solution: Blockchain technology has seen the invention of many cryptocurrencies and micro-loans, primarily in the developing world. With only a cell-phone individuals are able to safely open bank accounts and make peer-to-peer digital transactions.
In order for global commerce to take place, companies and entrepreneurs need to be able to prove that they are fiscally viable and responsible entities. To do so, we require financial institutions and government policies to set the standards of success and responsibility and to maintain and enforce them.
Whether a company (or an individual) is starting up or expanding, banks need adequate reliable data to demonstrate that this is a good investment. This requires intelligent estimates which are based on data; such as the company’s cash-flow and stock value or price.
Moreover, valuations are based on comparisons between different companies. Although this seems like a reasonable process, it is important to recognize that this is a classic case of comparing apples and oranges. Different companies do not necessarily use the same metrics for accounting. This creates a problem, as it may mean that comparing two different companies is meaningless, as the values are subject to different standards.
People and Paperwork
Yet another problem with gathering all of the necessary financial data, is that it is based on paperwork kept by the company and banks. And this paperwork is far from perfect.
Corporate financial statements should read like a clear ledger of numbers and transactions. However, they are often based on estimates and personal judgments that may be very inaccurate. That is, not only does each individual company decide how to keep its own records, they can decide to “cook the books”; as it is commonly referred to. This is a real-life problem, as managers receive incentives that have been known to interfere with accurate record keeping.
In fact, this is just what happened with Enron, and what inspired the Sarbanes-Oxley Regulations. Six years later, the 2008 financial collapse in the US leads to Dodd-Frank regulation. Both are regulations that responded to problems in financial accounting. The problem remains, that when records are not public or easily changed, companies can make themselves seem more valuable. Moreover, transparency and record-keeping have their own issues.
Business with Blockchain
Blockchain platforms are proving ideal for: making and keeping contracts, storing records of transactions, and peer-to-peer trustless transactions.
Because blockchain uses ‘smart-contracts’, contracts are fulfilled with a unique code. The transactions are encrypted and so made securely. Smart-contracts are electronic contracts; that meant they are only fulfilled once all of the conditions of the contract are confirmed. If the code is incomplete or unsatisfied, the transaction is unfulfilled.
The first successful application of blockchain was in 2008 with the creation of the first cryptocurrency Bitcoin. Bitcoins are simply strings of encryption, stored on a public ledger. That means that Bitcoin balances and transactions are public, but all personal information is private because the information is encrypted.
Encrypted transactions are the bread and butter of blockchain technology. Because with blockchain private information can be stored safely on an immutable public record. This makes blockchain ideal for storing records, and countries like Estonia have already moved to a fully digital bureaucracy.
That means that blockchain is ideal for storing money, equity, bonds, titles, deeds, contracts, and essentially anything of value. And because the information is encrypted and stored on multiple networks, theft of property and fraud are much less likely. This is especially good news for consumers, as the cost of economic and identity crimes typically end-up the burden of the consumer, rather than that of the company.
How Does Automation Help?
- Machines can work much faster than any human. This means algorithmic trading and machine learning are far better at making rapid decisions. Automation also reduces manual errors. Finally, algorithmic trading also takes into account news, social media, weather, and anything else that may affect the value of an asset.
- Machine learning means that computers are able to learn from successes and errors and improve on their own. This increases the potential for accuracy, as it once again removes human errors as well as specific biases.
- The more data that machines have the better they are able to perform. This includes stock market trades, which rely on accurate financial records.
The increase in data collection has also changed the face of the financial industry, improving accuracy through automation. At present, 2.5 quintillion bytes of data are produced daily. Although not all of the information is strictly financial, a large portion influences the way the market moves.
Big data is applied to algorithmic trading. Algorithmic trading is an automated trading process that is able to apply aggregate data to make market decisions within seconds. This bears on the blockchain, as it demonstrates yet another way that information is collected through automation. When it comes to financing, automation is key to avoiding human error, emotional decision making, and deliberately manipulating the numbers.
The important thing to take away is that finance and trading are vastly improved through automation.
Find out more about data in today’s financial world with our article: GDPR Takes on Blockchain
Problems with Traditional Analytics
Although many are open to improving the systems we have, others maintain the attitude that -if it ain’t broke, don’t fix it.
However, blockchain continues to demonstrate its strength as a financial tool, not only for cryptocurrencies but also for greater transaction transparency and efficiency. Moreover, as technology demonstrates its strengths, it also highlights the many weaknesses of our current method of financial record keeping.
The world of financial data is far from an opaque, quantitative study. In fact, it is fraught with problems. Many of the problems are due to the way that numbers are crunched, and how records are stored.
Issue #1: Lack of Universal Standards
Although many countries have moved to accept standardized financial record keeping practices, this has not proved to be as successful as initially thought. Two prime examples are the installation of GAAP and IFRS. Generally Accepted Accounting Principles (GAAP) is the typical standard of the United States. While the International Financial Reporting Standards (IFRS) is that of European countries.
By 2005, all public companies in the European Union had, essentially, abandoned their local accounting standards for IFRS. And today, at least 110 countries around the world use the system in one form or another.
However, the two systems do not share the same metrics. So, we are once again faced with the problem of comparing apples and oranges. What is more, it is still an optional standard, and countries such as China and India have developed their own versions of GAAP metric.
So, setting a universal standard for financial data is much harder than one might think.
Issue #2: Revenue Recognition
Revenue recognition is yet another challenge for proving the value and profitability of a company. This is particularly true of companies that deal with intangible services, such as social media. It is also true of companies that sell contracts and subscriptions, such as cell phone or internet providers.
Given the growth of tech and social media, these metrics have shifted, however, it still means that using quantitative data to make estimates is tricky. Thus the value of a company is based on current profits, debt, and future profits and debt. And for new tech projects, these projects prove to be difficult to accurately predict.
Issue #3: Unofficial Earnings Measurements
Earnings are measured with estimations that rely on earnings before taxes, interest, depreciation, and amortization. However, the truth is, this is all very subjective and idiosyncratic. When a company is measuring earnings it may be in their interest to leave room for discrepancies, in order to look like they are more valuable to shareholders, or less valuable for taxation purposes.
Again, it all comes down to what is being measured, and what kind of actuarial formulas are applied.
Enron is a classic example of this kind of market deception and total failure. Enron was an energy company based in Texas and holds the record for the largest bankruptcy in history in 2001. It was through corporate deceptions and report manipulation that the company inflated its value. And Enron went from shares at $90 to $1 over the course of a day, once the truth of their financials came out.
Issue #4: Fair Trade Accounting Standards
“Fair trade” is a term used which expresses the value of something based on 1) the original price of the company and 2) how much it would sell for at the time of appraisal.
This is yet another value that is difficult to standardize, as differences arise when comparing and assessing tradable securities, with intangibles such as reputation, patents, earn-out agreements, and research and development projects.
Even if all of these could be easily quantified, the reports would be of unknown length with a plethora of formulas to explain how these valuations were arrived at. That means that manually assessing such reports would be far too time-consuming for real life.
Issue #5: The Process of Cooking the Books
As has been made clear, while we want to believe that financial reports are built on clear formulas and numbers, they are not. Financial reports are devised using unique and sometimes unscrupulous measurements. Regulations have increased over the past 25 years, which has made financial records far more difficult to manipulate.
Nevertheless, reports still rely on corporate decision making that serves the interest of short-term reporting. As a result, the long-term performance of a company becomes less of a concern.
The Unbanked and Potential for Financial Inclusion
With the nearly 2 billion unbanked people in the world, it stands to reason that the world of money needs a facelift -something that Bitcoin and similar cryptocurrencies can offer.
Developments in FinTech applications have improved access in many ways which include:
- cashless digital transactions
- the advent of low-fee transactions and Robo-advisors
- the rise of crowdfunding and peer-to-peer transactions (P2P) or social lending
Currently, the World Bank estimates that there are nearly 2 billion unbanked people worldwide. That means that nearly one-quarter of the world’s population does not have a bank account. As a result, these people have very limited potential for financial success.
Because cryptocurrencies take on so many financial problems caused by accessibility and concerns about trust, Bitcoin and similar cryptocurrencies, are creating new wealth. Because of financial technologies and digital currencies, those who do not currently meet the necessary requirements to hold a bank account cannot fully participate in the local or global economies.
Bluzelle is an excellent example of financial technology and data collection. Bluzelle enables Dapps (decentralized applications) to function on the blockchain platform. Using apps such as this Bluzelle, companies are able to store data safely, without fear of hackers or theft.
Because Bluzelle is built on blockchain, it offers instant global coverage and continues to expand its scope. Presently they offer services in North America, Europe, and Asia, and are expanding to Africa, South America, and Australia.
Data servers are decentralized, like Bitcoin, which means that Bluezelle uses crowd-sourced developers. This increases network security and international scalability, as it is network inclusive, while it still applies the same secure encryption and consensus mechanisms of other blockchain applications.
The potential that blockchain’s cryptographic ledger offers financial data systems has been recognized. Not just by new start-ups, but by big names such as Microsoft’s Azure Blockchain, and Starbucks.
Blockchain and tokenization have also made possible new ventures with the use of ICO (initial coin offering), which essentially replace IPOs. ICOs allow individuals to invest in projects directly, as well as help with capital and liquidity.
Blockchain Capital, one of the industry’s largest investors, raised funds by issuing tokens by ICO, which was a first for the traditional industry. Companies such as Goldman Sachs, NASDAQ, Inc., and Intercontinental Exchange, the American holding company that owns the New York Stock Exchange, have all been among the largest investors in blockchain ventures.
The potential that blockchain offers have even gotten the attention of the US Congress. In 2020 released 32 Bills all dealing with blockchain development.
Blockchain can keep track of any kind of documentation and works as an immutable ledger. As such, it is ideal for managing financial data. This in turn creates greater reliability and transparency. If records are kept on the blockchain, there are also records of transactions and addendums.
Moreover, with the increasing applicability of machine analysis and algorithmic trading, blockchain makes room for improved data not just for the future of individual companies, but for the broader financial world.
How Does Blockchain Work
To learn more about how blockchain technology works check out the following articles on the blog: