Audits on the Blockchain

Tuesday, March 20, 2018 · 5 min read

Here is how blockchain technology could offer transparent audits of transactions with various use cases and end-user benefits.

au·dit (verb)

conduct an official examination (of an individual’s or organization’s records).

Checking the Math

Audits are exercises in checking the math. Blockchains can make this an open and verifiable process, unlocking a lot of value and time.

Blockchain technology creates a distributed, open ledger that contains a record of all transactions and transformations to the chain over time. The rules are also out in the open so that we can know the process by which a transaction is confirmed and legitimate without needing to trust any of the parties.

If I keep a copy of the network’s ledger, and diligently check everyone’s math, I can be sure that everyone played by the rules when conducting their transactions.

For this kind of network to work there has to be value in playing by the rules, being a referee, and in the ability to audit all players. Users will come to these kinds of networks because of the utility they provide. Whether the rules are worth agreeing to will be a function of that value the network unlocks for its users.

Bitcoin and its blockchain so far have been valuable to any number of people as a digital, auditable record of exchange. If users play by the rules, they can confirm that a digital asset has changed owners. Miners act as independent auditors because they get a cut of each transaction they confirm first and broadcast to the network.

Everyone gets a copy of the updated ledger, and can then conduct an audit for themselves, verifying that the asset did change hands. The innovation of the blockchain is that when you conduct the audit, you don’t have to trust any of the parties. If you run the numbers, you can know they all played by the rules.

Basic digital transfers are only the first of many uses for such an open and auditable system.

Audits Today

Our current systems of audit are fundamentally opposite the kind of radical transparency offered by the blockchain. We offload most of the process to centralized third-parties, giving them our implicit trust.

In a typical month, an average individual in America will trust thousands of such organizations.

When she gets a medical bill with deductions from her insurance, she trusts that the numbers are correct. To pay the bill with her credit card or checking account, she trusts a huge network of entities to transfer and confirm the transaction.

All of her utilities are run by centralized third-parties. She trusts that the meters that measure her water, electricity usage and gas, and the various prices quoted by her energy company are correct and accurate.

Her access to wireless networks for her cell phone and wired networks for her internet connection are set by various carriers.

When she buys a piece of clothing, she trusts that the workers were paid a fair wage in humane working conditions.

At work, the process that govern her payroll, 401k investments and healthcare are handled by vendors.

When she pays her taxes, she assumes the money for Social Security, Medicare and her state and city taxes are filled, stored and dispensed with correctly.

All of the records of her savings and investments are kept by third parties.

When she logs on to any website, she trusts them with her data and privacy.

We outsource the audits of all of these processes to accountants, lawyers and civil servants. We trust these individuals to check the math for us, and to apply just penalties for breaking the rules.

It works until it doesn’t.¹²³⁴

We live in a state of suspended belief, trusting these systems implicitly. As individuals, there is little opportunity for us to verify our trust in the institutions and organizations we rely on.

Audits Tomorrow

All of this offers a classic opportunity.

Compare any of the typical third-parties that you trust on a day-to-day basis. Would an auditable record of their actions be useful?

For example, it could be useful to know that your utilities are coming at a fair price. Or exactly how your tax payments are being used. Or where a public company is spending their money.

Moving any of these services to a blockchain model allows this kind of radical transparency. Software to analyze and report on transactions on a blockchain would give individuals the ability to audit the network, verifying that everyone plays by the rules.

We may find that our trust in some organizations is misplaced. It is possible, even likely, that many of these third-parties are cheating the current system.

Far superior products are coming to market that offer open and honest records of business. The utility of the distributed, record, available for anyone to audit and confirm is only in its beginning stages.

Expect to see many more interesting use cases as the technology matures.