It won’t be an exaggeration to think that blockchain is a game changer for auditing. For quite some time, it has evolved beyond just being a social buzzword. Quite obviously, many people have described it as a cultural paradigm shift. It would be quite interesting to see the impact blockchain technology will have on traditional audit and assurance processes.
We will discuss this in this blog in detail. We will dwell more on the effects of blockchain on auditing.
So, let’s get started.
What is Blockchain?
In its most basic form, a blockchain is a distributed ledger that stores the pertinent data for every transaction that has ever been executed. There is no central administration in blockchain; anybody may execute transactions using the computing power of specialized gear (nodes/miners) and get a bitcoin reward for doing so. Digital signatures ensure the legitimacy and authenticity of each transaction (cryptography).
The last few years have witnessed an exponential increase in the value of cryptocurrencies. You might have read a lot about this technology as the internet is flooded with information about blockchain. Many crypto enthusiasts have speculated that this technology will revolutionize a wide range of domains: with banking, real estate, financial services, and social media being some of the most prominent sectors benefiting from this technology. An audit is no exception; the rise of blockchain technology has ushered several potential advantages in the auditing process.
Bright Prospects That Blockchain Technology Has Brought to the Audit Process
Talking in terms of design, blockchains are inherently resistant to data alteration. A blockchain can function as an open, distributed ledger that records transactions between two parties efficiently, verifiable, and permanently. We can also use it as a source of verifying the reported transactions.
Let’s give an example of this. Instead of requesting client bank statements or submitting confirmation requests to third parties, blockchain security auditors may quickly check transactions on publicly accessible blockchain ledgers such as http://www.blockchain.info or http://www.blockexplorer.com. Automating this verification procedure will result in cost savings in the audit environment.
The days of sample-based substantive testing will soon be over, as auditors will use blockchain technology to evaluate the whole population of transactions over the observation time. This broad coverage will significantly boost the degree of assurance obtained in affected audit engagements.
A transaction of low value now takes around 10 minutes to validate in the blockchain since a single block verification is deemed suitable. The more blocks that pass before a transaction are considered validated, i.e., the lower the chain, the more immutable the connected transactions are. A high-value transaction will typically take around an hour to verify (6 blocks).
In typical financial transactions, information might take up to a month or more to be cleared. This blockchain feature of pseudo-real-time verification may influence the audit process. Instead of performing year-end (or interim) evaluations, blockchain audit firms can undertake continuous on-line assessments throughout the audit period.
We envisage that when we reach the end of this blockchain road, we will be able to see automated audits become a reality.
As the coin has two sides, even blockchain technology has a flip side. Let us now discuss some of the challenges it has introduced to auditing.
Challenges That Blockchain Has Brought To The Audit Process
Blockchain indeed promises highly secure transactions. However, there are ample fraud instances that cannot be fully eradicated. Most of the hacks happen when the security of smart contracts is compromised. This is why there are so many hacks almost every day, where hackers exploit the vulnerabilities and turn them into expensive exploits. Thus, going for smart contract auditing can save you from losing your funds.
The day-to-day security breaches point to the fact that the adoption of blockchain depends on the security of the underlying environment. To achieve the requisite level of assurance, audit processes must shift more toward assessing the operational efficacy of internal IT controls.
Let’s give some examples:
- If an entity’s employee transmits bitcoin to an incorrect or unauthorized address (receiver), there is presently no method to reverse such a transaction. As a result, auditors must determine if adequate automated controls are in place to check transactions before they are conducted.
- Because there is no central administration in blockchain, there is no fraud department to which an entity may report a phishing attack. This circumstance might potentially lead to the possibility of fraud. When confronted with such a risk, auditors must establish if internal controls to prevent and detect phishing assaults are effective.
- If a private key is lost, the entity loses access to any virtual money connected with that private key. These bitcoins will no longer be accessible to anybody on the bitcoin network; they will effectively be out of circulation indefinitely. Effective disaster recovery methods and backup and restoration protocols would aid in avoiding such scenarios. Such loss mitigation methods are also anticipated to be evaluated in order to determine if controls that address blockchain risks can be relied on.
We have seen an exponential trend towards a digital world with the spread of the internet over the previous few decades. Blockchain technology is expected to be the next phase in this progression.
While the blockchain concept appears to be secure, the blockchain ecosystem is nevertheless vulnerable to many technological dangers. The benefits of audit automation will almost certainly be offset by the need for new processes to manage the risks connected with the blockchain ecosystem.
These advances are expected to form a blockchain audit in which IT controls will play a larger role in giving reasonable confidence that the financial statements as a whole are free of substantial misstatement.