Ramifications of Open Source Accounting

Transcript

[Music] thank you all right hello everybody my name is Eric Brown I'm the co-founder and CEO at Franklin payroll and today I'll be talking about the ramifications of Open Source accounting so why would a talk on accounting be included in the blockchain for public goods track it seems like it could be a business-centric niche topic that's a little bit better fit for startups are investing but there's an important reason here accounting is a discipline that sits below our economies and runs like a

stream to keep everything going it's similar to the code that sits beneath our applications when it runs smoothly is without bugs and is in a sturdy execution environment we can use our apps and other Technologies with ease we can abstract away the how of things working and understand the app's core usefulness and utility the same goes with accounting when the books are balanced and entries in the journal are made properly we can have confidence that our economic systems and other Technologies are built on a solid foundation and that we have all the necessary information to grow in a stable manner but we have seen this go wrong time and time again in the broader economy as well as within our own web3 ecosystem so that's why we're here to discuss the

topic today we'll take a look at some of the biggest accounting frauds that have happened in recent memory along with their impact to set the stage so we could send uh all day talking about some of the biggest and most varied accounting scandals in recent memory but here are a couple of highlights the wire card fraud was reported back in 2015 and it took us about until 2020 to fully understand and unfold the full accounting fraud and there still unfortunately continues to be loose ends from The Fallout they were a german-based payment processor that essentially inflated their revenue and acted as a very efficient money laundering operation after years of audit and investigation it was determined that they had 1.9 billion pounds missing from their

balance sheet that probably never existed in the first place they're eventually dismantled and partially sold off to Santander after that we have this interesting case from Tyson Foods between 2016 and 2020 a rancher in Oregon started selling cattle to Tyson Foods the only problem was the cattle didn't exist he extracted about 224 million dollars from Tyson who clearly did not have proper accounting for their invoicing delivery and supply chain of this vendor uh unfortunately we're much more familiar with Celsius and FTX and those accounting frauds many people within our ecosystem are still dealing with the Fallout from this and we're harmed by

this fraud to note three of the four cases here the accounting fraud was exposed by journalists not by their their accounting firms reporters who started to line up the financials that were publicly available and compared that against the statements made by leadership the average users of these former Services would have had to have combed through piles of data and spent months trying to understand that this accounting fraud was actually happening or by gaining access to non-public information so open source accounting what is it and how can it help us open source accounting are tools for financial record-keeping and Analysis and a framework which defines the treatment of assets liabilities and

equity we have the second part of this the rules are relatively transparent in the United States there's Gap the generally accepted accounting principles and in Europe and much of the rest of the world there's the international financial reporting standard also known as IFRS on the technology side we are lacking however most businesses use tools like QuickBooks or xero for their record keeping the importance of these systems is to generate reports that follow those common standards that are laid out in gaap or IFRS but presently the only way to check that these reports are being generated correctly is for companies to hire audit firms to essentially double check those reports and you know time consuming in the alignment of these exercises completely

off an auditing firm doesn't verify every transaction they're only looking at a test of sample transactions that may or may not be representative of the larger book of business for that organization and auditing firms are also paid by the very entities that they're supposed to be keeping in check there's unfortunately a lot of examples of auditing firms that decided not to bite the hand that fed them not every company is required or can't even afford to go through a financial audit which is another problem in this space so we kind of have to take their financial statements at their word the components of Open Source accounting tools are that they're rent free modifiable and transparent while it seems like accounting in web 3 should be easy since all the transactions should

be readable on a public blockchain what's missing is the analysis part of the equation there are unclear counterparties on and off ramping lacks transparency and the categorization of different assets are unclear this is exacerbated by the fact that gaap and IFRS have not yet created guidance on the crypto landscape about how crypto assets should be reported on in alignment with the Fiat economy there have been a couple solutions that have been proposed so far by the space for open source accounting one of which is probably the oldest called triple entry bookkeeping which is supposed to be an improvement on our traditional double entry system in our current double entry system each transaction has two entries against it

in record keeping software a debit and a credit with a triple entry a third entry is added to each transaction which is meant to link and verify those two entries together in a sense to seal them you can kind of think of it like a financial transaction hash triple entry bookkeeping is uh still quite conceptual there are not to our knowledge any triple entry accounting softwares in operation today they're difficult to deal with because they don't have a method for marrying crypto and Fiat transactions together into a single report there are also no Auditors out there that we know of that audit triple entry books so as a result this solution lacks a practical application

the other most popular open source proposal that we've seen take off in the past year so LED primarily by binance is proof of Reserves this is a public attestation usually used by a crypto exchange that shows the wallets owned by exchanges which custody users funds The Exchange might sign a transaction in each wallet to prove ownership of these of these wallets and the funds within them this method is obviously flawed right it only shows one portion of the assets on the balance sheet we're missing the other assets involved including liabilities and equity so it's not providing us with a full picture taking a look at binance's proof of reserves so this is a snapshot of their website from March 1st of 2023. the full

list contains only a list of 24 assets it doesn't link to wallets directly so in order for us to verify this list we need to be able to toggle back and forth between the report that binance published etherscan to find a list of balances verified or binance's verified wallets and their balances in our own spreadsheet to calculate the conversion price and the balance at the time of the snapshot that they provided us with this is also an attestation that is voluntary and there's no requirement to do it or to do it regularly at best it helps exchanges avoid a liquidity crisis by instilling a sense of confidence in their users but it's not helping with understanding the efficiency longevity or health of the organization

so how can we think about creating a report that is easily readable transparent and accountable Current financial statements fall short in telling the full story of crypto assets the main financial statements that companies produce are balance sheets which show assets versus their liabilities and Equity this is a point in time report that is meant to show the full value of a company they also produce income statements or profit and loss statements which show their revenue against their expenses indicating the profitability of the organization and that's a period in time report lastly they produce a statement of cash flows which shows the differences imbalances between asset accounts essentially how much money is going in and out of an organization at any given point in time

we would like to propose a new type of financial statement called the statement of crypto flows which not only shows the inflows and outflows of crypto from a company's wallet or exchange but also the fluctuations in price something that is not currently captured well in standard financial statements our calculations only done around tax time to calculate the capital gains and losses this is something that would be captured in the statement of crypto flows which is tracking the change in price over the various periods that are reported on the statement of crypto flows would also be organized by asset rather than listed out by wallet or exchange to give a better picture of the Holdings of the asset across the firm as it's all held in a single place opposed to being across many different entries

but one thing that this doesn't account for is the first part having the right tools for record-keeping and Analysis IT addresses the second part of Open Source accounting that we reviewed earlier so to understand the tools of Open Source accounting that we need to kind of complete this picture on the crypto side of the things we have many of the ingredients needed to assemble this report available to us on the internet many people are familiar with price feeds and block explorers especially if they've done crypto bookkeeping or their own taxes along with many other tax preparers accounting services would like to see crypto exchanges move towards standardizing their reporting outputs this enables those who need that information removing the present day requirement to do complex data Transformations on those reports and finally we're happy to share our

template of the statement of crypto flows for public use it's a simple report that any company their investors customers or other stakeholders can use to get a better picture of the organization's Financial Health we'll link it on Twitter later today thank you very much I guess questions we have time foreign could you just say something more about your organization and how are you promoting these kind of approaches standards I I celebrate this by the way I'm guilty of being a financial analyst myself and just thinking what are we doing we have so much a great opportunity here so I want to hear more

about what you're up to thanks yeah thank you for the question so I work at Franklin we're a crypto payroll company so we make it a crypto enabled we make it possible to run payroll both in cash and crypto so we'll manage all the complexities around your reporting managing your taxes filing paying the IRS as well as any you know other HR tools that you need to have around your payroll services and so for us accounting and compliance is of utmost importance and so as we've seen some of these things happen in our own industry and of course we're aware with the accounting frauds that have happened elsewhere we're very mindful about how can we help move this space forward not only for our own customers to ensure that they have a full picture of their

Financial Health but for the industry as a whole to ensure that everybody's reporting on a common standard and right now we lack that I mean hi Malisha from streamflow we help Webster teams with talk investing and also crypto native real-time payroll but as you said like taxes compliance and accounting is a big big part of it and I just want to kind of add on to um this guy's question I didn't hear your name sorry but it's more of a like um philosophical question is like how do you see the standardization of this because you do it for your for one jurisdiction or I don't know maybe United States if I figure it out but how do you see this

actually getting implemented throughout the world and becoming some sort of a standard right yeah of course I think really similar to how the rest of the crypto space has evolved is there needs to be a open source discussion around it right so this is a way that we can put forward a methodology that we believe will help improve the current state of affairs of accounting and open source accounting and so of course we highly encourage discussion to be engaged around this as a community to see ways that we can further improve on it in ways that it can marry well both with gaap and IFRS standards so that it's comprehensive globally not just within U.S jurisdictions or european jurisdictions but is a comprehensive solution hi uh Jason thanks for the talk um you you set up the problem really

well um you're you're sorry to be a troublemaker but you didn't solve it Your solution was um we're gonna have this statement of crypto assets shaping of crypto flows something like that um but that doesn't get you an income statement and so my question to you is how does an income statement come about because it's not going to be from that to develop an income statement you're gonna have to tag every transaction yeah so this is a piece of the puzzle of course and I think that with tagging every single transaction you know there is the benefit of these transactions all being publicly Unchained a conversation I was having earlier though is that they're still going to need to be humans involved in this process of tagging all

the information together right and while we have a lot of that information publicly available via the blockchain that publicly available information and those transactions don't include all of that information and so this is one way to understand the crypto inflows and outflows of these organizations thinking about exchanges posting proof of reserves we believe that this is a way to better report on that and provide more information there but like you mentioned it's just one of the financial statements that is going to be included and so to make all these financial statements more robust and inclusive with crypto there's going to be you know further steps that need to be taken yeah just to build on this it seems like it's going to need solutions that are engineered at the contract level right because if you have a conversation about

the way that activity needs to be structured in order to create faithful reporting then in principle that can be automated but this seems to be like problem that is sitting at a completely different order of concern than where devs and Engineers are currently focused at at the moment um so anyway just just to build on this I I want to see movement on it but it seems like um yeah it's it's a concern that sits at a very different level at this point yeah definitely I think when you think of making this more automated of course developers are going to need to get involved uh I think that there could be some interesting standards developed about how certain Financial smart contracts are emitting events and Reporting on the events that are happening within those contracts that

are more descriptive than the financial transaction that you see on chain that just shows the flow of funds you could have events being emitted that under give you a better sense of where those funds are moving along the way and give more complex information about what that transaction was doing on chain of course that would require a standard maybe it'd be an interesting uh non-technical EIP about implementing Financial smart contracts great thank you [Applause] [Music]