How to Value Distributed Ledgers
by Sean Stein Smith, CPA, Lehman College –
April 4, 2019
The distributed ledger and blockchain boom has changed what CPAs need to know. CPAs are well positioned to not only leverage distributed ledger technology themselves, but to also assist in the valuation and reporting of these ledger systems.
While cryptocurrencies likely led the interest in and development of the broader blockchain environment, the practitioner conversation has shifted more toward the underlying technology itself. No matter where an organization or its clients are located, blockchain choices and options continue to play a prominent role in professional conversations. While blockchain itself, and the distributed ledger technology that drives blockchain functionality, can be presented as if they are equivalent, that is an incomplete view. Prior to a deep dive into different blockchain models, and a discussion of valuation considerations for distributed ledgers, it seems appropriate to differentiate between blockchain and distributed ledger technology.
Distributed Ledger v. Blockchain
Blockchain may receive the buzz and recent inflows of investment dollars, but the underlying distributed ledger technology (DLT) is not necessarily a new development. Put simply, a distributed ledger is a database that exists across multiple platforms or among multiple network participants. As opposed to a centralized database structure, which creates a single point of failure and target for hacking attempts, a distributed ledger spreads the risk, liability and responsibility for data integrity across network members. Blockchain represents a unique interpretation of a distributed ledger system via the blocks of transactional information that, in turn, form the blockchain. Additionally, the options in terms of data encryption — including the currently unhackable Proof of Work protocol on the bitcoin blockchain — differentiate blockchain from other distributed ledgers. Put simply, blockchain is a version of DLT that places security and encryption at the core of the entire ecosystem versus treating it simply as an add-on or patch to be added at a later stage.
As practitioners are seeking to obtain a better handle on how to value and implement blockchains, it’s important to understand the two types of blockchains.
The idea of a public blockchain is the closest to the completely decentralized and distributed ledger that lies at the core of the blockchain ecosystem. Current market examples of public blockchains include the bitcoin blockchain and the ethereum blockchain, which are maintained by a core group of programmers but are free for anyone to search and/or join. From an enterprise perspective, however, these types of models might not be as appropriate as other models outlined below. The reasons why these options might not work as effectively include the lack of testing ability on a public blockchain before going live with an application, contending with proof-of-work consensus validation — which is energy and power intensive — and the concerns that public models are too closely affiliated with volatile cryptocurrencies.
Contrasted with the decentralized and distributed system such as those utilized by bitcoin and ethereum, a private blockchain seems closer to a traditional enterprise database than a decentralized and distributed ledger. Implemented by several large organizations, a private blockchain model has achieved success and adoption in various areas of the marketplace. In essence, a private blockchain or DLT allows for greater efficiencies and cost savings to be achieved, since the consensus-based model of approval necessary for data to be validated is not usually as energy intensive as the proof-of-work model employed by public blockchain options. While the greater transparency and identification of network members may reduce some of the anonymity prized by initial blockchain adopters, the enterprise applications of such a distributed ledger model are clear. Returning to the marketplace, the blockchain implemented by Walmart is a private blockchain model.
A consortium model of blockchain seems to be the most applicable for industry- or sector-specific blockchain applications, including a joint venture underway between the Big 4 and a group of approximately 20 Taiwanese banks. In essence, a consortium is a blockchain model that is jointly owned, operated and maintained by a number of organizations. Such a distributed ledger model spreads risk between members — which is a positive — but also can lead to liability being spread across different entities. That said, this type of sector-specific or industry-standard model does seem appealing due to the cost reductions, information sharing and increased transparency. In 2019 and beyond, it would seem logical to expect more consortium-based blockchains to emerge.
Valuing Distributed Ledgers
Establishing and reporting the value of a distributed ledger is, of course, important from both an accounting and organizational perspective, but the value of the ledger appears to be driven by two factors. First, the type of distributed ledger certainly makes a difference, and, as outlined above, there are several different types and iterations available for organizations. Second, and arguably more important, is the assets stored on the ledger. Contrasted against traditional ledgers or information technology systems, blockchains themselves often form a significant portion of the value attributed to a project or initiative using this tool. In addition to the often-significant costs associated with implementing and maintaining a blockchain or other form of robust distributed ledger, the intersection between the blockchain and the data stored on that blockchain raises an interesting point. Put simply, the security and encryption are core to the value of both the technology as well as the assets stored therein. This raises an interesting question that needs to be addressed in more detail: In the case of valuation, how much of the value attributed to a distributed ledger should be attributed to the information or assets stored on the ledger versus the ledger itself?