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Article

Cryptocurrency Affair Reflects Complex Interplay between Off-Chain Practices and Blockchain Accounting

Accounting
Published on:

Since December 2022 and the arrest of Sam Bankman Fried in 2023, the FTX founder has been at the heart of a scandal rocking the world of cryptocurrencies and the on-chain features that underpins its entire existence. But it is also illustrating the impact of off-chain factors involved in blockchain operations. These off-chain characteristics are forms of communication and coordination that need to happen for the technical activities of the blockchain to function. Recent research by professors Dane Pflueger (Assistant Professor in the accounting department HEC Paris), Martin Kornberger (Vienna University) and Jan Mouritsen (Copenhagen Business School) helps to shed light on the complexities surrounding FTX’s accounting. The academics’ December 2022 publication in the European Accounting Review, explores the issues of governance, organizing, and trust that buttress the blockchain accounting systems. In a long interview from his HEC campus near Paris, Pflueger challenges the notion some have that blockchain technology does not need intermediaries like accountants to function.

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FTX Scandal Reflects Complex Dance between Off-Chain Practices and Blockchain Accounting

 

You began exploring blockchain accounting five-six years ago. The FTX scandal has put a spotlight on its accounting practices. How does your research help explain some of the mechanics of this affair?

I think the biggest parallel that we can make between FTX and our research is that in our work we emphasize what we call the off chain work involved in blockchains. By off chain we mean all the forms of communication and coordination that need to happen for the technical activities of the blockchain to function in the real world. As far as FTX goes a lot of ancillary services like exchanges and wallet providers are necessary. This means you need all sorts of people to come together to make the technical functioning of bitcoin or any other coin to work. And all of these services exist off chain, in the real world. As such, they're susceptible to all the same real-world problems that the blockchain often claims to be solving.

 


With the off chain part of the blockchain activities, predictable types of financial frauds happen in a space that often claims to not rely on people.

 

So we have unsophisticated and predictable types of financial frauds happening in a space that often claims to not rely on people and to overcome these types of human problems. Because of this claim we probably have even more fraud than in traditional organizations. I think what our research emphasizes is that all the messy real world problems exist in blockchain just around it and at the edges. And such frauds are predictable in light of our research. Unfortunately, there are a lot of people who have found out the hard way and lost a lot of money. 

Still, you do point out the importance of blockchain for the accounting profession: it’s far more than a simple technical tool to facilitate existing tasks and functions. There's the old adage about throwing out the baby with the bathwater. You're not throwing out blockchain accounting or its potential for the accounting profession, are you?

Well, there’s a couple of things to consider. Once you understand that blockchain is going to require both on-chain and off-chain work, the greatest opportunity for the accounting profession is to contribute to this off-chain aspect. Blockchains need accountants as intermediaries to work out an appropriate course of action when things become complicated, when things fail or when judgment is required.

Arguably, the greatest asset the accounting profession has, its greatest selling point, is that it can be relied upon to make complex judgments, presumably without too little oversight. We require them to tell us if a company’s depreciation policy is appropriate, or whether its level of write-offs is appropriate, and to address all these spaces of grey that exist in financial accounting. That is exactly where financial accountants thrive. Auditing is required. So, we see a huge space, a golden opportunity for the accounting question to thrive in the blockchain world by providing that judgment.


So, we see a golden opportunity for the accounting to thrive in the blockchain world by providing a complex human judgment.

 

However, the kind of conflict that we identify in our research is that this area of complex judgment is not something that the accounting profession is very happy to talk about. Much research shows the accounting profession moving away from judgment towards the use of data and other decision tools that eliminate judgment. These changes are there to obscure the fact that judgments are actually taking place. So, we tend to think of accounting less as an art today than we did in the past, at least in its explicit form. But there is a risk: if accountancy were not to some degree art, we wouldn't need the accounting profession. We could have computers do it. So we need to promote this kind of accounting profession in order to operate in the space to sell and market and be upfront about what it provides, which is judgment. 

You say that blockchain technology has an economic rationality which can bypass the messiness of politics. And your research tries to encourage the exploration of more productive crystallizations in blockchain. Can you explain what you mean by that? 

When you critically evaluate blockchain’s imaginaries, and when you look at what the blockchain is claimed to do, it’s a significant development that nonetheless contains a high degree of naivete about what’s possible. The idea of algorithmic management devoid of human judgment has been around for a long time – usually as a warning rather than as a kind of goal. At the same time, I believe there are reasons why people don’t trust traditional intermediaries. We probably do want to find ways to challenge people of authority and to question their domains of expertise. And I think right now the early stages of blockchain technology are probably not embracing the complexity of these two lines of thought. It’s probably leaning too far towards the naive way of thinking in a way that doesn’t really learn from what we know, what we've learned in the past about power control, things like that.

 

We need more conversations about governance and autonomous decision making, and our research should help that.

 

So, what we're asking for is a little bit more of an advanced and complicated conversation about governance, about autonomous decision making. I wouldn’t say that this is not happening when I go talk to technologists today. And I guess we’re seeing this kind of reflection concerning AI governance already, which is a good sign that the conversation is evolving. As conversation is developing, our paper is supposed to be a way of helping everyone to further develop that line of thought.

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