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The Evolution of the Ledger
Before we can understand distributed ledger, let’s look into what exactly is a ledger. As early as 1,000 years ago, Europe and China had records of ledgers, and also the Sumerians had stone ledgers as early as 4,000 years ago.
In the 16th century, someone regularly put a large volume or service book in one place, and everybody can browse the related transaction income and expenses. This is the initial prototype of the ledger. Over time, this idea of ledger has gradually evolved into the book of accounts for commercial entities that we are now acquainted with.
Book of accounts are based on accounting vouchers, which are used to record and calculate all financial transactions in a comprehensive, systematic, continuous, and classified manner. It records capital flows and financial revenues and expenditures, and provides data for the preparation of accounting statements.
Double-Entry Ledger Accounting
In modern society, ledger accounting is a financial information and management system.
Every business has its own business ledger. If you would like to verify the occurrence of a financial transaction, you’d need to check out the books of both businesses. All transaction items are recorded in at least one debit and one credit account, and the total amount entered on the debit account must be equal to the total amount entered on the credit account. as a result of this double transaction accounting method, it’s named as double-entry ledger accounting.
Double-entry ledger accounting is an accounting method used to record financial transactions in two or more accounts. It keeps a company’s accounts balanced, showing a real financial picture of the company’s finances.
Each company’s account books will formulate its accounting standards according to the company’s needs. These ledgers are managed in different ways and use a spreadsheet to record transactions. This is often how modern databases work, all transactions are digitally recorded in the database.
But compared with traditional paper ledgers, digital ledgers can store more data, have more flexible recording methods, and provide more powerful functions.
But again we’ve to face the risk of digitization gambit: in the digital world, all digital data is mutable, and it can be very difficult to maintain its truth and security. People can easily edit, copy and transfer the digital ledgers and databases from all corners of the world.
The disadvantages of a single ledger are obvious.
For example, in the smurf village, Papa Smurf is the practical village leader for all smurfs, he manages all the affairs of the smurfs, including the transaction record in the ledger.
Every Smurf will need to report their transactions to Papa Smurf for him to record in the ledger. However, this method isn’t 100% secure or trustable:
- Papa Smurf may be ill and forgot to record the transactions of the smurfs.
- Maybe Papa Smurf was drunk and recorded the wrong transaction item.
- It is also possible that after Baby Smurfette dating with Brainy Smurf, then she secretly helps him to modify his transaction so that he will pay less to Clumsy Smurf.
This is the biggest problem with a centralized single ledger. Over-reliance on the center and authority caused the smurfs to gradually lose power.
To combat the weaknesses of getting a single ledger, each smurf distributed a ledger, and every Smurf recorded every transaction. This is the concept of the distributed ledger.
In other words, the ledger is distributed on the network. In this way, there’s no single copy of a single center, and there aren’t any specific rules to alter the ledger. Thanks to the effect of decentralizing the authority, the system is more robust.
The nodes of the distributed ledger are distributed in different places and are independent. All nodes will maintain a common ledger, thus avoiding a single ledger from being controlled or modified. Because the ledgers are distributed in many different nodes, unless all nodes are destroyed, the integrity of the account data is guaranteed.
Distributed ledger seems to solve the single ledger weaknesses. But how to ensure that the ledger between nodes can be shared, replicated, and synchronized with each other? This is another key concept in blockchain technology that I will introduce.
In addition to the concepts of distributed ledger and cryptography, another important key concept of blockchain technology is: consensus mechanism.
Based on the information asymmetry of the distributed ledger, network participants must formulate an agreement to reach a consensus on data accuracy.
Blockchain consensus mechanism uses peer-to-peer encrypted transmission protocol and Proof-of-Work (PoW) to allow distributed nodes to reach a consensus and acknowledge the validity of the record (block ledger).
The mechanism of proof-of-work is to encourage honest miners to create new blocks full of processed transactions and share it with the rest of the network. It helps prevent certain types of economic attacks, such as double-spending. It also can coordinate all distributed nodes to synchronize blocks in a short time and to reach an agreement on the current state of the system.
Triple-Entry Accounting in Blockchain
Blockchain has introduced smart contracts, which integrate programming and logic into digital ledgers, so that its role is no longer a simple record of credit and debit transactions, thus presenting tremendous progress and development.
Distributed ledger and blockchain also introduce the concept of triple-entry accounting. In triple-entry accounting, in addition to recording each company’s transactions on its ledger, transaction records also are recorded on the distributed ledger. This third public ledger entry has more weight because both parties in the transaction have secured it.
According to the blockchain triple-entry accounting method, all transactions are going to be recorded in the blockchain. The ledger entries of all parties will be consistent and encrypted and sealed by a third party, which is a record that can’t be edited. The blockchain is the only true source of all transactions. If the blockchain record does not exist, the transaction item doesn’t exist.
It can be pointed out that the blockchain triple-entry accounting method greatly simplifies the auditing of business ledgers. We only need to audit the blockchain ledgers and do not require coordination of the separate ledgers from different companies. However, distributed ledgers don’t necessarily use blockchain technology, and blockchains don’t necessarily have distributed ledgers, but the combination of the two can show truly powerful capabilities.
Knowing what a distributed ledger is, we will explore in depth what a blockchain is.