Web3 makes Accounting 3.0 a Reality
Web 3 makes Triple-Entry accounting possible, which means Accounting 3.0 is here! The last time we had this was when accounting 2.0 was introduced in 1494 AD, or 500+ years ago.
TL;DR: Triple-Entry accounting allows for super complex business arrangements without the cost and company energy to maintain it.
Hello Professionally Curious One!
I was recently asked “what excites you about Web3” and “what do you see in it”. Turns out, it’s a bit hard to articulate beyond the cultural phenomenon it has caused.
So, for the month of June, I’ll be spending time sharing with you all my excitement in Web3. For today’s issue, I’m using accounting language. That’s right, I went and did it.
Using the structure of Web 1.0, Web 2.0, and now Web 3.0 (now short hand as Web3), I’ll be taking you on a journey on accounting.
As always, you can find TL;DRs and graphics shortcuts explaining the concepts.
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WTF do you mean?
WTF is Accounting 1.0
WTF is Accounting 2.0
WTF is Accounting 3.0
WTF do you mean?
TL;DR: Meet Accounting 1.0, 2.0, and now 3.0
Accounting 1.0, or single-entry accounting, existed for 99% of human history, from when the first businesses were created all the way to the 15th century, and even beyond. Primarily used by small business owners, and also medieval kings relying on treasuries, it’s basically a cash-in and cash-out view of your cash. It answers the question of “what happened”.
Accounting 2.0, or double-entry accounting, was introduced in 1494, giving powers to banks, central authority, and whatever we’re calling what’s on the stock market today. Our entire financial system relies on accounting 2.0. It answers the question “who owns what”.
Accounting 3.0, or triple-entry accounting, was introduced in 2008, right after the financial collapse, thanks to Bitcoin proposal. It answers the question of “how do we agree that happened”.
TL;DR: Single entry is writing down what happened.
Accounting 1.0 is what I call single Entry accounting. It’s a great system when I only have ME to deal with.
Up until some Italians created a banking system, business was a “Single Entry Accounting” endeavor.
You make business solely for yourself, because the only thing you really cared about was your cash balance.
You record cash in, you record cash out, and your remaining balance is your cash. That’s it.
Who cares about anything else.
A lot of accounting, financial, and data technology solutions I’ve seen often focus on being incredible data recorders. However, they don’t do a great job establishing relationships.
What do I mean relationships?
What happens when you have to deal with people beyond yourself, that may have ownership over your business too? What do they see? How?
What happens when you have people you do joint business with (partnerships) and people who give you loans (Investors)? What do they own? How?
How do I trust what you are reporting? How do I verify that?
Single entry accounting is a system not welcoming of outside parties.
While it is super simple to do, it also comes with pitfalls including it being easily manipulable (how do I trust your numbers), and it only focuses on income and expense activity, but nothing on ownership.
TL;DR: Double Entry accounting is writing down what happened, and explaining it using another account.
Accounting 2.0 is the Double Entry accounting system. It’s a great system that allows me to determine how much investors own, and how much I own, and the relationships between my financial accounts.
One transaction is represented across two accounts via a “Debits and Credits” system. This double entry establishes a relationship that can be followed by a third-party, and does a decent job on what is owned, what is owed, and what value remains.
At base, the double entry accounting formula looks like this
Assets = Liabilities + Stockholder’s Equity
This is the general bible equation for all accountants.What I own = What I owe + Investment Value
Here’s it translate to plain English
This double entry example shows that we now have $7k in cash, and it was derived from consulting services.
Double Entry Accounting works wonders when it is setup in one company, with one ledger (or book of records). If done right, I can independently check to see the relationship between the financial accounts and investors can focus on what they care about (their ownership).
It does come at a cost- it is significantly much more expensive to maintain a Double Entry Accounting system, and while the calculation error rate is a lot lower than Single-Entry, it can all be manipulated as the “ledger”, or the book of records, is kept and maintained by one company only.
So in scenarios where there are multiple business parties involved, what often happens is that “one company does all the record keeping”, and the rest of us, especially the small ones, are at the mercy of how that one record keeping company behaves.
…Usually its one company waiting for the other company to report, and then waiting for a verification on the accuracy of what was reported, and then some processing lag time. Before you know it, we’ve come to a realization that working with other companies is a pain in the ass from an accounting perspective and is only worth doing if we’re in the multi-mega millions.
TL;DR: Triple Entry accounting is writing down what happened, explaining it using another account, and telling everyone that it happened.
Hot take - Web3 / Blockchain is Accounting 3.0, and its represented as Triple Entry Accounting. It is an evolution on Double Entry Accounting (Accounting 2.0), and is currently now tangibly possible concept through blockchain technology - though it isn’t usually presented in this light.
There are three entries that happen:
The Debit is recorded
The Credit is recorded
The Cryptographic part
The cryptographic part is important, and serves as a huge deterrent and helps to prevent financial manipulation and fraud.
How?
Imagine the rigor of scientific peer review, where one person publishes the results, and everyone else corroborating and validating the results, applied to every single transaction. Every single one. In seconds. At an economical cost (y’all know it cost 12 cents to send $300,000,000 in BTC?)
Now imagine that rigor, with the fun principle of “no take backsies”, where once its published, that transaction is effectively permanent.
If you make an error, you can change the value of it using another transaction, but there’s a paper trail of all corrections and entries made, that everyone in the blockchain network can see.
You can’t hide your mistakes or your fudging.
In blockchain technology, there is a “public ledger” that everyone who is in the network is using. Imagine a Google Doc Spreadsheet actively used by 50 people, with the confidence that everyone is actually correct.
Blockchain enables Triple-Entry Accounting, which in turns will enables more joint-venture businesses at small business sizes, and more complex business relationships that involve people outside your company, with very minimal need for operational resources - aka there’s no need for a “record keeping company”.
The cost to do transactions will be significantly lower - across organizational energy, record keeping, and payouts.
What can we expect to see with Accounting 3.0?
TL;DR: More complex, multi-party business models across big companies and one-person companies too.
Here’s what I expect to see because of Accounting 3.0 / Web3:
I fully expect to see these types of business models:
Fractional Ownership
Revenue Sharing
Cost Sharing
I also fully expect to see leveled and transparent business engagement from big companies with small companies such as:
Independent Sole Proprietors
Small time creators
Random one-time product creators
Triple Entry Accounting which is enabled by Blockchain, which is part of this Web3 craze, significantly lowers the operating cost and barriers to doing business together, and also to trust each other.
This here is where I see the real ingenuity of Web3.
I hope you got a glimpse at seeing Web3 the way I do!