Budgets on the Blockchain: Maximally Transparent Transactions

Blockchain is a technology principally intended to be a public ledger – a radically transparent tool for bookkeeping and recording transactions in real time. Of its many use cases, the most practical one is the use of blockchain technology for government accounting. The value proposition of on-chain accounting and tokenisation – creating units of exchange from blockchain networks – directly addresses growing public distrust resulting from misappropriation of government finances through corruption and the public’s lack of awareness with how budgets are spent. Enhancing financial transparency by improving public budget literacy and providing opportunities for real-time tracking of public spending can not only minimise incidences of corruption and improve government efficiency, it can also rebuild trust in government.

Transparency and good governance are important determinants of efficiency, effectiveness and quality of service in the public sector, which in turn influence public trust in government. Around the world however, public trust in government is experiencing a multi-decade malaise. This public trust deficit is a direct consequence of corruption and the deterioration of transparency in government and public-facing institutions. It has had far-reaching, harmful effects not only on confidence in democracy (as recent work by the Bennett Institute for Public Policy at the University of Cambridge shows), but also on government service delivery and economic growth. In the United States for example, corruption is increasingly viewed as a national issue and not just a local or state problem.

Corruption, including the misuse of funds for procurement and public projects, bribery, embezzlement and tax evasion (Figure 1), significantly impedes government service delivery and increases the cost of public expenditure. It is enduringly obstinate and widespread; in recent decades it has affected everything from football federations to global NGOs to national bureaucracies. In Latin America, for example, several governments were implicated in a corruption scheme known as the Odebrecht case, a scandal involving $788 million in bribes to heads of state, ministers, CEOs and hundreds of individuals across more than 13 countries for over 30 years. 

Corruption of this scale results in fiscal leakages at multiple points as funds flow into, through and out of the public sector. It is estimated that 2–5 per cent of the world’s GDP, approximately $1.5–$2.6 trillion, is lost through corruption. This leads to lower levels of economic growth and reduced investment as talent is misallocated, aid funds are diverted, tax revenue is lost, budgetary imbalances accumulate, public infrastructure and services degrade, and public projects are selected based on their alignment with the highest opportunities for kickbacks or bribes.

Great strides have been made to enhance transparency in public spending in recent years. Governments as well as private companies and multinational bodies have adopted stringent fiscal governance frameworks to guide their operations and management of public resources. Without these frameworks, corrupt practices risked becoming an accepted “cost of doing business”.

Technology has also widely been embraced as a tool for reducing corruption and increasing accountability. In procurement services, for example, countries such as the UK have encoded “red flags” in e-procurement systems to identify suspicious activities. In 2017, the UK’s Competition and Markets Authority successfully launched a “Screening for Cartels” tool to help procurement officers identify bid-rigging. It is likely machine learning will continue to improve the ability to recognise unusual transactions and pricing patterns in both the public and private sectors. 

Electronic procurement systems have been successfully used to streamline contracting timelines and provide transparency and accountability to procurement processes in municipalities such as New York, and in countries like Korea and Chile. In 2003, Chile launched its electronic procurement marketplace, Chile Compra, for contracting goods and services from vendors. In the two decades since, the digital contracting platform has provided high levels of transparency, and has facilitated the strengthening of efficient processes that have resulted in cost savings – as much as $693 million a year – and resource management for 900 government agencies and tens of thousands of suppliers.

The publishing of Requests for Expression of Interest (RFEIs), Request for Proposals (RFP), contracts and more on e-procurement platforms such as Chile’s has opened the public’s eyes to public-sector bidding and awarding processes and levelled the playing field for vendors around the world. The ethos of creating open, competitive and transparent marketplaces for government transactions has become the standard within OECD countries, with digital procurement platforms being one example of the initiatives opening up information to the public. This degree of transparency has allowed citizens, policymakers and journalists to have more visibility of these public-sector transactions. 

Globally, open data portals have taken paper documents and turned them into machine-readable data or application programming interfaces (APIs) that developers, journalists, academics and the public at large can access freely, without the need for data requests to authorising agencies. Data.gov, the US data portal site, for example, has more than 335,000 datasets available for public use. Similarly, data.europa.eu is a repository of several hundred thousand datasets aggregated from the European Union and other countries that are available in various data formats. While the quality of these data – commonly referred to as open government data (OGD) – varies widely, the distribution of raw datasets related to demographics, economics, healthcare, climate, education and energy, as well as overall service delivery and the operations of government, is creating a standard operating procedure for data publishing as agencies default to opening up data to public access.

The open-data movement has had a significant impact on the accessibility of public information, leading to uninhibited data-driven journalism and broad enquiry into far-reaching government affairs. In Brazil, for example, journalists using the Transparency Portal were able to uncover questionable credit-card transactions by government officials that led to the resignation of the then minister of promotion of racial equality and the repayment of $30,000 by a minister who inappropriately charged personal expenses to the government.

Despite the use of open data and procurement portals, financial-transaction information ranging from large procurement projects to microtransactions is largely untrackable in real time. Budget reports are seldom shared with the public or are shared in limited fashion and often in grandiose political settings. The power of the purse is therefore hidden within the halls of capitols and parliaments, between stacks of paper printouts, and in wire transfers between agencies and corporations.

Since its introduction in the 2008 bitcoin white paper, blockchain has been an elusive technology capable of solving everything and criticised for achieving nothing. The blockchain protocol that underpins cryptocurrencies solved an important problem in cryptography and game theory: the Byzantine generals problem. It further solved the issue of having to rely on a trusted third party to verify information by using a decentralised peer-to-peer network to verify information on public ledgers. Its value proposition for the public sector therefore is its trustless, transparent and immutable technology that achieves consensus through computations.

Applied to use cases in government, blockchain does indeed provide many of these unique selling points. After all, immutability and a degree of decentralisation make transactions less susceptible to corruption by a central authority. If the essence of blockchain is decentralisation, the ethos is openness. Blockchains built for the government can therefore become protocols for transparency in day-to-day public-sector operations.

The ability to write smart contracts into a blockchain, execute code autonomously or perform other programmatic functions defines the evolution of blockchain. While decentralised apps (dApps) are utilised in decentralised finance, when applied to government applications these may soon be known as government apps (gApps). gApps may distinguish themselves through newer consensus mechanisms such as delegated proof of stake or proof of authority that do not require high computational power and can be maintained through a small number of approved node validators. Centralised blockchains are permissioned blockchains where access is controlled but data can still be public. These blockchains would be necessary in virtually all situations. But even centralised blockchains with permissioned settings for the validation of the network are not distributed databases, as they require consensus – a feature that bestows immutability and security. Consequently, the extent of distribution of consensus and block verification would ensure that the data are permanently accessible and nearly uncompromisable. A procurement website may have an HTTP error, but with an on-chain approach, there is no downtime. 

Going back only a few years, blockchain has been touted as a possible solution for many of the critical functions of government, including streamlining operational processes, reducing waste and maximising accountability. Governments are already using centralised blockchain applications to improve service delivery and efficiency. The use cases for cryptographic protocols have included land registries, vehicle titling, central-bank-issued digital currencies, credential validation, vaccine verification, loan and grant tracking, tax tracking and blockchain-based voting.

In the US, the state of Colorado created a new role for a “blockchain solution architect” to manage the state’s blockchain infrastructure and expand pilot programs. In 2022, the state of California issued an executive order to create “a comprehensive and harmonised framework” that would better understand how state and public institutions can improve government operations using blockchain. In South Burlington, Vermont, the city has been recording property deeds with a QR code tied to an Ethereum transaction. There are now several cities and states that are piloting blockchain-based mobile voting.

Several other countries have begun pursuing blockchain-based governance solutions. In Colombia, the Ministry of Information Technologies and Communications has issued guidelines for technology projects aimed at emphasising the legal framework and spirit of transparency encouraged by blockchain. Like other governments, the country is experimenting with issuance of land documents on digital ledgers and has also identified a pilot for verifying the authenticity of academic diplomas.

In 2022, Brazil launched the Brazilian Blockchain Network (RBB). The partnership between Court of Accounts of Uniam (TCU) and the Brazilian Development Bank (BNDES) has been inked, but the network technology is still in development. The purpose of the network is to address the distrust that Brazil’s population has in state governments. One government technology executive in Brazil has shared his optimism, publicly stating, “The Brazilian Blockchain Network (RBB) can definitely change the functioning of the public machine in terms of transparency, efficiency and security.” In fact, one of the RBB’s main goals is to provide greater accountability with respect to public expenditures.

In Peru, a similar problem of low trust in institutions was a result of a number of scandals including the Odebrecht affair, which enabled more than 100 contracts to generate $3.3 billion for a conglomerate construction company. The scandal toppled presidents, politicians, business figures and lawyers, and led the former president of Peru, Alan García, to commit suicide as his home was raided.

In the wake of the Odebrecht case, the government of Peru worked with a private contractor in 2019 to begin developing a procurement system that would verify and track government contracts. The goal was to prevent internal fraud, data or contract manipulation, unauthorised activity, or improper documentation throughout the procurement process. The technology relied on LACChain, a multi-country blockchain ecosystem led by the Inter-American Development Bank, but the programme did not pass the pilot phase.

In the Aragon region of Spain, a blockchain-based procurement system has been in operation since 2018, though very much as a limited proof of concept. The technology developed in this case resembles a distributed database much more than a traditional public ledger, but binding agreements have been made via smart contracts with public visibility. The smart contract delineates the rules for the contract to be awarded while ensuring integrity in the process. 

Putting all financial transactions on-chain makes a comprehensive accounting of a government entity possible in real time. Each and every monetary transaction is recorded on the blockchain and can be seen by anyone. This offers an unprecedented degree of immediate transparency, as the books of government finances are opened up to anyone with an internet connection. Every agency’s or official’s financial transactions would be visible via a public wallet address. As wallet addresses can be tied to specific individuals or entities, all their transactions from vendors to petty-cash payments are recorded and linked with their unique address.

Transaction data also become searchable in perpetuity. Where audits of the past have lasted months or years, consuming hundreds or thousands of human hours, any member of the public can query data instantly. There is a visible and public trail for any person to audit as financial data become indexed. Where blockchain explorers and analytics platforms exist – such as Etherscan, which serves to provide search functions for Ethereum-based blockchain transactions (Figure 2) – so too can these search engines be built for financial tracking for governments. Like Google search, individuals would be able to search for transactions using labels, name or department tags, addresses, public website links and so on.

Figure 2

Design for a blockchain explorer to search for any government transaction

Source: Author

Red-flag alert systems run by bots can call attention to specific transactions or identify emerging patterns through evaluation of transaction trends. Researchers in Italy, for example, were able to apply standardised machine-learning techniques to the procurement data of roadwork contracts, and showed the effectiveness of standardising the collection of data by monitoring authorities and identifying corruption patterns. They concluded that looking at data may offer the power to predict when and where corruption may occur. 

Eventually machine-learning tools will be used beyond identifying malicious or suspicious activity: they will enable us also to improve efficiency and reduce waste. Increased spending before an election or an increase in overtime pay for an infrastructure project may show trends in uneconomical expenditure, for example. Finally, the records of transactions become unalterable, preventing data manipulation unless the node validators agree to revert or remove a transaction from the chain. The one source of truth for the finances of governments becomes the blockchain, and two clear benefits emerge: 

1: Open Data 2.0: All Data Go On-Chain

The holy grail of transparency is open data. However, open data are typically released to media organisations and reporters months or years after an initial request. Open-data standards are not the norm. What’s more, machine-readable data and APIs are not always a technology standard in government. If data are released, they are often in PDF or paper format. 

With an on-chain open-data standard, immediacy is no longer a luxury or lucky event. On-chain data as the default assumes that if it is a public transaction, it is immediately accessible. In this way, journalists can react faster to important transactions.

An on-chain data standard also establishes composability – the idea that developers can use or integrate code or data into software elsewhere. Software tools that employ artificial intelligence to analyse and optimise government finances or predictive analytics to assess solvency using “what if” scenarios only become possible if data are made freely available within a standard that makes them usable and doesn’t require data massaging. Thus a rule can be applied: if the data are in the public domain, they should go on-chain.

2: Budget Literacy for the Public Improves

Budget awareness generally increases the demand for operational efficiency in government. However, public spending is rarely openly communicated by political actors. Cherry-picked data are often used to reinforce political narratives. It is rare for voters or constituents to have accurate, detailed, up-to-date knowledge and understanding about public spending and the flow of public funds within and from government.

Through the standardisation of on-chain open data, gleaning these data becomes materially easier. Open-data software programmers, data scientists and civic designers would be able to design and build tools, dashboards and visualisations around these data. Data-wrappers visualising transactions could automate clear-cut, intelligible spending reports and more. Moreover, increased fiscal transparency in public spending can improve public budget literacy, leading to better overall financial management and greater accountability.

Several decentralised autonomous organisations (DAOs) currently employ one of numerous methods of public bookkeeping. Some of these public and private organisations use APIs to track spending and their treasury balances. Credit cards are linked to a third-party API which automates the reporting of transaction data to a centralised database. Even the smallest transactions, petty-cash expenses and per-diem stipends are automatically updated on the ledger.

For Brazil’s RBB, the technical solution is a layer-1 protocol that acts as a platform for other applications, tokens and networks. Its main purpose is to create a permissioned public blockchain ecosystem to allow for the creation of apps with three types of participants including patrons, i.e., the Brazilian public entities, TCU and BNDES, associated participants who also contribute to network’s validation, and partner participants who can access the network’s resources. Brazil’s blockchain is also based on proof of authority (PoA), which requires both public and private validators for the network to verify the transactions that take place. Remarkably, the network does not have its own token, and payments do not require a digital currency, but the network and its participants may back and undergird the creation of tokens if authorised. This is intentional. The initial scope of RBB is to create the infrastructure – similar to the TCP/IP protocol that established the internet – which carries with it larger goals for uses and function. In clarifying the vision for the network, TCU’s former minister Ana Arraes stated: “The use of blockchain enables greater protection, transparency and integrity in the public database, in addition to allowing the auditability of the data entered in the network. RBB is a public and non-profit national network formed by several institutions with the objective of facilitating the donation of blockchain technology in public services.”

Still, similar to RBB, a minimal viable system for a public-sector blockchain would need to be its own layer-1 protocol blockchain establishing both data and standards as well as the consensus mechanism. A complementary sidechain would constitute a layer-2 blockchain, and the creation of an application with an interface that makes use of that chain would characterise that application as a layer-3 technology. 

At minimum, a protocol base layer with the creation of a single standardised token would need to be built using a PoA consensus model. A digital treasury, responsible for governance and network validation, as well as external validators, would be needed to hold a reserve for local currency and issue digital tokens. The issuance of tokens would occur after the collection of taxes and other revenues in the local currency. This currency would then be held in abeyance by the treasury, to be released only once an external payment exits the public payment system. At this point, the digital unit of account – the token – would be “burned” once the transaction were approved by the treasury.

Because of the one-to-one exchange, and a treasury reserve that matches and reflects the exact unit amount created, parity would be established and there would be no risk of manipulation or de-pegging where the currency loses its stable value. By design, no outside party or actor would be able to create a token or manage a wallet to hold. Not even the treasury would be able to mint new units without equal deposits in the local currency. This model would feature a high degree of centralisation, but it would nevertheless provide an unprecedented level of transparency. 

An Honest Accounting: A Cost–Benefit Analysis of Implementation

Blockchain-based solutions have their own limitations and may not be a technically efficient or streamlined solution for everything in the public sector. However, tokenising the exchange of value within government as a digital currency and establishing technical standards for protocols of transparency should remain a high priority.

The running costs of implementing a novel and technical blockchain solution are as yet unclear. Potentially high short-term costs, associated with any emerging technology, may seem daunting for firms and governments, but the benefits must be discussed as part of the investments and weighed against these costs. It should also be acknowledged that the cost of the status quo is one that significantly undermines public trust, economic growth and development, and stifles innovation.

What type of additional services could be provided if processes worked more smoothly because of increased transparency? What impact might the recapture of 2–5 per cent of a national budget have on public services and a government’s spending priorities? What impact could even a 1 per cent reclamation of GDP lost to corruption have on overall economic growth? 

These may be presumptions, but they are reasonable scenarios in which on-chain data and technology can serve to address the intractable problem of corruption. As the flow of money through the pipelines of government is brought into the daylight, one can only expect the forecasts for the future to become sunnier.

Lead Image: TBI