Bitcoin and Blockchain
Jayanth R. Varma
Jayanth R. Varma is professor of
finance and accounting at the Indian
Institute of Management Ahmedabad.
His research interests include
financial markets and their regulation,
mathematical modeling, and computer
simulation. He has a doctorate in
management from the Indian Institute
of Management Ahmedabad. He can
be contacted at jrvarma@iima.ac.in.
© Business Expert Press 978-1-94944-329-5 (2018) Expert Insights
www.businessexpertpress.com
Abstract: The blockchain is a decentralized system that
offers an alternative to conventional systems centered
around highly trusted, systemically important institu-
tions. Bitcoin is the best known application of the block-
chain; however, blockchain is also used for many other
things, and in the decades to come, these applications
may overshadow Bitcoin. The blockchain is an evolv-
ing and improving technology, which is another way of
saying that it is an immature technology. Noncurrency
uses of blockchain are in their infancy, and radically
new technologies take many decades to realize their full
potential. Thus, it is perfectly possible that blockchain
would prove revolutionary in the years to come. What is
certain is that businesses should be looking at this tech-
nology, and understanding it, because its underlying
ideas are powerful and likely to be influential.
Keywords: Blockchain, Bitcoin, Byzantine Failure,
Distributed Ledger Technology (DLT)
The twenty-first century has seen an erosion of trust
in institutions and governments around the world, es-
pecially in the aftermath of the global financial cri-
sis. This has aroused interest in decentralized systems
like blockchain, which offer an alternative to conven-
tional systems centered around highly trusted, systemi-
cally important institutions. Bitcoin is the best known
application of the blockchain; however, blockchain is
also used for many other things, and in the decades
to come, these applications may overshadow Bitcoin.
Blockchain is still an evolving and, therefore, immature
technology, but managers and leaders need to under-
stand this new technology and think deeply about how
their businesses could adopt it. This article discusses the
key ideas underlying the blockchain with particular
­emphasis on financial applications.
Introduction
The second half of the twentieth century saw the cre-
ation and growth of large, centralized systems in the fi-
nancial sector. Indeed, the word “central” was used to
describe many of these entities—Central Banks, Central
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 Bitcoin and Blockchain
Counter Parties (CCPs), and Central Secu-
rities Depositories (CSDs). As the finan-
cial sector globalized, institutions emerged
at the international level to provide cen-
tralized services—Society for Worldwide
Interbank Financial Telecommunication
(SWIFT) for global transfer of money, and
CLS Bank for settlement of foreign ex-
change transactions are prime examples.
In some cases, institutions that were not
set up as central institutions grew in size
to become de facto central hubs—a hand-
ful of banks dominate correspondent bank-
ing, and an even smaller number provide
custodial services to large investment in-
stitutions. Throughout the second half of
the twentieth century, it was commonly
assumed that the financial strength and
sound management of these central hubs
ensured that they were extremely unlikely
to fail. More important, it was assumed
that they were Too Big To Fail (TBTF), so
that the government would step in and bail
them out if they did fail.
Erosion of Trust
Many of these assumptions were shattered
in the very first decade of the twenty-first
century. During the Global Financial Cri-
sis of 2007 to 2008, many large banks failed
in the richest countries of the world. Many
more would have failed if their governments
had not bailed them out. A severe political
backlash against such bailouts led to new
legal frameworks that made such bailouts
difficult if not impossible in future. Sud-
denly, we could no longer trust the finan-
cial institutions that occupied some of the
critical central hubs of twentieth-century
finance. The second decade of the century
has shaken trust in the governments them-
selves. The Eurozone Crisis of 2010 to 2012
stoked the fear that governments of even
rich countries could potentially default on
their obligations.
As the aftermath of the GFC continues
and with politics becoming more unpredict-
able, trust in governments has been further
eroded. Brexit was one prime example: The
2 © Business Expert Press 978-1-94944-329-5 (2018) Expert Insights
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people of the UK voted in a referendum
to leave the European Union, upending
longstanding assumptions of businesses
and individuals in the UK and in the rest
of Europe. While democracies do spring
surprises like Brexit, authoritarian coun-
tries are even worse in terms of destroying
the trust of their people as they resort to
increasingly repressive measures to exert
control.
If we can no longer trust either the
institutions that occupy the hubs of
twentieth-century finance or the govern-
ments that regulate and back stop these
institutions, then it obviously makes sense
to look at decentralized systems that elimi-
nate the need for that trust.
The twenty-first century has also brought
with it heightened fears of cyber risk.
The second half of the twentieth century
was relatively stable and peaceful—a wel-
come relief from the two World Wars that
marred the first half of the century. For
most people (outside some endemic con-
flict zones) the world was a very safe place.
One could hope to go through life without
being robbed, injured, or killed. That still
remains largely true of the physical world,
but the online world is very different. Not
a day passes without news of one or the
other large institution being hacked by cy-
ber criminals. When we enter the online
world, it is as if we are transported back
several centuries into the past into a wild
world where an enemy lurks behind every
shadow.
There is no refuge in big institutions
because they too are being hacked. It is
reasonable to worry about what would hap-
pen if one of the central hubs of finance
were hacked by a malicious player. What
if a bank were hacked and all account bal-
ances were erased and made zero? What if
the CSD were hacked and all information
about ownership of securities were de-
stroyed? Would we able to go back to some
reliable backup data and restore at least
the balances as they were a day or two ago?
What if the hacker is patient and slowly
 Bitcoin and Blockchain
corrupts the data a small amount at a time,
so that, by the time the hack is discovered,
even past backups are corrupt? Once again
the question arises: Is it such a good idea
to organize modern finance around a few
hubs that represent single points of failure?
Or should we be looking at more decentral-
ized solutions?
Trust Models
Modern financial markets rely on several
different trust models as seen in Figure 1:
After the global financial crisis, all of
these trust models appear suspect. Trust-
ing the bank is fine if your deposit is
covered by the government’s deposit insur-
ance, because, otherwise, it becomes a bet
on the bank not failing. After the failure of
Lehman and AIG, regulators have tried to
move many markets away from the OTC
model of peer-to-peer trust and push more
and more products onto central clearing.
As a result, people are now worried about
whether the clearing corporations (CCPs)
are becoming single points of failure for
the entire financial system.
Cyber Risks and Byzantine Failure
When it comes to cyber risks, two kinds of
failure are possible as depicted in Figure 2.
The first is a software glitch or denial of
Figure 1: Different Trust Models
© Business Expert Press 978-1-94944-329-5 (2018) Expert Insights
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Figure 2: Normal Failure and
Byzantine Failure
service attack that temporarily disables the
trusted third party (TTP). The consequence
is quite serious: The entire market that is
served by this TTP simply comes to a halt.
However, this risk might be tolerable if it oc-
curs quite rarely. The second kind of failure
known as Byzantine failure is catastrophic in
financial markets. For example, if the TTP is
hacked, then it may be very difficult or even
impossible to recover from this even after
the cyberattack has been repulsed. In the in-
terim period in which the TTP was under
the control of the hacker, data could have
been altered in all kinds of malicious ways.
Bitcoin: Minimal Trust and High
Resilience
In the backdrop of the heightened risks
emanating from the global financial crisis,
Bitcoin was created as a form of electronic
money designed to operate with minimal
levels of trust and be highly resilient to all
kinds of failure, including Byzantine fail-
ure. Bitcoin has sometimes been described
as the digital equivalent of gold, and it is
instructive to take a look at gold before ex-
amining Bitcoin.
Gold: The Original Minimal Trust Money
In the twentieth century, we became so
used to government-issued money that we
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