Buildingariskmarketforthedigitalage
17thAugust2015
MichaelFolkson
[email protected]
Abstract
TheInternetwasoriginallydevelopedasanetworkforinformationexchange.
Nowamultitudeofentrepreneursandsoftwaredevelopersarebuildingthe
Internetforvalueexchange.ThenextlogicalprogressionistobuildtheInternet
forriskexchange.Justasunitsofcurrencycanbetransferredtoathirdparty,
insurancecontractstransferriskexposurestoathirdparty.Blockchain
technologyhasthepotentialtoradicallytransformhowtheinsuranceindustry
operatesandhowriskexposuresaresharedanddistributed.JustasBitcoin
offersaprotocolforpeer-to-peervaluetransmissionbypassingthetraditional
bankingsystem,aninsuranceindustryleveragingapublicblockchainpresents
anopportunityforindividualsandentitiestotransparentlyretain,shareor
transferriskexposureswithouttherequirementforriskexposurestositonan
insurancecompany’sbalancesheet.Theinsuranceindustryisalreadypresented
withamultitudeofopportunitiestobroadenitscoverageofriskswhilst
concurrentlymakingcoveragemoreaffordabletopolicyholders.However,risk
aversion,lackofinnovationandanuninspiringpublicperceptionmaypreventit
fromtakingadvantageoftheseopportunities.Asthedataavailableto
consumers,companiesandgovernmentsproliferates,itisvitalthatall
participantsbecomemoreriskawareandriskliteratesothattheyareableto
separatethesignalfromthenoisewhenmakingdecisionsbasedonthisdata.
Theinsuranceindustryhasinpreviouserasbeenanentrepreneurial,pioneering
sectorandnewtechnologiessuchastheblockchaincanbeleveragedtoreboot
thesectorandreengagewithitsclientsonthesubjectofrisk.
Imaginingthefutureofinsurance
Sciencefictionfrequentlyoffersinspirationforwhatanindustrycouldlooklike
infuture.Theshortspeculativefictionentitled‘KnowWhentoHold’Em’byK.G.
Jewellisasomewhatdystopianvisionoffuturisticinsurancebutitdoesexplain
howtheuserinterfaceofapeer-to-peerinsurancemarketcouldoperate.Inthe
story,theleadcharacterJonasactsasaninsurerontheplatformMicroRisk.
Amongthemicroriskshechoosestoprovideinsurancecoverageforarevacation
sickness,examresults,fashion(twoindividualswearingthesameoutfitatan
event)andbeingstooduponafirstdate.Heisrequiredtopostcollateralintohis
MicroRiskaccountbeforeinsuringariskandisabletoauditclaimsbeforepaying
outonthem.Thepolicyholder’spremiumandtheinsurer’scollateralarefrozen
inescrowuntilthecontractclosed.Someoftheserisksmaybedifficulttoprice
duetolimiteddataandincreasedmoralhazard.However,thestorydoesstirthe
imaginationwhenenvisagingwhatpersonalriskscouldbeinsuredifthe
requirementtogothroughaconventionalinsurancecompanywaslifted.
Abriefhistoryoftheinsuranceindustry
Thetransferanddistributionofriskdatesbacktoatleasttothesecond
millenniaB.C.Inapproximately1750B.C.Mediterraneansailingmerchantspaid
theirlenderanadditionalsumtoagreetoterminatetheirliabilityconditionalon
theshipmentbeingstolenorlostatsea.Lloyd’sofLondonoriginatedfroma
coffeeshopintheCityofLondoninapproximately1688.Itisacorporatebody
ratherthanacompanyandactsasapartiallymutualizedmarketplacewhere
investors(“members”)grouptogetherinsyndicatestoinsureparticularrisks.As
atDecember2014,therewere96Lloyd’ssyndicates.Thecapitalstructureis
organizedsuchthattherearethreelevelsofassetsbackingtheliabilities;
syndicatelevelassets,member’sfundsheldintrustatLloyd’sandcentralassets.
CentralassetsareheldbytheCorporationofLloyd’sfortherareinstanceswhere
thefirsttwolevelsofassetsareunabletomeetallliabilities.TheCorporation
determinesthelevelofcapitalmembersmustinvesttosupporttheirproposed
underwriting.
ThereareanumberofparticipantsintheLloyd’smarket.Brokersactas
intermediariestoconnectinsurancebuyersandsellers.Underwritersdetermine
thepremiumsthatshouldbechargedinconjunctionwiththeactuarieswhoalso
estimatethereservesrequiredtomeetfutureclaimsonanongoingbasis.Claims
adjustersverifythelegitimacyofinsuranceclaimsandassessthesizeofthe
payout.Itisamarketthatemphasizestheimportanceoftraditionandface-tofaceinteraction.Itisgenerallyslowtoexploitnewtechnologiesasdemonstrated
bytheslowtransitionfrompapertodigitalrecords.However,itsuniquehistory
andcapitalstructurewithsyndicatescompetingundertheLloyd’sumbrellahas
helpedbuildasuccessfulandenduringglobalbrand.AswithLendingClub(see
later),asignofitsmaturityisthatmanysyndicatesnowcloselyresemble
traditionalinsurancecompaniesandindeedmanyoftheirmembersarethe
world’smajorinsurancegroups.
Thepeer-to-peerlendingmodel
Therearemanyparallelsbetweenthebankingandinsuranceindustrieswith
bothsectorsrewardedforacceptingriskexposures.Ratherthanlendingout
fundsand(hopefully)receivingthembackatafuturepointintime,insurance
companiesreceivefundsinadvanceandreturnthemcontingentonfuture
events.LeadinginvestorslikeWarrenBuffettpreferthisbusinessmodelas
insurersbenefitfromthe“float”whichallowsthemtogeneratereturnsonthe
premiumscollectedbeforetheyarereturnedtopolicyholders.Thepeer-to-peer
lendingmodelhasthrivedinrecentyearswithcompanieslikeLendingClub,
ProsperandZopafacilitatingoverabilliondollarsofloansbetweenindividuals.
LendingCluboriginallylaunchedin2007asaFacebookapplicationhopingto
leveragethetrustbetweenmembersonthesocialplatform.Itssuccessisatleast
partlyexplainedbyreestablishingadirectlinkbetweeninvestorsandspecific
creditriskexposuresatatimeofeconomicuncertainty,sovereigndebtcrises
andcomplextoobigtofailbankinginstitutions.Thesedirectcreditrisk
exposuresallowaninvestortodiversifyheroverallportfolioandthereare
minimalinfrastructurecostsincomparisontotraditionalretailbanks.In2012
LendingCluballocated20%oftheloansontheirplatformforinstitutional
investorsechoingthematuringinLloyd’sofLondon’sevolution.
Thepeer-to-peerinsurancemodel
Similarly,apeer-to-peerinsuranceplatformreestablishesadirectlinkbetween
investorsandspecificinsuranceriskexposures.Today’sinsurancecompanies
andLloyd’ssyndicatesaresolarge,complexandheavilyregulatedthatthedirect
linkbetweenaninvestorandspecificinsuranceriskshaseroded.Ifaninvestor
wantsexposuretoinsurancerisktodiversifyherportfolio,shehaslittleoption
buttoinvestinthesharesofaninsurancegroupandbeexposedtomultiple
insurancerisksinadditiontoassetriskssuchassovereignbonds.Itisextremely
difficulttomatchaninvestor’sriskappetitewithspecificinsuranceriskssuchas
personalorcommercial,home,car,healthortravel.Moreover,itisimpossible
foraninvestortooptoutofspecificriskexposures.
Theonlyinsurancerisks
investorscangetdirectexposuretoarecreditandcatastropheriskthroughthe
issueofcatastrophebonds.Thepeer-to-peerinsurancemodeloffersinvestorsan
opportunitytogeneratehigherinvestmentreturns,transparencywithregardsto
riskexposuresandthesatisfactionofdirectlyinsuringindividualsorbusinesses
ratherthaninvestinginafacelessinsurancecompany.Itofferspolicyholders
accesstocheaperpremiums,fasterclaimpaymentsandinsurancecoveragethat
mightnotbeavailablethroughtraditionalchannels.
Lloyd’sofLondonhastransitionedfromagreeingpeer-to-peercontractsina18th
centurycoffeeshoptoahighlyregulated,centralizedinstitutionforcollecting
riskexposuresfromallaroundtheworld.Itwasalogicalevolutionforan
institutionoriginallybuilttoserveasmalltrustedcommunitybutnowmatching
capitalproviderswithinternationalpolicyholders.Therearenowprohibitive
barrierstoentryforstartupsintheinsuranceindustry,whichhasresultedinan
industrythatisslowtoinnovateandstrugglestocompetefortoptalent.Arecent
Accenturereport1foundthatjusttwopercentofrecentcollegegraduateswanted
toworkintheUSinsuranceindustry.However,totalglobalpremiumsfor
propertyandcasualtyinsurancecontinuetogrow,reaching$4.9trillionin2013.
Cruciallytheopportunitiesforgrowthinthisindustryarevastastechnology
disruptsmanyofthekeyindustriesitprovidescoverageto.
Bitcoin,thesharingeconomy,InternetofThings,self-drivingcars,3Dprinting
andartificialintelligenceareeffectivelyincubatingaperfectstormforslow
movingincumbentsinvariousindustries.Theinsuranceindustryisnodifferent.
Therearevastamountsofdatathatarebeinggeneratedbytelematicsandsmart
devicessuchasconnectedmetersanddetectiondevicesthatcouldbeleveraged
forriskmitigation,insurancepricing,real-timecoverageadjustmentsandclaims
validation.Lackoftechnologicalexpertise,legacyITsystems,operational
complexityandinternalconflictsoverpotentialcannibalizationprevent
insurancecompaniesfromfullyexploitingtheseinnovations.Thispresentsan
extremelyattractiveopportunityfornewentrantstobuildanewindustryfrom
theground-upexploitingtechnologicalinnovationsandthevariousmodelsfor
sharinganddistributingrisksuchaspeer-to-peerinsurance,mutualsand
captives.Rakuten,theJapaneseonlinemarketplace,hasrecentlymovedintothe
insurancespacebyacquiringaninsuranceunderwriterwhichgrantsthem
accesstodatawhichcouldpotentiallybeusedtodrivesales.
Perhapstheinnovationwiththegreatestpowertorestructuretheinsurance
industryistheblockchainthatunderliesBitcoin.SatoshiNakamoto’swhite
paper‘Bitcoin:APeer-to-PeerElectronicCashSystem’describesaprotocolfor
enablingpeer-to-peermonetarytransferwithoutrequiringafinancial
institution.Bitcoindependsonthesharingandreplicationofauniversal
accountingledgerordatabaseofeverytransactionmadebyeveryparticipant.It
providesamechanismforalloftheparticipantstoarriveataconsensusthatis
cryptographicallyverifiable.RichardBrownproposesthattheblockchain
providesanenvironmentfortwoseparaterevolutions;acensorship-resistant
platformforopen,permissionlessinnovationandablueprintforbuildingmore
efficientindustry-levelsystems.SatoshiNakamoto’sprimaryachievementof
preventingusersspendingthesamebitcoinonmultipleoccasions(‘double
spending’)withoutarelianceonatrustedthirdpartyisanhistoricfeat.
However,itisworthemphasizingtheobviousthatthisprotocoldoesnotwholly
eradicaterelianceontrustedthirdpartiesforallfinancialcontracts.Forexample,
escrowmechanismsthatareeasilybuiltusingtheBitcoinprotocolmaystill
requiredisputeresolutionifthereisadisagreementoverwhetherthegoodsor
servicesdeliveredareofsufficientquality.
NeverthelessanescrowtransactionbuiltonaBitcoin-likeblockchaincouldbea
templateforhowfutureinsurancecontractsareconstructed.Theinsurance
buyerandtheinsurancesellercouldtransferthepremiumandthecollateral
respectivelyintoamulti-signature(2-of-3)Bitcoinwallet.Thethirdsignatoryto
thewalletwouldbethearbiter.Fundswouldbereleasedfromthewallet
conditionalon2partiessigningthetransactionpreventingthebuyer,selleror
arbiterfromfraudulentlyseizingthefunds.Thiscantechnicallybedoneby
recordingthe3publickeysinthefollowinglockingscript:
2<PublicKeyA><PublicKeyB><PublicKeyC>3OP_CHECKMULTISIG
Atleast2ofthosepublickeysmustprovidesignaturestoreleasethe
encumbrancesuchasinthefollowingunlockingscript:
OP_0<SignatureA><SignatureC>
Alternatively,becausemulti-signaturescriptscanbecumbersometouseand
takeupsignificantlymorememorythanabasicBitcointransaction,an
alternativewouldbetouseapay-to-script-hash.Thisreplacesthelockingscript
withacryptographichashsuchthatthe‘redeemscript’matchingthathashis
presentedatredemption.
SmartcontractsonEthereum
Buildingthefirstdecentralizedpeer-to-peerdigitalcurrencywassuchastep
intouncharteredterritorythatBitcoinwaspurposefullylimitedforsecurityand
efficiencyreasons.ItsscriptinglanguageisdeliberatelynotTuringcomplete
(abletosimulateothercomputerlanguages)withrestrictedfunctionalitysuchas
aninabilitytoconstructloops.Ethereumisabletoleveragetheachievementsof
Bitcoinandrelaxsomeofitsrestrictionsbybuildinganindependentblockchain
andprogramminglanguagewithgreaterfunctionality.Ifitsucceeds,Ethereum
willbeamorenaturalplatformfortheconstructionofsmartcontractssuchas
insurancecontractsasitisstateawareandblockchainaware.(Thesuccessof
EthereumisnotdependentonitreplacingBitcoin.Manyobserversbelievethere
willbeanumberofindependentblockchainsco-existinginfuturewithlinkages
betweenthem.)NickSzabodefinesasmartcontractas“acomputerized
transactionprotocolthatexecutesthetermsofacontract”.AlternativelyTim
Swansondescribesitasa“simplerulesengine;cryptographicallyassured
businesslogicthathastheabilitytoexecuteandmovevalue”.Similarlyto
Bitcoin,smartcontractsholdthepotentialtosimultaneouslyminimizefraud,
minimizetherelianceontrustedintermediariesandminimizethecostsof
enforcingthecontract.
Ethereumhasbeendescribedasa“worldcomputer”anda“platformfor
platforms”whichmakesiteasytobuildapplicationsforprovidingdecentralized
servicesontheInternet.Applicationssuchasmarketplaces,socialnetworks,
paymentsystems,electionsandassetregisterscanbedeployedonthe
blockchainwithoutneedingtosetupormaintainservers.Thecryptocurrencyor
digitaltokenassociatedwiththeEthereumblockchainiscalledEtherandthisis
usedtopaytransactionfeesand‘fuel’theexecutionofsmartcontracts.Sendinga
transactiontoacontractcausesitscodetoexecuteandthemorecomputationit
requiresthemoreetheritconsumes.UnlikeBitcointhatisprimarilyacurrency
andapaymentsystem,Ethereumprovidesaccesstoavastvirtualmachineable
toreadandwriteexecutablecodeanddatatoablockchain.Itwillenablethe
buildingofdecentralizedautonomousorganizations(DAOs)thatencodethe
assetsandbylawsofanorganizationintoself-enforcingsmartcontractsoffering
thepotentialfora‘minimumviablebureaucracy’.
Theroleoftheclaimsadjuster
Justastheexecutionofastandardescrowcontractwillrelyonanarbiterto
resolvedisputesbetweenthebuyerandtheseller,theexecutionofaninsurance
contractreliesonclaimsadjusterstoverifythatincomingclaimsarevalidandif
necessaryestimatethemonetaryvalueoftheclaim.Thisservicewillvaryfrom
reviewingevidencesubmittedbytheclaimanttophysicallyinspectingthescene
oftheinsuredeventdependingonthemagnitudeoftheclaim.Itiscurrently
difficulttoautomatethisfunctionandartificialintelligenceisnotyetadvanced
enoughtorebuffallhumanattemptsoffraudulentsubmissions.Inthefictional
exampleusedpreviously(‘KnowWhentoHold’Em’),theinsurer(Jonas)hasthe
optiontopayforanauditforeachclaimhereceives.Itisnotclearwhetherthis
auditiscarriedoutbyemployeeshiredbytheMicroriskplatformorexternal
auditors.Areallifepeer-to-peerinsuranceplatformalsohastheseoptionsbut
thereareadditionaloptionsifitaspirestobeatrulydecentralizedplatform
minimizingrelianceonatrustedthirdparty.
Theroleofreputationsystemsindecentralizedapplications
Decentralizedplatformsheavilyrelyontheefficacyanddependabilityof
reputationsystems.TheupsideofbypassingcentralizedservicessuchaseBay,
KickstarterorUberisthatnothirdpartycanchargeexcessivefees,impose
restrictivepolicies,prohibitBitcoinpaymentsorpresentasinglepointoffailure
inthestoringofusers’personaldata.However,thedownsideisthatno
organizationisresponsibleformaintainingtheintegrityofthesystem.Insteada
mixtureofuserfeedback,reputationscoringandfinancialincentivesmustbe
combinedtoconstructrobustreputationsystems.Thealternativeistobuild
quasi-decentralizedsystemsthatmaybeanimprovementoncentralized
systemsbutdon’taccrueallthebenefitsofpurelydecentralizedsystems.For
example,thevariousactivitiesofaninsurancecompanycouldbeunbundledso
thatsomeactivitiesareautomatedwhilstothersareoutsourcedtoexternal
providers.Itmaybethecasethatquasi-decentralizedsystemswillneedtobe
builtasanintermediatesteporthatoptimalsystemswillneverbepurely
decentralized.However,itmakessensetofullyexplorealltheoptionsand
capabilitiesofthisrevolutionarytechnologybeforefallingbackonhowcurrent
systemsalreadyoperate.
Theroleofreputationsystemsinonlinecommerce
OpenBazaarisadecentralizednetworkforpeer-to-peeronlinecommercethat
hasnofeesandcannotbecensored.ItiseffectivelyanamalgamationofeBayand
BitTorrentconnectingbuyersandsellersdirectly.Manyofthecomponentsof
OpenBazaarcontractswillberequiredforinsurancecontracts.Cryptographic
keysestablishidentity,digitalsignaturesproveanidentityagreedtothecontract
andacryptographichashofthecontractactsasatamper-proofrecordofthe
contract.Productsarepaidforusingmulti-signatureescrowcontracts
(explainedearlier)witharbitersdigitallysigningtransferoffundstotheselleror
backtothebuyerincaseofdisagreementoverthequalityorspecificationsofthe
goodsdelivered.OpenBazaar’sreputationsystemreliesonusersratingand
providingfeedbackonotherbuyers,sellersandarbiters.Theratingsofarbiters
anddocumentationrelatingtotheirpriordecisionsareaccessibletobuyersand
sellerssothattheycanagreeonanarbiterpriortothebuildingofthe
transaction.Forexample,documentationmayincludefeedbackfromwinning
andlosingpartiesandevidenceofadherencetodisputeresolutionstandardsto
allowuserstoassessthequalityofpastdecisions.
Theroleoforaclesinpredictionmarkets
AugurisadecentralizedplatformforpredictionmarketsbuiltontheEthereum
blockchain.TheAugurwhitepaperdescribesapredictionmarketas“aplace
whereindividualscanwagerontheoutcomeoffutureevents”.Itiscommonin
financialtradingtothinkaboutmatchingspeculators(investorsseekinggreater
exposuretorisk)withhedgers(investorsseekingtoreducetheirrisk
exposures).Althoughtheremaybesocietalvaluebytappingintothe“wisdomof
thecrowd”,Auguressentiallyprovidesaplatformforindividualstospeculateon
theprobabilityoffutureevents.Buyinginsuranceisgenerallyconsidereda
hedgingactivityassociatedwithadesiretotransferriskexposurestoanother
party.Themajorityofpredictionmarketswon’tintersecttheriskscoveredby
insurancecontractsthoughitisplausiblethattherewillbeoverlapwith
predictionmarketsrelatedtoweatherorearthquakesforexample.
Augurhasasimilarneedfortheequivalentofclaimsadjustorsinthatitrequires
accuratereportingontheoutcomeofevents,aftertheeventsoccur.Forexample,
apredictionmarketonthenextU.S.Presidentrequiresaprocessfordetermining
whowonthepresidencyandthereforewhichwagersweresuccessful.Augur
solvesthisbypre-selling‘Reputationtokens’whichwillgivetheirholdersthe
abilitytoreceiveaproportionofthetradingfeesinreturnforreportingonthe
outcomeofevents.Thesetokenscanbeautomaticallylostandredistributedif
specificholdersfailtoreportcorrectlyonevents.Ratherthanasinglearbiter
beingassignedsuchaswithOpenBazaar,eacheventisreporteduponby
multipleindividualsandthesereportsarecomparedtoestablishthecorrect
outcome.
Reputationsystemsacrossplatforms
Bitratedisbuildingatrustplatformacrossthecryptocurrencyeconomyandthis
willarguablybethemostsophisticatedonlinereputationsystembuilttodate.Its
reputationenginedeterminesaBitratingscoreusinghistoricalratingsfrom
previoustrades,metricsfromonlineaccountssuchasTwitterfollowersor
Redditkarmaandwhatitdefinesasa‘weboftrust’.Thisleveragesthetrusted
relationshipsbetweeneach‘trustagent’sothattheyareabletovouchforone
anothertoincreasetheirBitratingscore.However,ifauseryouhavevouched
forreceivesanegativerating,thiswillalsoreduceyourownBitratingscore.This
incentivizesuserstobecarefulwhomtheyvouchfor.GiventhatBitratedcollects
dataacrossvariousplatforms,itispossiblethatdecentralizedplatformssuchas
OpenBazaarandAugurcouldutilizeBitrated’sreputationsysteminfutureand
converselythatBitratedcouldadjustusers’Bitratingscoresinresponsetousers’
behaviorsonthoseplatforms.TrustagentsonBitratedhavetheabilityto
monetizetheirhighBitratingscoresbyactingasarbitersinthefacilitatingof
transactionsandtheresolvingofdisputes.Bitratedisconsideringchargingfees
tomakeitmorecostlytomanipulateitsreputationsystemanditisalso
conceivablethatreceivingonlinetipsfromcustomersusingmicropayment
serviceslikeChangeTipcouldincreaseyourBitratingscore.
Honinginonthestartupbusinessmodel
In‘ZeroToOne’PeterThielprovidestwoparticularlyvaluablepiecesofadvice
tostartupsseekingtoleveragenetworkeffects.Headvisesstartupsto“dominate
aspecificnicheandthenscaletoadjacentmarkets”.JustasAmazonoriginally
focusedonsellingbooksandFacebooktargetedstudentsatHarvardUniversity,
Ebay“startedbydominatingsmallnichemarketscateringtosmall-time
hobbyists”.Inaddition,Thielrecommendsthatratherthanaimingtodisrupta
market,startupsshouldseektoexpandthemarketoverallandavoidcompeting
withincumbentsheadon.Heedingthisadviceguidesaninsurancestartupto
lookatproductsorservicesthattraditionalinsurancecompaniesareunwilling
orunabletodevelopatthecurrenttime.Insurancecompaniesaretypicallyslow
tocapitalizeonrecenttechnologicaldevelopmentsornewlyaccessibledatain
thedesign,underwritingorpricingofinsurancecontracts.Onepotentially
fruitfulavenueforastartuptoexploreistheroleofinsuranceinthenascent
industryoftheInternetofThings.NotonlyisthereanInternetofThings
prototypebuiltonablockchainbutthisprototypealsoprovidesanopportunity
toautomatethetroublesomeroleoftheclaimsadjuster.
InsuranceandtheInternetofThings
InJanuary2015,IBMandSamsungreleasedaproofofconceptforADEPT
(AutonomousDecentralizedPeer-To-PeerTelemetry),aplatformforInternetof
Thingsdevicesthatisautonomous,decentralized,peer-to-peerandableto
withstandindividualpointsoffailure.Buildingadecentralizedplatformfor
potentiallybillionsofdeviceswasmotivatedbythelimitationsofcentralized
approacheswhicharedescribedasexpensive,lackingprivacyanddifficultto
securewithlimitedscalability.Inaddition,IBMbelievesthateverydevicecould
become“apointoftransactionandeconomicvaluecreation”forownersand
usersand“abletoautonomouslyreacttochangesinmarkets”.Theblockchain
canbeusedasthesystemofrecordforcontractsbetweendevices,theownersof
thedevicesandthemanufacturersofthedevices.Amongthebenefitsofusinga
blockchainforthispurposeareguaranteeddataavailability,datasharing,
uptimeandcodeexecution.Itisatransparentsystemthatassignsusers
pseudonymousidentities.
OneoftheprototypesIBMpresentedutilizingtheADEPTarchitecturewasan
autonomouswashingmachinewhichwasabletodetectafailingpart,check
whetherthefailingpartwasunderwarrantyandplacearequestwiththe
nearestservicevendorwithouthumanintervention.Althoughthisisavaluable
serviceintheconsumermarket,perhapsthegreateropportunityliesinprivate
andpublicsectorsupplychainswhereitisextremelydifficulttoreceiveinstant
updatesonfailingpartsandautomaticallycallonoutstandingwarranties.
Everledgerisanexampleofastartupthatisusingtheblockchaintocreatea
decentralizedownershipledgerforhighvalueassets.Solutionssuchasthiswill
allowownersandinsurerstomonitorthelocationandstatusoffixedassets
simultaneouslytoavoidtheprocurementofunnecessaryreplacementsand
fraudulentinsuranceclaims.
TheADEPTarchitectureusestheTelehashprotocolforsecure,encrypted,
trustlesspeer-to-peermessagingforcommandssuchasstartingawashingcycle.
TheBitTorrentprotocolisusedfordistributedfilesharingforlargerfilessuchas
diagnosticdatadetailingtheperformanceofthewashingmachine.The
Ethereumblockchainisusedfordeviceregistration,contractlookupand
transactionsbetweendevices.Whenthewashingmachinedetectsanairfilter
failureitchecksitswarrantystatusontheblockchain.Ifitisinwarranty,itfinds
anauthorizedserviceproviderwhoisregisteredontheblockchainandplacesa
replacementorder.Theserviceproviderisabletoindependentlylookupthe
deviceIDandthesmartcontractreferencetoverifythatthewarrantyclaimcited
bythewashingmachineisindeedvalid.Theservicecalldetailsarethenreported
totheowner.
Awarrantyisessentiallyaformofinsurancecontract.Althoughamanufacturer
mayofferafreeproductwarrantyforaspecificterm,thepurchasermaychoose
tobuyanextendedwarrantyfromthemanufacturerorathirdparty.This
extendedwarrantycontractcanberecordedontheblockchainandintegrated
intotheADEPTprototypesuchthatthewashingmachinecheckstheextended
warrantystatusinthecaseofanexpiredwarranty.Iftheextendedwarranty
contractincludesadeductibleintheeventofaclaim,thisdigitalpaymentmaybe
madeautomaticallyovertheblockchaintotheinsureratthepointthecontractis
triggered.IBMwillbesharingthecodedevelopedaspartoftheADEPTproofof
conceptatalaterdateandisdevelopinganAPIsuitefortheADEPTcorestack.
Asmoreapplicationsarebuiltandmoreassetsareregisteredtotheblockchain,
theopportunitiestoattachinsurancecontactswillmultiply.
Whyshouldwepursuedecentralization?
Therearetwomainargumentstopursuedecentralizationandtheyrevolve
aroundriskandinnovation.Thesearegenerallyperceivedascompetingforces
withinnovationintroducingnewandinsomecasesunforeseeableriskstoa
companyoranindustry.However,decentralizationcanopenupopportunities
forpermissionlessinnovationattheedgewhilstalsodecreasingthefragilityand
riskofcollapseofthesystem.Ahighlycentralizedsystemonlyallowsinnovation
whenpermissionisgrantedbythecentralparticipant,requiringanalmost
clairvoyantprescienceinthefutureofinnovation.Insuchasystem,humanbias
andself-interestatthecentercanpreventvaluableresearchanddevelopment
frombeingadvancedandexcessivefeescanbechargedtoevenparticipateinthe
system.Similarly,acentralizedfinancialsystemrequiresexecutivesand
regulatorstohaveaclairvoyantprescienceinspottingfuturebubbles,predicting
whichemployeeswillengageinfraudulentactivitiesandwhichlatentrisksare
hiddeninhideouslycomplexderivativeportfolios.Unsurprisinglytheyhavenot
beenuptothetaskandthefinancialsystemhaslurchedfromonecrisisto
another.Adecentralizedsystemdoesnoteliminatehumanbiasorself-interest
butitpreventsdownsiderisksfrombeingconcealedandconcentratingatthe
centerthatcancauseentiresystemstocollapse.Participantscanunilaterallyexit
andthesystemcarriesonregardless.Inadditionstoringcustomerdatawith
trustedthirdpartiespresentsasinglepointoffailurethathasbeenexploitedby
hackersoncountlessoccasions(Target,Sony,etc).
InsuranceandBigData
Thevolume,velocityandvarietyofdatageneratedbydigitaldevicespresents
variousopportunitiesforinsurancecompaniessuchasadjustingpolicyholders’
premiumsandcoverageinrealtimedependingonthepolicyholders’latest
behaviorsandrisklevels.Forexample,telematicsenablethemonitoringofa
policyholder’sdrivingtocontinuouslyreassesstheprobabilitythattheywillbe
involvedinacaraccident.Inaddition,companiessuchasCounsylrelyonits
customerbasebecomingmoreriskawareandmoreriskliterate.Counsyloffer
individualsandfamiliesaccesstogranulardataabouttheirbodies,theirhealth
andtheirgenetics.Thisaccesstonewsourcesofdatawillimpactlifechoicesand
futureinsuranceneeds.Itiscriticalthattheenduserunderstandsthe
implicationsoftheseresultsifthisisgoingtoleadtomoreinformed,riskliterate
decisions.Unlessthislitmustestismet,thenewsourcesofdatawillhavelittle
value.
Thepublicperceptionoftheinsuranceindustry
BuyinglotteryticketsandgamblingatresortslikeLasVegasandMacauare
immenselypopulardespitegamessuchaslotteries,rouletteandpontoonbeing
simplegameswithfixedodds.Theirpopularityreliesondistraction,delusion,
glamourandexpertmarketing.Sportsbettingatleasthasvariableoddsbuthow
manygamblersspendthetimetoconsidertheodds,stakesandpayoffsoftheir
ownlifedecisionswiththesamevigorthattheyconsidersportsoutcomes?
Financialtradingreliesonjudgmentandtechnicalanalysisinthelongtermbut
intheshorttermitisessentiallyspeculatingonthedirectionandspeedofthe
herdofhumans,algorithmsandbots.Incomparisoninsurancegenerallyhasa
publicperceptionofbeingdullandmandatory.However,notonlydoesitrequire
theevaluationofuncertainvariableoddsforadiverseassortmentofrisks,itis
alsoapublicgoodprovidingamechanismfortransferringrisksfromthose
unableorunwillingtobeexposedtothem.Itencouragesustodiscardmythsand
superstitionsandmentallyprepareforawiderrangeofoutcomes.Itemboldens
ustolivericher,moreadventurouslivesandaddressvividdownsiderisksrather
thanworryingobsessivelyaboutthem.Avalidcriticismofinsuranceisthatitis
bureaucraticandsubjecttocomplex,onerousregulationandthisleadsto
insurancepremiumsbeingmoreexpensivethantheyneedtobe.
Conclusion
Althoughprivateblockchains(or‘permissioneddistributedledgersystems’)are
usefulforkeepingdatabasesinsyncinamoretrustedenvironment,theyarean
incrementalinnovationwhencomparedtothepotentialofpublicblockchains.
JustasBitcoinopensthefloodgatesforpeer-to-peertransactionsand
permissionlessinnovation,peer-to-peerinsuranceleveragingasmartcontracts
protocolsuchasEthereumcouldprovideaplatformformatchinginsurance
buyersandinsurancesellersforanyrisktheyagreetoexchange.This
marketplacewouldbearadicalparadigmshiftfromtoday’scentralizedand
spatiallyanchoredinsuranceindustry.Theblockchainprovidestheopportunity
tobuildamoreinnovative,expansiveandtransparentindustrythatevolvesto
theneedsandrequirementsofitsusers.Z/Yenbelievesthattheroleofthe
insurercouldshiftfromacceptingriskexposuresontoitsbalancesheetto
providingexpertadviceandmanagementofvariousmechanismsforits
customerstoretain,shareandpoolriskexposures.Thisprojectaimstobuilda
riskmarketforthedigitalageandthiswhitepaperisthebeginning.Please
contactmeifyouwouldliketoparticipate.
Glossary
Bitcoin–Adigitalcurrencyandpeer-to-peerpaymentsystemthatenables
instant,globalpayments.Userscantransactdirectlywithoutrequiringan
intermediarysuchasabankinginstitution.Transactionsareverifiedbynetwork
ofcomputers(miners)andrecordedintheblockchain.Thereisnocentral
authorityandanychangestothesoftwaremustbethesupportedbythemajority
ofthenetwork’sparticipants.Theopensourcesoftwarewasreleasedin2009.
Blockchain–Aledgerordatabaseofeverytransactionmadebyparticipants.
Transactionsareverifiedusingcryptographyandcollectedintoblocksof
transactionsthatareconfirmedusingdecentralizedconsensusacrossthe
network.Thiseliminatestherelianceonatrustedthirdpartytovalidate
transactions.AlsoseePermissioneddistributedledger.
Claimsadjuster–Alsolossadjuster.Assumestheresponsibilityofscrutinizing
insuranceclaimstodeterminetheextentoftheinsuringcompany’sliability.This
includesverifyingthattheclaimanthasnotviolatedthetermsofthecontract.
Cryptography–Theencipheringanddecipheringofmessagesinsecretcode.
Bitcoinusespublickeycryptographythatallowstransactionstobesignedwitha
privatekeywithoutexposingtheprivatekey.Thenetworkcanvalidatethatthe
transactionwassignedbythecorrectprivatekeybutcannotdecipherwhat
alphanumericcharactersmakeupthatprivatekey.Minerscompeteforthe
rewardsofnewlymintedbitcoinbysolvingcryptographicpuzzlesthatcollect
groupsoftransactionsintoblocks.
DAO–DecentralizedAutonomousOrganization.Theassetsandbylawsofan
organizationareprogrammedintosoftwarecodethatisself-enforcing.Ithasthe
abilitytoexecuteandmovevaluewithoutanycentralcontrol.Alsoseesmart
contract.
Deductible–Theamountthatmustbepaidbyoutofthepocketofthe
policyholderintheeventofanyfutureclaim.Theinsurerwillcompensatethe
claimantforvalueabovethisdeductibleamount.
Digitalsignature–Thesecuredigitalequivalentofsigningacheck.TheElliptic
CurveDigitalSignatureAlgorithm(ECDSA)ensuresfundsareonlytransferred
bytheowneroftheprivatekey.Theprivatekeyisusedtogeneratethe
signatureandthepublickeycanbeusedtoverifythatthissignatureisvalid.
AlsoseeCryptography.
Ethereum–Aworldcomputerorplatformforplatformsthatmakesiteasyto
buildapplicationsforprovidingdecentralizedservicesontheInternet.Unlike
Bitcointhatisprimarilyacurrencyandapaymentsystem,Ethereumprovides
accesstoavastvirtualmachineabletoreadandwriteexecutablecodeanddata
toablockchain.
Escrow–Acontractualarrangementinwhichfundsaretraditionallyplacedin
thecontrolofanindependentthirdpartytoprotectbothbuyerandseller.The
fundsarereleasedonthecompletionorterminationofthetransaction.Notethat
withmulti-signatureBitcoinescrowcontracts,thethirdpartyisunabletosteal
thefundswithoutthecomplicityofeitherthebuyerorseller.
InternetofThings–Anetworkofphysicalobjects(e.g.lightbulbs,heaters)
withembeddedsoftwareandsensorsthatareconnectedtotheInternet.This
enablesthemtosendandreceivedatawhilstbeingcontrolledremotely.
Multi-signature–Anaddressthatisassociatedwithmorethanoneprivatekey.
Transactionsmustbesignedorauthorizedbymultipleprivatekeys.Anm-of-n
addressisassociatedwithnprivatekeysandrequiressignaturesfromatleastm
oftheseprivatekeystotransferfunds.
Permissioneddistributedledger–Aprivateblockchainthatlimitsaccess
and/orrighttomodifytospecificusers.Incontrastanyonecanread,senda
transactionorparticipateintheconsensusprocessonapublicblockchain.
Reputationsystem–Amechanismforcollecting,aggregatinganddistributing
feedbackaboutusers’pastbehavior
Smartcontract–Acomputerizedtransactionprotocolthatexecutesthetermsof
acontract.Thesoftwarecodeiscapableofholding,transferring,receivingor
spendingdigitalassets.
Sybilattack–Anattacktoundermineareputationsystembycounterfeiting
multipleidentitiesandusingthemtodisproportionatelyinfluencethenetwork.
Turing-complete–Aprogramminglanguageabletosimulateanyother
languagewithconditions,loopsandread/writememory.
Wallet–Afilethatstorestheprivatekey(s)thatauserneedstotransferfunds.
Thereareweb,desktop,mobile,hardwareandpaperwalletsthatoffervarying
tradeoffsbetweensecurityandusability.
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