Re-Imagining InsuranceTech

Insurance, The Blockchain, and The Sharing Economy: Re-Imagining InsuranceTech with P2P Social Insurance Networks on the Blockchain.

We all want to help one another. Human beings are like that. We want to live by each other’s happiness – not by each other’s misery. We don’t want to hate and despise one another. In this world there is room for everyone. And the good earth is rich and can provide for everyone. The way of life can be free and beautiful, but we have lost the way

Charlie Chaplin, the Great Dictator

Insurance Origins

“Friendly Societies” or “Collaborative Communities” was the original model of the insurance business. However, the modern problems associated with the insurance business can be somewhat attributed to corporate centralization, state controls, and constructive policy decisions.

Essentially, the development of the modern business of insurance started, and is largely dependant on a “hedge” or bet against risks, especially regarding cargo, property, death, automobile accidents, and medical treatment, which can be attributed, historically, to “Mutuals” which were formed by fire fighters, farmers and other groups to share in their losses and gains. The early peer to peer nature of industry helped to eliminate risk, and spread said risk from the individual to the larger community. This provided an important source of long-term finance for both the public and private sectors. [01]

Before the development of large-scale government, employer health insurance programs, and other financial services, friendly societies played an important part in many people’s lives. Many of these societies still exist. In some countries, some of them developed into large mutually run financial institutions, typically insurance companies, and lost any social and ceremonial aspect they may have had; in others incarnations, they continue to have a role based on solidarity and democracy without an objective to make profit.

Take for example the early cases of medical insurance, especially in America, members typically paid regular membership fees and went to lodge meetings to take part in ceremonies. If members became sick, they would receive an allowance to help them meet their financial obligations. Typically in member/friendly societies, members of the group would visit sick peers to give emotional and other support, and possibly to verify that the sick member was not malingering, “Malingering” is fabricating orexaggerating the symptoms of mental or physical disorders for a variety of “secondary gain” motives, which may include financial compensation (often tied to fraud)[02].

Eventually, The shift away from the decentralized nature of insurance—to a system of paying for a company to take on that risk—had resulted in expensive premiums, fraud, incomplete information on policyholders, and the moral hazards of coverage.

I would propose that by going back to the roots of insurance, coupled with a few modern technology networks and protocols namely; the internet, social networks and the blockchain, We can provide an new approach to an old world system that will mitigate risks, reduce costs, and ultimately provide better service to a broader range of people worldwide. The peer group, enabled by the internet, social networks, and the blockchain can self insure to a point and partner with either an insurance carrier or reinsurance organization to deal with almost any type of insurance from the simple protection of valuables to really catastrophic and unexpected losses.

The Sharing Economy

It can be argued that the most valuable companies, and fastest growing of recent time, can be attributed to a group of startups that primarily focused on monetizing unused or underused inventory leveraged through online networks. By creating a marketplace and the ability to discover these unseen “assets” companies like AirBnB, Lyft, and Uber have dramatically reshaped the landscapes of their respective industries, creating a new category called the “Sharing Economy”.

The Sharing economy refers to peer-to-peer-based sharing of access to goods and services (coordinated through community-based online services).[1] Sharing economy can take a variety of forms, including using information technology to provide individuals, corporations, non-profits and governments with information that enables the optimization of resources[2] through the redistribution, sharing and reuse of excess capacity in goods and services.[2][1][3] A common premise is that when information about goods is shared (typically via an online marketplace), the value of those goods may increase for the business, for individuals, for the community and for society in general.[***]

Collaborative consumption as a phenomenon is a class of economic arrangements in which participants share access to products or services, rather than having individual ownership.[03]

The concept of the sharing economy applied to insurance, can be a relevant premise, provided that it can deliver greater value to consumers while at the same time enabling large insurance companies to transform, sustainably to market transitions, and or enable themselves to participate in said market transformation, while at the same time opening themselves up to new, and/or previously unviable markets, through the scale of the system.

The value of P2P social insurance networks enabled by the blockchain is that it can draw on the benefits of decentralization, prediction markets, decentralized autonomous corporations,  social networks and traditional insurance to create a superior product, by streamlining information, accessing underserved markets–viably, more accurately assess risk, as it can be market driven, and through dramatic cost reductions.

With more than seven billion people living in the world today, we’re realizing the importance and benefits of sharing. While most of the applications available now are fueling the shared economy, many of them use some sort of middleman. The inherent nature of the blockchain is that it allows people to manage and share their wealth without any intermediaries, with greater transparency, transnationally, and with market and network consensus on truth. This translates, simply, to efficiency, trust, and risk mitigated cost for both individuals and organizations.

Through social networks and decentralized autonomous corporations/organizations, a known, or unknown group of people, organized by interest or demographics can select its own members without being regulated by government bodies that have restrictive legislation; can then invite only those individuals who are more likely to be better risks because they are generally known – either in person or through social networks – to other members of the group.

This screening can prevent more risky participants to join the peer group and hence reduce the frequency and severity of events or claims eg. If the costs for everyone else in the group depend in part on one’s behavior, the group has an incentive to encourage one to act in a way that reduces the likelihood that any of us have a claim, when a lot of groups aren’t filing claims, that lowers the cost to all  purchasing insurance.[04] Moreover, it’s not just policyholders who are benefiting from the social insurance model. Insurance companies stand to benefit as well.

I propose that under a P2P model, Insurance companies can expect happier, more loyal, and more engaged pool of customers, because they’re partaking in a more pleasurable user/customer experience, as the platform/marketplace is dis-intermediated, thus reducing the onerous task of acquiring insurance, as well as realizing tangible savings. This can only invariably lead to high overhead costs, particularly on fraudulent and small claims, shrink, while driving scale.

P2P Insurance

Innovators the world over are looking at ways to leverage the power of your social networks, and increasingly now the Blockchain, to reduce and distribute costs, provide more accurate, albeit market driven risk mitigation, while at the same time bypassing onerous regulatory impediments.

In today’s peer-to-peer models, insurance policyholders form small groups online. A part of the insurance premiums paid, flow into a group fund, the other part to the insurer. Minor damages to the insured policyholder are firstly paid out of this group fund. For claims above the deductible limit the regular insurer is called upon. When there is no insurance claim, the policyholder gets his/her share refunded from the group pool, or credited towards the next policy year. If the group pool happens to be empty, a special insurance comes into force[05]

A group can be set up by the policyholders, forming an “social insurance network”.The only requirement is that all group members must have the same type of insurance. Examples are liability insurance, household contents insurance, legal expenses insurance and electronics insurance. The peer-to-peer insurance concept carries no costs other than the special insurance. The providers are financed through brokerage commissions of insurance, in this case through a decentralized autonomous corporation existing within the blockchain.

Insurance rates are determined by how risky insurance companies think it is to cover you, or in tandem with what a second group of peers “predict” or assess your risk is based on thier  based mostly on demographics, location, lifestyle and history. (More on this below in Prediction Markets). The fewer claims your group has, the less money you’ll spend with peer-to-peer insurance.

The goal of social insurance, in the context that I’m proposing, is to give people more control over potential insurance costs, arrive at a market derived risk assessment through prediction markets, cover deductibles, encourage safe behavior, lower rates and administrative costs, while at the same time by-passing staid regulation. The natural fit for this model is to utilize aspects of the blockchain, that can reduce friction in the transaction process, while providing a higher degree of information flow and market dynamics to drive out costs and promote adoption.

The Blockchain and Insurance

As I mentioned above, exploring how blockchain technology can interact with insurance, has become an endeavor that has led me to talk to many industry professionals, as well as entrepreneurs looking at possible implications in terms of the relationship between individuals, insurance and insurers; and current perspectives on the relevance and potential of blockchain technology. I have tried to distill as many concepts, or at the least the core elements here to describe, the discussions, however I would disclose that my views are skewed towards the challenger, with hopes that collaboration can create shared value for both the incumbent and challenger, but with aims to provide insurance products to markets that have been historically underserved–primarily the underinsured and uninsured.

Blockchain technology’s main innovation is an electronic public transaction record of integrity without central authority. Beside cryptocurrencies and distributed payment systems, blockchain applications could include areas of finance where a central, trusted third party has traditionally been used eg. escrow accounts, trade finance, and in this case insurance.

Blockchains can contain set of documents, record assets and help to manage interconnected devices. Emerging applications, such as smart contracts and decentralised autonomous organisations, might in future also permit blockchains to act as automated agents.[05]

Blockchain technology has the ability to transform the very way people engage and conduct finance, and close the gap, or make irrelevant the divide between global and local in payment and processing times; influence consumer perception of value added services; drive honesty and transparency; and, influence consumer perceptions of risk that could change the way insurers support mutualisation.

Non-insurers are more likely to be the first to create insurance or insurance-related applications. As we see with the innovative startups “Guevara”, and “Friendsurance”. However, I believe that companies of this nature can go even further, if enabled by Blockchain applications, and I expect to see more experimental startups add in enhancements to thier platforms that are likely to start with self sovereign digital identity systems, proof of existence functions and zero knowledge proofs to manage personal property and data.

Emerging Blockchains and Applications

Blockchain technology has the potential to enhance and create transformative financial services applications, including insurance. Through distributed applications hosted on decentralised platforms, such as: Bitcoin, the first blockchain protocol released in 2009; Ethereum, an open platform which could host distributed applications, namely smart contracts; “Bitshares” which boasts transaction speeds approaching Nasdaq; Eris, an Ethereum “Fork” and blockchain-manufacturing and management toolkit; or the much anticipated “Rootstock”, a smart-contract peer-to-peer platform built on top of the Bitcoin Blockchain, a more recent project which aims to provide Ethereum capabilities on top of the Bitcoin blockchain.

I’m eager to see how companies can support the automation of insurance products based on betting- like insurance products and financial derivative utilizing a platfom like Augur to integrate prediction markets into thier transacation process (more on this below)

Moreover, blockchain technology and distributed applications open up the range of assets and information that can be managed and stored on and from the blockchain, some of which can be relevant to insurance.

Interesting models include applications to create or store genetic and medical record data using for example Genecoin, which allows individuals to securely back up their own DNA by recording it on the blockchain or, DNA.Bits which aims to provide access to large samples of anonymised medical records and genetic data through the blockchain.[06]

Third, new insurance solutions could emerge to handle risks arising from blockchain technology usage (e.g. account hacking on exchange where individuals can buy AltCoins to participate on a blockchain), digital asset protection or even in relation to the security of Internet of Things solutions, depending on demand (i.e. the extent to which individuals want to outsource emerging risks to third party providers) and feasibility.[07]

Self Sovereign Identity

Blockchain technology and related applications can transform the way insurance companies manage and facilitate digital identity (ID), personal information and history. An ID scheme relying on a decentralised blockchain combining a public ledger of records with an adequate attestment and zero knowledge proofs, as I mentioned in a previous post could rival state-backed identity (which is generally checked against other databases, uses biometric data and is backed by law) in terms of security through decentralisation and cryptography.[08]

A number of digital ID schemes are emerging, including ONENAME, and OpenID Connect, a protocol combining an identity layer and an authorisation server, which allows clients of all types (e.g. developers) to request and receive information about authenticated session and end-users across websites and apps without having to own or manage password files.[09]

Creating a self sovereign  digital ID that is trusted and can be used widely,  In practice,  would be a blockchain-based identity scheme that could take the form of a distributed application hosted on a blockchain protocol which could use arbitrators i.e. pre-determined experts authenticating documents or information submitted) or oracles allowed to cross-reference information securely with other data sources, including government attested documents

The application could enable additional functions including personal data storage, authorised access frameworks for external providers or even reputation ratings, most probably through connected social media, or transaction history etc..

Combining authentication and personal data management functionalities with decentralised and secure blockchains could lead to new frameworks for identity management.

In insurance, the streamlining of digital authentication and better management of personal data and history disclosure could translate into more direct and efficient relationships between insurance companies and individuals.[10]

Market Scale and Reach

Blockchains are distributed across networks of computers, themselves distributed across space. Blockchain technology has the potential to shape different interactions between individuals and places, further blurring the divide between local and global.[11]

Blockchain technology and related applications can be global in scope and in scale as to some extent the only requirement from a user perspective is to have a computer, smartphone an Internet, or wifi connection.

This scale and potential access to underserved regions of the world could support the tailoring of insurance products that are specifically designed where there is not sufficiently strong market demand (historically for legacy system) or enough quality data (e.g. creditworthiness).[12]

Where this can be directly applicable is Microinsurance, which is insurance characterized by small premiums and claim amounts, is an important risk management tool for the unbanked and uninsured in emerging markets around the world.  Billions of individuals around the world do not have access to basic financial services such as banking and insurance.  Access to this market has been hindered primarily by transaction costs and lack of verifiable and credible identification.Moreover, given my inclination to disruptive innovation, this falls directly in line with the now common understanding of a valuable form of innovation that incumbents should surely watch out for. The Notion that people can contract with each other round the globe using robust technology. More material in that people can handily set up local insurance vehicles easily. The mid-ground might be many local vehicles sharing global reserving or reinsuring facilities.

Widely distributed social insurance platforms, provided they get the scale and breakout velocity they need to reach these underserved markets could also see blockchain-based risk management models emerge, if not intended,  including self-managed or administered risk protocols, peer-to-peer insurance platforms and even fully funded solutions. Over time disintermediation could take place as a result of automation, particularly for well known and perhaps more common risks.

Blockchain technology could support the rise of peer-to-peer insurance platforms and thus contribute to enabling self- and mutual- risk management frameworks. Distributed mutualisation combined with the ‘wisdom of crowds’ could support efficient claim management and fraud reduction.Further, such insurance mini- mutuals might increase the need and spread but perhaps reduce the size of typical reinsurance. Blockchain-based solutions could help to automate and achieve efficiency gains by using smart contracts, which in turn could lead to self-administration of certain insurance products, such as betting-like insurance products or hedging mechanisms (e.g. prediction markets). [13]

This is not a likely scenario in the near-term, but one could imagine a DAO contained in a completely automated blockchain. Customers would no longer rely on intermediaries, rather wholly on the technology and its persistence. Where the blockchain provides a platform for participants to take on pre-determined risk and manage it, possibly in conjunction with expert advice. As a result, in such instances, insurance companies’ role is likely to evolve from that of risk handlers to one of risk management advisors.[14]

As a result, the technology and its applications could eventually contribute to changing the role and function of insurers in society. Blockchain technology and distributed applications could for example support access to affordable and quality insurance products through distributed micro-insurance solutions combined with mobile technologies; or, by extending insurance product coverage to previously excluded populations, provided that adequate identity and information management functionalities (e.g. notary or personal data management function) are in place.[15]

Taking the concept of decentralised blockchain operated platforms further could lead to the emergence of decentralised marketplaces where insurance companies compete to meet the needs and requirements of clients or groups of clients whether in terms of insurance products or risk management expertise and advice.

Should this materialise at scale, the shift in insurers’ role from risk handler to expert advice and knowledge provider in relation to direct risk management (including preventive measures) is likely to be reinforced.[16]

Innovation and the Battle for the Future

Incumbents, or those in the industry that have come to sustain their lives and or business from the existing state of being, and the challengers who provoke thought and change within the landscape; think of the blockchain technology and related applications as something that could radically change the nature and scope of the insurance industry. While Incumbents are skeptical, yet curious, they lack the courage to make the required experiments that will provide the necessary transformation that will provide“competitive sustainability”. Challengers on the other hand, see the blockchain and the insurance landscape as fertile ground to experiment with new models, and revolutionary missions, that change the very notion of what insurance is, and can be, for a wider group of people around the world. Through disintermediation of the industry, the emergence of new actors, primarily small, innovative entrepreneurs, technologists, and startups are investigating distributed peer-to-peer insurance platforms, encouraging and empowering the self-management of; self-sovereign identity, risk verification, social networks, and collaborative consumption, thus contributing to changing the role of insurers to an actor in an ecosystem, as opposed to the centralizing force that controls and shapes the market.

For innovators, either in startups or incumbent companies, the blockchain is an exciting and positive development, however for those who do not understand the truly transformational potential of this technology, and the platform for creativity that can bare to be, it is a dangerous technology which will incur unintended consequences, mostly perceived as detrimental to the status quo.

Change is inevitable, in what incarnation that brings is unknown at this time, however, we know that it will radically change the notion of what insurance is, how it is delivered, and who it is delivered to, and under what circumstances. The landscape of the industry will change with the onset of blockchain technology, but in what form, will largely be determined by those innovators who successfully experiment with the technology and what their ideological perspective is, in deploying the technology to achieve their objectives. When the blockchain takes hold of the Insurance industry, and related applications emerge within markets known, and to be revealed; this will fundamentally change and open the market(s) to new third party providers/constituents other than insurers. The most likely, under the model I’m porposing, is crowds acting as markets that will shape the nature of the services and products. Some degree of centralisation is likely to stay, however, I believe that “swarms” or decentralized groups aggregating in collaboration, will most likely replace the centralizing economies of scale that have been the predominant nature of the industry up until this day. The emergence of peer-to-peer insurance platforms where perhaps the only aspect of the market that is ‘centralized” will be autonomous agents that provide the commercial touchpoint for the ecosystem to work effectively.

While blockchain technology offers dynamic and unknown prospects for the future of the Insurance industry, the most challenging, and disruptive elements exist within the context of the surrounding the legality and regulation of the related decentralized applications that make the entire technology relevant.

Decentralized Autonomous Insurance Brokerage

Decentralized Autonomous Corporations, “A ÐAO is an algorithmically-governed programme that, in using trustless decentralised computing, can serve as a way to formalise multilateral relationships or transactions outside of traditional legal architecture. These automatons exist entirely as decentralized networks over the internet, carrying out the computations that keep them “alive” over thousands of servers that live entirely on the cloud and yet control powerful financial resources and can incentivize people to do very real things in the physical world[17] and or Smart contracts, are like an autonomous agent that runs a certain piece of code every time a transaction is sent to it, and this code can modify the contract’s internal data storage or send transactions. Advanced contracts can even modify their own code. Smart contractsare an idea that has been around for several decades, but was given its current name and first substantially brought to the (cryptography-inclined) public’s attention by Nick Szabo in 2005. In essence, the definition of a smart contract is simple: a smart contract is a contract that enforces itself.[18] these applications are built “on top’, but more accurately within the blockchain network, which would facilitate a Peer-to-peer transaction network, processing reputation through prediction markets, and execute the tenets of a policy for a group, or pool of consumers is a new approach to the already innovative P2P insurance concept. It endeavors to create a free-market environment for insurance seekers, and insurers, while at the same time providing a third group of speculators the ability to manage risk prediction market based reputation.

By design, Insurance inherently becomes a matching market of sorts, where users have a notion of the risk and coverage of the “pool” or “group” and creators have a notion of price, and can participate in the underwriting in conjunction with an insurance company, or many.

In this scenario, there is minimal intermediation–which drives down costs for all parties, there is no centralized authority that sets value, the social network becomes a true, decentralized market guided by its users. See the essay Formalising and Securing Relationships on Public Networks by Nick Szabo to learn more on the subject.[19]

Nick Szabo uses the example of a vending machine:

A canonical real-life example, which we might consider to be the primitive ancestor of smart contracts, is the humble vending machine. Within a limited amount of potential loss (the amount in the till should be less than the cost of breaching the mechanism), the machine takes in coins, and via a simple mechanism, which makes a freshman computer science problem in design with finite automata, dispense change and product according to the displayed price. The vending machine is a contract with bearer: anybody with coins can participate in an exchange with the vendor. The lockbox and other security mechanisms protect the stored coins and contents from attackers, sufficiently to allow profitable deployment of vending machines in a wide variety of areas.

Smart contracts are the application of this concept to, well, lots of things. We can have smart financial contracts that automatically shuffle money around based on certain formulas and conditions, smart domain name sale orders that give the domain to whoever first sends in $200, perhaps even smart insurance contracts that control bank accounts and automatically pay out based on some trusted source (or combination of sources) supplying data about real-world events.[21]

As you can see from above, Smart contracts are modular, repeatable, autonomous scripts, which can be used to build applications for yourself, for a community, for a client, for a bounty, or even for autonomous, self executing insurance policies.

Smart contracts can be coded to reflect any kind of business or engineering logic which is data-driven: from actions as simple as up-voting a post on a forum, in this case a prediction market tied to risk of the policy, or to the more complex, such as loan collateralisation and futures contracts, to the highly complex such as repayment prioritisation on a structured note.

By building business logic in smart contracts, developers (and lawyers) can give their users and clients an increase in the verifiability and certainty which comes with distributed technology while simultaneously building a system of rules which will be structured so that it can supersede regulation, as in the case of cross-state insurance regulation in the United States, as well as provide clear self-execution procedures for consumers to enable the automation of insurance brokerage.

What about the brokers as they exist right now you might ask? Let us step back for a moment from the specifics of smart contracts and think about a commercial deal which will involve many entities of different data-driven interactions within the market and the life of the application. How innovators for the commercial entities would likely structure the administration of the data driven aspects of the deal would be to establish a tracking system which is completely under the control of that commercial entity and, perhaps, provide some programmatic interface for others to query records or send new information regarding a record. It is likely that each of these dozen commercial entities will each establish a similar system to monitor and track the data interactions over the course of the deal. Therefore, in the case of the brokers, their role, as with the role of the insurers and everyone else on the network their actions will change, their competencies will need to change, but fundamentally, they will be required, however in a largely different capacity. It can be imagined that their role will essentially be the same, however, their efforts may be directed and facilitated through social media, or digitally, as a way to engage uninsured, or underinsured candidates to sign up to pools. They would become actors in the digital space that would be compensated for their ability to onboard constituents to the platform.

This is where the execution certainty of smart contracts married with the historical transaction certainty of a blockchain should become increasingly interesting for commercial players, now and into the future. If the commercial entities were wise about how they structured the deal, they could track all of their data-driven interactions on a smart contract-enabled blockchain without having to build twelve different systems, ensure their interoperability, and expend labour-time to appropriately categorize and file relevant transactional data. Every entity having access to the blockchain will be able to completely verify the entirety of the interactions as well as the entire history of the data set, which would be automatically maintained over the life of the deal and summarised at its conclusion.

While the different commercial entities may be legally incorporated and would not be required to move to a completely trustless system of the kind described above, they would all experience significant cost savings from the increased verifiability and automation a blockchain-based smart contract system would permit.

Mitigating Legal, Regulatory and Policy Frameworks with Smart Contracts and DAOs
Smart Contracts: self-enforceability vs. legal enforceability

Smart contracts also eliminate the need for trust amongst the parties, who can be sure that the contract will be performed exactly as agreed.  Indeed, as opposed to traditional legal contracts, smart contracts are always and necessarily deterministic – i.e. all possible outcomes of the contract (including penalties for breach of contract) must be explicitly stipulated in advance — something akin to what liquidated damages clauses and letters of credit do in the paper world..[22]

Discussion is currently very focused on the technical aspects of smart contract deployment and their implementation within a particular technological framework. Smart contract proponents claim that many contractual clauses could be made partially or fully self-executing, self-enforcing, or both. Smart contracts aim to provide security superior to traditional contract law and to reduce other transaction costs associated with contracting. Some even propose a future where self-enforcing algorithmic law would supplant traditional law.

Yet, many people forget that these applications are meant to operate in a world that is regulated by traditional rules of law. While smart contracts are increasingly able to handle complex deal logics, many kinds of transactions do – eventually – have to interface with the “real world”.   It is at those “choke points” that the legal system will ultimately have a say in the context of a breach.

In this regard, one important question is to determine whether smart contracts are in fact actionable in the real world. While they can be regarded, at their core, as a written contract drafted in a computer language,  it is not clear – at this date – whether their code is “legally binding” upon the parties interacting with these contracts. Legal enforceability would essentially allow for only the main-case set to be handled by smart-contracts, leaving the edge-case set to be handled by the courts.[23]

Most importantly, in many real-world situations, contracts are performed without the need to be enforced by law, as the threat of one party resorting to the legal system is sufficient for the other party to comply with the contracted terms. In order to be as effective as their traditional counterparts, smart contracts must therefore also be actionable in the real world. This might, of course, requires them to comply with all the standard formalities required for a court to enforce a contract under the law.

I would propose through another interesting blockchain company and tool developerEris Industries, a way to extend the reach of blockchain-based transactions by having smart contracts render into conventional legal documents. This allows for the smart contracts (as the administration layer) to remain simple, while relying on the legal contracts (as the enforcement layer) to handle the edge cases.

Dual Legal Integration

Dual integration is the process of integrating a specific legal contract (which can be built with Legal Markdown or any other contract building system) into a specific smart contract which runs on a distributed data store such as Eris Industries’ [24]

The idea of dual integration is to allow users to be able to have the certainty of having a real world contract which can be taken to a court and enforced using established dispute resolution processes in the jurisdiction(s) of the user(s) while also using a smart contract as the primary mechanism for administering the data-driven interaction which attends to the agreement between the parties.

For another system which is also seeking to bridge this gap see Primavera de Filippi’s Draft Legal Framework For Crypto-Ledger Transactions.[25]

The reason Eris Industries recommends to all users of Distributed Technology, and particularly smart contracts, to dual-integrate their smart contracts with real world legal contracts built by lawyers qualified in the jurisdiction(s) that will be relevant to the agreement, is simple. Smart contracts are necessarily limited.

As they are, at their core, just scripts which live in a distributed data store, the pure code of a smart contract has a limited ability to “reach” outside the context of their data store to incorporate a legally-binding contractual understanding. While they are capable of being structured in a manner which would automatically administer a data-driven interaction and ensure harmony of the data set in which the smart contracts reside (if they have permissions to do so),judges are unlikely, for the foreseeable future, to be able to easily resolve disputes stemming from smart contracts solely on the basis of their coded parameters (meaning without an integrated legal contract) without simply applying the commercial defaults for the agreement in the jurisdiction – an end that is unlikely to reflect the intention of the parties to the agreement in question. For these reasons of the limited reach of smart contracts and the limited enforceability of smart contracts, we highly encourage all smart contract systems developers to utilize dual integration of some kind.

Risk and Transactional Insurance Prediction Markets

Market-based principles can be used to manage the risk of distributed peer-to-peer transactions. This is demonstrated by PTRIM, (Peer-to-Peer Transaction Risk Management) a system that builds a transaction default market on top of a main transaction processing system, within which peers offer to underwrite the transaction risk for a slight increase in the transaction cost. Essentially a Peer-to-peer prediction network to facilitate the truth of market/network risk and reputation in processing a transaction within a financial market.

Prediction markets (also known as predictive markets, information markets,decision markets, idea futures, event derivatives, or virtual markets) are exchange-traded markets created for the purpose of trading the outcome of events. The market prices can indicate what the crowd thinks the probability of the event is. A prediction market contract trades between 0 and 100%. It is a binary option that will expire at the price of 0 or 100%.

Research has suggested that prediction markets are at least as accurate as other institutions predicting the same events with a similar pool of participants[26] this has a profound, if not purely innovative approach to assessing risk in an insurance network. The insurance cost, determined through market-based mechanisms, is a way of identifying untrustworthy peers and perilous transactions. The risk of the transactions is contained, and at the same time members of the peer-to-peer network capitalise on their market knowledge by profiting as transaction insurers.

It is being progressively recognised that information systems and applications supporting collaborative tasks, including online transaction processing systems, that currently follow centralized client-server models can also be based on the maturing wave of peer-to-peer architectures [27,28]. In order to manage and reduce the risk inherent in peer-to-peer transactions and their decentralised and uncontrolled environment, a variety of approaches have been proposed, with reputation and trust management systems being the most prominent.[29]

These aim to provide peers with estimates of the risk involved in their transactions, based on the observed past behaviour of their counterparties. Though reputation management systems (either centralized or distributed) offer a lot in this direction, the information they provide about past behaviour may not be enough to accurately assess the risk involved in a transaction.

On top of a generic transaction processing system, PTRIM creates a peer-to-peer transaction insurance market-like layer that is used to manage the risk of transaction default. The transacting peers have the option to request offers from peers in this layer to underwrite the risk of their transaction, and therefore alleviate themselves from the need to collect, process and evaluate reputation information.[30]

Image credit: A Market-Based approach to Managing the Risk of Peer-to-Peer Transactions

A transaction default market is thus built on top of the main transaction processing system, within which the cost of “insuring” a transaction is determined through market-based mechanisms. The main contribution of our approach is that it proposes a novel way of identifying untrustworthy peers and perilous transactions, based on the insurance offers the market will produce; the risk of peer-to-peer transactions is contained at a small additional cost; and at the same time, our system showcases a way for members of a peer-to-peer network to participate in a new profitable role, as transaction insurers.

Our approach for managing the risk of distributed peer-to-peer transactions is based on the principles governing financial markets. PTRIM builds and utilises a transaction default market on top of a main transaction processing system, within which peers offer to underwrite the transaction risk for a slight increase in the transaction cost.[31]

The cost is determined through market-based mechanisms, and forms a way of identifying untrustworthy peers and perilous transactions. The risk of the transactions is effectively minimized while the transacting peers are alleviated from the need to collect, process and evaluate reputation information. At the same time our system showcases a way for members of a peer-to-peer network to capitalize on their market knowledge by participating in a new role, as transaction insurers.

The PTRIM approach can be considered as an alternative, but also as complementary to the use of distributed reputation management systems. Under this system, individuals would vote not on whether or not to implement particular policies, but rather on a metric to determine how well their country (or charity or company) is doing, and then “prediction markets” would be used to pick the policies that best optimize the metric.

Essentially, you are literally putting your money where your mouth is. Second, over time the market has an evolutionary pressure to get better; the individuals who are bad at predicting the outcome of policies will lose money, and so their influence on the market will decrease, whereas the individuals who are good at predicting the outcome of policies will see their money and influence on the market increase.

The system also elegantly combines public participation and professional analysis. Many people decry democracy as a descent to mediocrity and demagoguery, and prefer decisions to be made by skilled technocratic experts. Individual experts and even entire analysis firms to make individual investigations and analyses, incorporate their findings into the decision by buying and selling on the market, and make a profit from the differential in information between themselves and the public[32]

So what are the practical benefits of adopting such a scheme? What is wrong with simply having blockchain-based organizations that follow more traditional models of governance, or even more democratic ones? Cryptographic protocols have a much lower need for trusting central authorities (if you are not inclined to distrust central authorities, the argument can be more accurately rephrased as “cryptographic protocols can more easily generalize to gain the efficiency, equity and informational benefits of being more participatory and inclusive without leading to the consequence that you end up trusting unknown individuals”).[33]


The potential for blockchain technology to significantly transform the way the insurance industry operates in the near term, is inevitable. The question is who will do it, and what will it look like?

Blockchain technology adoption and the development of related applications in insurance is likely to depend on insurance industry practitioners and their readiness and appetite, however innovative startups around the world are challenging the notion of what this future might look like, which may force incumbents to adopt new ways of doing business faster than they expect.

Insurance players, their digital innovation units in particular, need to “explore and exploit” in order to manage evolutionary and revolutionary change. Explore the power of this new tool, yet exploit their existing business in order to provide the necessary framework to manage innovation in their space properly.