Industry the September 2017 issue

Blockchains, Cryptocurrencies and Smart Contracts—Oh My!

You don’t have to get bogged down in the technologies to understand what they can do for you.
By Colby Daboul Posted on August 31, 2017

The insurance industry has historically been the techno-laggard of the financial services world. Nonetheless, when an insurance organization invests in new technology early on, it can experience a slew of benefits, gaining significant advantage over other players in the field.

Recently, there have been several new technologies emerging through insurtech investments that can bring radical change to the industry and a competitive advantage to early adopters. However, as I’ve seen as an intern at The Council, there has specifically been a lot of excitement surrounding blockchain use cases in and outside of the insurance industry.

You’ve certainly heard of blockchain, cryptocurrencies and smart contracts, but you may have gotten bogged down in the technical definitions of each, the consensus algorithms behind them, and the “mining” that allows it all to function. If so, you probably just threw in the towel because you saw no correlation to the insurance industry, rightly identified the technology’s immaturity, and were confident it wouldn’t take effect any time soon.

Frankly, I don’t blame you. To start, cryptocurrency is a limiting term that has little relation to the insurance industry, and it’s outdated for the technology it runs on—blockchain. Bitcoin, the first token to emerge in 2009, was and still is a cryptocurrency in its purest form (a digital currency). Since then, we’ve seen the emergence of many other players in the space, one of which is synonymous with smart contracts: Ethereum.

Ethereum, which is Bitcoin’s biggest competitor and is frequently cited as the future of blockchain and smart contracts, has completely revolutionized the blockchain ecosystem. Ethereum has produced so much change with smart contracts and dapps (decentralized applications) that there are calls for ditching the term cryptocurrency altogether and replacing it with cryptoasset. The revised term encompasses so much more than strictly digital currencies or tokens, reflecting the capabilities of Ethereum, blockchain and the like.

For those in the insurance industry, a blockchain, also referred to as distributed ledger technology, should simply be thought of as a synchronized, append-only database of contract, claims and policyholder information that is not centralized in any contributing party, allowing for standardized recordkeeping as well as increased security and transparency.

There are three types of blockchains: public, private and consortium. Consortium blockchains will likely be the direction the insurance industry takes. This is especially evident in the emergence of the Blockchain Insurance Industry Initiative (B3i), a consortium of 15 insurers that are testing blockchain use cases for the industry.

But to understand a consortium chain, you must first understand public and private ones. In a public chain, such as Bitcoin or Ethereum, anyone can access and make transactions on it. Those transactions must be validated and organized into blocks by miners. The first miner to create a block submits it for validation to the general mining community. Once the mining community validates the specific block and consensus is established, it’s appended to the blockchain, which every node in the network (users and miners) can see.

The miner that successfully submits the block that is appended to the chain receives newly “mined” tokens for the work. Tokens are not mined on private or consortium chains; therefore, those responsible for validation and consensus building are referred to as nodes.

In a private chain, parties need permission (which is why they are also referred to as permissioned chains) to access, view and transact on them. There is one predetermined node, typically the organization managing the chain, responsible for validation and consensus building. As a result, private chains are more centralized than public ones, since one node is validating and building consensus compared to a vast community of miners on a public chain.

Consortium blockchains are a hybrid of public and private chains. Since they have multiple validating and consensus-building nodes, like a public chain, they can be considered decentralized. Despite the multiplicity, they are predetermined and consist of the organizations managing the chain (e.g., the 15 members of B3i), similar to a private chain. Furthermore, on a consortium blockchain, only permissioned transactions are being facilitated, hence increased efficiency and privacy, also like private chains.

Now that we’ve established the blockchain basics, let’s add in smart contracts and see how the combination can help decrease fraud, increase efficiency, and mitigate legal disputes in the insurance industry, as some experts are claiming.

A smart contract is a digitized contract (literally code built into the blockchain) that automatically processes claims by validating and executing payments when predetermined conditions are met, and it cannot be altered unless all stakeholders come to a consensus. So, in regards to fraud, one claim couldn’t be submitted multiple times; in fact, no claim would be submitted at all. The smart contract codifying a policyholder’s insurance contract would only execute payment if predetermined conditions specified in the contract were met.

The smart contract is triggered soon after the event occurs, shortening what could be a month-long process to a matter of minutes. A claims adjuster, plenty of paperwork, and back-and-forth communication are no longer needed to finalize the claim, saving plenty of processing fees. 

The smart contract codifies the intent of the two parties who created the contract or policy. There is no textual ambiguity in code; it does exactly what it’s designed to do. Therefore, a policyholder has no grounds to sue the insurer, because coverable conditions were specified in the contract and coded onto the blockchain.

With every successful proof of concept, blockchain and smart contracts’ potential to revolutionize the insurance industry grows.

Blockchain in insurance is still in a proof-of-concept stage. Scalability is a major dilemma for all of the major players. Some things hindering full implementation are insufficient blockchain network infrastructure, consensus architecture, characteristics (such as scaling without centralizing the network) and threats to integral blockchain principles. But consortiums, such as B3i, and independent companies, such as AIG and Standard Chartered bank, are constantly testing different use cases.

With every successful proof of concept, blockchain and smart contracts’ potential to revolutionize the insurance industry grows. Your firm should be proactive, get involved in proofs of concept and test out possible use cases for blockchain in the industry. The question is no longer how or to what degree blockchain will change the insurance industry; it’s when. 

Daboul is a graduate of Ithaca College and interned at The Council in 2017.

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