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Discussion

Our Distributed Futures Forum team has a good habit of taking a long-term view on issues surrounding the rising 'ecosystems' of cryptocurrencies and distributed ledgers.  This session, held at Furniture Makers' Hall on 24 April was no exception.  The evening began with introductions and a discussion presentation led by Professor Michael Mainelli of Z/Yen Group,
Insuring Smart Ledgers - Distributed Futures Forum 2018.04.24 v1.0.pdf.  His presentation focused on the comparison with Protection & Indemenity (P&I) mutuals as a model worthy of exploration for ICO 'ecosystems'.  There were a number of remarks from around the room starting with a variant of the Chatham House rule - "what's recorded on the blockchain stays on the blockchain".  The discussion ranged widely pointing out some implications on "single point of failure", conflicts of interest between token holder and shareholders, remarks on the number of exchanges that have gone broke, an exploration of the various ways in which 'inside' knowledge is not being addressed by the ICO/ITO communities, why transfer agencies impede simplification, comparing some insurance proposals with the FDIC, and the ICO need for investment in traditional risk management approaches for their ecosystems.  What follows tries to make sense of a high-powered evening.

Smart Ledger hype can only be fulfilled if numerous groups of organisations want to work together mutually and decide that Smart Ledger technology will help them avoid much of the natural monopoly problem described above. Some of the emerging applications that could create large mutual networks include:
• private or public-private international identity systems for both corporates and individuals. Regulations around anti-money laundering, know-your-customer, and ultimate beneficial ownership increase legal and regulatory costs and hassles. Ninety percent of businesses responding to the International Chamber of Commerce’s 2016 Global Survey on Trade Finance pointed to anti-money laundering as the most significant impediment to trade. The 53 Commonwealth nations are exploring how they might create such a mutual identity structure for themselves.
• trade facilitation infrastructure. These trading systems can be almost ‘unowned Alibabas or Amazons’, or deep wholesale trading markets for specialist players in reinsurance or commodities or other narrow but capital-intensive markets. Singapore already has a trade facilitation system for SMEs based on Smart Ledger technology, FastTrackTrade.co.  FastTrackTrade has backing from the Prudential for trade credit insurance and five banks in the region. 
• ‘internet of record’ services or timestamping. The States of Alderney has been operating such a system, MetroGnomo.com, since 2015.

From Toys To Tools

However, it’s unlikely to be an overnight revolution. A distributed ledger is an order of magnitude more complicated than a traditional database. Multi-organisational projects are also an order of magnitude more complicated than projects within a single organisation. Combined, Smart Ledger projects could crudely be estimated as 100 times more difficult than traditional projects.

While pilot and proof-of-concept projects abound, including insurance ones such as B3i or R3’s Insurance Industry Centre of Excellence, they remain mostly baubles and toys. The real action is in insurance clients. Smart Ledger trade system announcements from governments, shipping firms, large IT firms, and the like, are where the action is at. Why should payments, banking, and insurance think they should lead the introduction of a universal technology? Sure, when databases were introduced in the 1970s they affected payments, banking, and insurance, but databases also affected every other commercial and government organisation.

It’s true that wholesale insurance markets are full of bureaucratic inefficiencies. It’s true that many of these inefficiencies are due to historic attempts to prevent Goliath central third parties controlling the market. It’s true that Smart Ledger might help increase efficiencies by providing more mutual solutions. In fact, Z/Yen too believes that identity, documentation, and agreement exchange via Smart Ledgers is the most likely area for ‘killer apps’. But why is all the Smart Ledger talk about insurance processing? Isn’t there insurance business?

Mainstream Insurance

The group started discussing the business opportunities for insurance in the Smart Ledger sector. They are numerous. This is a potential new class of business insurance for the mutual structures that support Smart Ledgers (‘ecosystems’ is the current jargon for many coin, token, or ledger clubs). Classic cover could be extended - business interruption, 3rd party liabilities, property losses, intellectual property losses, credit insurance, custodial insurance, professional indemnity, kidnap & ransom, and errors & omissions.

There are numerous new risks. Is the ledger truly immutable? Who indemnifies whom for data entered on the ledger, e.g. insuring the quality of anti-money-laundering data? What about systemic failure? And there are some potentially big solutions out there that insurers can provide. One such approach is to consider having the major ecosystems use structures conceptually equivalent to shipping’s Protection & Indemnity mutuals. These ecosystem P&I clubs would effectively cross-underwrite one coin or token system’s catastrophic failure by reimbursing customers with a basket of coins or tokens from the group.

Another big area for consideration is the use of insurance-linked securities (ILS) for ‘ecosystems’. Z/Yen is working with a reinsurer to build a pilot Smart Ledger cyber-catastrophe ILS trigger. The Smart Ledger polls IP addresses across a network in a geographical area to determine whether the network is functioning correctly. Think the UK internet. The polling system will publish a controlled index of the state of the network. The polling system will trigger if a threshold of IP addresses is not functioning. This trigger could, in turn, be linked to a contract payment backed by a tradable security. The ILS could be used to provide cyber business interruption cover by carriers. Smart Ledgers are ideal for these types of applications because the information provider cannot extract excessive rents if the index becomes highly valuable as a reference.

A further area is clients using Smart Ledgers to meet their contractual terms. There is talk, for example, of shipping companies perhaps using ‘geostamping’, i.e. a timestamp with a location recorded on a Smart Ledger, to ensure that they meet their exclusion requirements, or trigger additional cover if they move into an excluded area. Already, clinical assessments are being recorded by our clients for healthcare regulators in North America and Europe. This basic use of timestamping and geostamping will emerge as condition of cover in many areas. Another example is gambling companies who have cover for the quality of their random number generators being required to timestamp the numbers provided to customers as a condition of their policy.

Sidecars

In conclusion, Smart Ledgers will be of increasing importance to the business of insurance. While the technology will help remove paperwork and inefficiencies from insurance over time, it will be a slow evolution to remove incumbent processes. The technology will also show up in areas related to insurance, such as identity systems for anti-money-laundering and know-your-customer operations. However, the biggest area of all may be the most traditional. Selling risk management products to the very ‘ecosystem’ mutuals that are at the heart of all this hype.

Having covered such ground, we all needed a drink.  Traditionally, Distributed Futures Forum members partake of a cocktail before dinner.  This time it was a Sidecar, equal parts cognac, Cointreau, and lemon juice, for not-so-obvious reasons.