The world’s first decentralized cryptocurrency, Bitcoin, and the technology underpinning it, Blockchain, was created in 2009. Since then, there has been a proliferation of other cryptocurrencies, such as Ether and Ripple, and other forms of digitised tokens which are generally in use on other forms of distributed ledger technologies similar to Bitcoin’s Blockchain. As the world reels from 12 months eye-watering cryptocurrency price volatility, record raising initial coin offerings (or ICOs) and an ever evolving slew of Blockchain related announcements from international regulators, it is perhaps easy to overlook how much cryptocurrencies, other digitised tokens and the Blockchain infrastructure supporting them have become part of the fabric of the established financial services and wider global economy.
“Blockchain or distributed ledger technology? Distributed ledger platforms of all varieties are often referred to as Blockchains in the same way vacuums are called hoovers as a result of the company of that name inventing the first such iteration of the technology. The phase ‘Blockchain’ is principally associated with public, permissionless distributed ledger networks.”
During the same period, there have been several high profile instances of businesses, from industries which are traditionally regarded as the cornerstones of the global economy, such as trade finance and trade supply chains, insurance, banking, energy and mining and precious stones, which are using private, permissioned distributed ledger technologies to improve business processes and generate efficiencies in their transactions with commercial partners.
“What is an ICO? An ICO is a method of crowdfunding that allows participants to provide funds in exchange for digitized tokens that have a utility function or form of asset right. These tokens are usually issued in exchange for established cryptocurrencies and, in some cases, fiat currencies.”
Many established businesses (including Microsoft) accept payment in Bitcoin. Cryptocurrency exchanges are now common place and provide a bridge between the world of Bitcoin and its peers and fiat currencies such as USD, EUR and GBP. UK digital bank Revolut now enables users to buy, hold and exchange cryptocurrencies in any of the fiat currencies supported by the app. One of the “big four” accounting firms is accepting payments for services in Bitcoin in certain jurisdictions. A quasi-established venture capital and hedge fund investment industry now exists in relation to businesses wanting to raise funds through ICOs. Wallet storage businesses, which essentially offer banking services for cryptocurrencies, now provide an array of products, including desktop (for example, Mist and MetaMask), hardware (Trezor and Ledger Nano S), mobile (Jaxx) and web (MyEtherWallet and Coinbase) wallets and are an essential component of this new decentralised economy.
Despite Bitcoin’s initial associations with the dark web and being predominantly used for the facilitation of crime and money laundering, use of cryptocurrencies and other digitised tokens might arguably now be described as mainstream. Many transactions associated with these assets and their underlying Blockchain technology infrastructure have risks which are typically insurable in certain contexts. These risks include cyber, such as theft from crypto wallets, business interruption and losses resulting from other hacking and code failure type events, all of which might be purchased by individuals and businesses. Those dealing with these assets or carrying out ICOs also have traditional insurance needs against claims from third parties, such as D&O and E&O cover.
What is clear is that as the crypto economy develops and matures, customers and businesses transacting and dealing with crypto assets are and will increasingly require and be willing to pay for insurance coverage for risks associated with this part of the economy. It is also becoming evident given the size of the crypto economy that the market for this insurance – and potential economic rewards for those willing to underwrite it – is large.
The established insurance market has to date been cautious about underwriting risks relating to the decentralised economy. There are limited exceptions to this – such as the wallet storage insurance taken out by a leading crypto exchange and a reported handful of D&O policies – but traditional insurers are generally refusing to cover these risks. One of the problems frequently cited by underwriters is the concerns around money laundering and financial crime. It does seem however that an equally – if not greater issue for incumbent insurers – is the problem of assessing the underlying risk where new and rapidly changing technology means it is entirely possible only those with intricate knowledge of the underlying technologies will have the ability to take a view on this. There are examples of MGA type businesses with the relevant code auditing and technological expertise setting up, but the perennial challenges of capacity and funding are likely to remain challenging in the short term.
“What is tokenisation? At a conceptual level, tokenization is the process by which rights or assets, both tangible and intangible, are given a digital representation that can be stored, managed and transferred on a digital platform.”
In addition to the changing risk profile of traditional product lines in relation to businesses operating within the crypto sphere and the potential for product innovation, new Blockchain enabled approaches to the distribution and management of risk cover are also beginning to emerge. As evidenced by the increased focus on InsurTech related opportunities in the distribution, product, claims and administration parts of the value chain over the past couple of years, the insurance industry has acknowledged that its well established business models are not immune to technological disruption. However, few have sought to contemplate the implications of the small but growing movement to challenge the existing insurance value chain through the transformation (or tokenisation) or insurance type risks through Blockchain enabled platforms.
Numerous models have been proposed to manage insurance type risks through the medium of Blockchains. These range from disruption in the existing insurance value chain by building platforms on Blockchains to create new digital distribution channels, through to challenging the underlying concepts of traditional risk coverage by the development of alternative risk management models, based on a principle closer to the original insurance concept of a mutual.
These new models include insurance intermediation platforms which involve the use of tokens as a form of premium that prospective insureds can exchange with the platform in return an insurance policy being placed with an insurer. In this model, the platform acts as a digital provider of insurance intermediation services, so still relies on the traditional insurance market for capacity, and so still leaves incumbents as the last decision maker in relation to underlying risks. Etherisc, a smart-contract enabled, Blockchain based, fully-automated decentralised flight insurance provider that formed part of Cohort 3 of the FCA’s sandbox, is one such example of this model.
The established insurance market might have more concern – in terms of lost opportunity - from true decentralised economy insurance platforms which allow prospective insureds to exchange tokens with the platform as a form of premium in return for direct risk cover.
In this risk pooling model, the platform acts as a digital risk coverage provider enabling underwriting and claims handling like processes in addition to management of the capital model to be conducted on a decentralised basis through the platform. Importantly, these platforms allow the coders and designers of the crypto economy infrastructure – the individuals with the most expertise – to assess the risks which can be accepted by the platform. All payments within such tokenised platforms can be represented in cryptocurrency and therefore do not need to reference back to the fiat currencies and balance sheets of the traditional economy. Nexus Mutual is once such project, which is intended to launch in 2018.
Perhaps unsurprisingly, given their decentralised nature and potential global reach, insurance platforms built on top of a public Blockchain pose a number of challenges from legal, regulatory, technical and commercial perspectives. But, nonetheless, some of these new platforms are likely to succeed as they are seeking to fill the coverage gap left by a traditional market which is unwilling to provide coverage for willing and legitimate purchasers in the crypto economy.
Nicholas Berry is a partner and Charlotte Rowlandson is an associate in the London office of Norton Rose Fulbright.
A version of this article was published in Insurance Day, April 25, 2018. 2018 Informa plc.