The Insurance industry traditionally has relied on historical losses, actuarial data, statistics, legal precedence and damage awards to evaluate and insure a risk.
Currently we are in the Digital Age with insurers trying to gauge these risks and underwrite based on these traditional methods, with traditional policies ( industrial aged insurance policies). Is this working? No, not in my opinion.
Enter Blockchain. The Digital Age on steroids. Blockchain is new, constantly evolving, and open to a new sets of risks Insurers need to understand.
In its most basic form the blockchain is a decentralised electronic ledger which appears in duplicate from thousands of computers worldwide. It is a peer to peer network where records are known as blocks, each one timestamped and linked to a previous block. This means that the data in a block cannot be altered retrospectively, enhancing both the security and transparency.
Is it different to a Distributed Ledger? Yes.
Blockchain and Distributed Ledger Technology (DLT), also called shared ledgers, are often referred to as one of the same. However this is not the case even though it is not hard to see why lots of people think so.
Put simply Blockchain is one form of DLT. Governments around the world tend to use the term DLT as it has a wider meaning than Blockchain to describe the regulatory and licensing framework needed with this new technology.
Blockchain technology has come into prominence in the past few years as the technology that underpins the pioneering virtual currency Bitcoin and many other crypto currencies.
So what are the risks for blockchain technology and companies using blockchain?
Apart form your standard matrix of risks like, Reputational, Security, Contractual, Supply Chain, Strategic and Business Continuity, extra consideration needs to be given to:
- Regulatory uncertainty
Many countries around the globe are challenged on how to regulate if at all for blockchain and virtual currencies. Some countries like Japan have gone down the licencing route and have licensed 11 crypto currency exchanges (in an effort to reduce fraud), while others are on a watch and see approach, and are very careful not to stymie innovation by over regulation. Some counties like China have banned virtual currencies and ICO’s (Initial Coin Offering) altogether.
Japan has the biggest share of the virtual currency market and in March 2017 they passed the Virtual Currency Act declaring they are assets and can be used for payments .
- Global exposures
As the technology and the consumer are borderless, dealing with foreign regulated markets is a challenge for clients and most insurers. Particular expertise is needed to handle these global risks.
- Price volatility
With cryptocurrencies using blockchain technology, as well as many new ICO entities using those currencies as a mechanism to buy tokens, many suffer from extreme volatility. In the public company space such price volatility of a stock can often bring shareholder scrutiny or could even mean class actions against directors.
- Systemic risk
Insurers want to avoid risks where a whole industry or market can collapse. Evaluating and protecting against multiple claims across multiple policies has become very difficult for clients and insurers.
- Fraud and Credit risk
With 45% of all bitcoin exchanges having failed or become insolvent this exposure sends fear down the spine of Insurers. Cyber hacking risk is not new but with such a large pot of crypto currencies the exposure to fraud has intensified.
Reuters recently reported that Coincheck, a Japanese crypto exchange, only a few weeks ago had 523 million coins, worth around $400m, stolen from 260,000 users. The company has said it will repay all 260,000 users impacted by the hack. Coincheck said it will use its own capital to reimburse them.
Bloomberg also just reported that Bitfinex a large exchange is under US regulation investigation and is under a subpoena order.
- Pace of change
I am not sure what version of Blockchain or DLT we are on today but with the technology mostly open source it is evolving every minute, which is a good thing, right? Remember VisiCalc the very first version of spreadsheets, after many many years of revisions and changes we now have Excel which most of us cannot do without.
- Transparency vs Privacy
There is much debate about privacy and many countries have strict laws around this subject. However the blockchain is based on transparency to drive the consensus mechanism. Can the two work in a decentralised ledger world?
Transparency is where you don’t mind people knowing your bank account details and which bank you use but the transactions in that account you want to remain private.
While the current risk transfer policies of Directors and Office Liability, Professional Indemnity, Property and Business Interruption together with Cyber Crime and Crypto theft seem obvious there will no doubt be a need for new and innovative risk transfer models. The “early adopter” underwriters accepting these risks (with mostly very little premium pool) will have a head start on their competitors when they want to join in.
Virtual currencies alone in 2017 raised approximately $5 billion across 800 deals. I am not sure what percentage effected insurance but this number will grow.
Whether Bitcoin, which uses the blockchain, survives as a currency is highly debatable. DLT and the blockchain are here to stay and will enhance (in many cases disrupt) many business models we use today e.g. Financial Services, Supply Chains and Real Estate to name a few.
Like any new industry it will evolve, improve, self regulate and de-risk itself to survive.
Understanding the complexities, helping manage risk and providing capital protection is what the insurance industry has done well for decades and I am confident will keep on doing so.
Written by Con Manetas, Coverforce Leed Insurance Brokers
This information and views expressed are my own and are of a general nature and not to be construed as Insurance advice.
I own a number of Cryptocurrencies and HODLing.