Blockchain in Insurance

Many popular accounts of the original Bitcoin blockchain and its newer derivatives leave out the essential concepts required to understand these systems from first principles.

White papers talk about “automated audit”, “unprecedented financial services innovation”, “disruption” and the like, claims that without sufficient details will leave a jaded practitioner at best skeptical. In this respect, we have a situation not dissimilar to the still recent flurry of “big data” projects, albeit one where the subject matter is better amenable to concrete definitions.

In my General Insurance Seminar paper I have tried to explore some of the foundational concepts of blockchain technology, hoping to highlight those aspects that indeed might promise unprecedented opportunities for innovation.

First thing to note is that the original Bitcoin protocol combined together several (in themselves quite complex) ideas to create the complete system.

• Direct application of public key cryptography and related ideas to the facilitation of financial transaction (rather than their transmission, storage etc).
• A significant innovation in distributed consensus algorithms
• Smart contracts

It is thus generally a mistake to think about the “blockchain” as a single concept. Different applications may require only some of the above (in particular, smart contracts and cryptography are often of independent value from distributed consensus).

As all of these building blocks are likely to be novel to the readers with a background in financial services, in my paper I’ve tried to focus on them individually before describing their interaction.  

Several blockchain native applications have emerged to date that are particularly relevant to insurance: distributed lotteries and prediction markets. These schemes offer a fascinating glimpse into what a truly decentralised organisation might look like and the ideas can be built up to even more complex arrangements. While it is appears quite unlikely that any such “from the ground up” designs will be able to replace traditional insurance products, there is considerable scope for new products that better fit the technology.

Block chain technology also encourages one to rethink many of the processes taken for granted in financial services.

One such example is audit – it is possible, for example, for a Bitcoin exchange to create public proof of the funds it controls without engaging an external party to validate its accounts.

Another example is “smart contracts” – traditionally, core IT systems in insurance and banking are very inflexible and require long and complex projects even for minute changes. Smart contracts invert that pattern – all of “business logic” is included in the transaction itself. A new generation of flexible core systems that focus only on executing smart contracts can dramatically reduce complexity associated with IT change management and allow for a much greater degree of customisation, automated settlement etc.

Dimitri will present his presentation and paper: Blockchains, Smart Contracts and Possible Insurance Applications at the 2016 GI Seminar in Melbourne on 14-15 November. Registrations are still open.

For more on Bitcoins, why they work, and challenges for the system, read actuary Milton Lim’s comprehensive article: ‘Bitcoins, Banking and the Blockchain’.

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