Tag Archives: dan robles

Blockchain Consortia With Engineers

Anyone who was around in the early 1990s may remember that the mantra of modern globalization was that decentralized markets were good and centralized markets were bad. The math supporting the efficiencies of the comparative advantage economic model was, and still is, indisputable. Further back, the concept of laissez-faire has been the cornerstone of modern capitalism since the late 1600s. So we have seen this picture before, and it should be acknowledged that there is, in fact, reliable precedent to examine as we approach the era of machine-enabled decentralized governance called blockchain technology.

Blockchain technology is incredibly interesting to me because many of the opportunities and concerns regarding the technology are similar to the conditions surrounding my involvement in the implementation of the NAFTA agreement more than two decades ago. Specifically, I worked on standards for the mutual recognition of engineering professionals between the U.S. and Mexico.

While the effort largely failed, I was able to directly observe efforts to control a decentralized network. The effect was that markets were administered unevenly and rarely met the conditions of insurability. Today, the standing joke in the blockchain domain is that the “act of trying to control a decentralized market eliminated many of the benefits of having one in the first place,” Let history be our teacher.

See also: Blockchain: No More Double-Entry Books?  

Today, while we may face similar peril, it is much more serious. Blockchain technology is far more powerful than linear Comparative Advantage Theory. Blockchain promises exponential efficiencies or exponential deficiencies. The difference is that we also have the knowledge, foresight and profound responsibilities to get it right this time. We have a choice.

In 1993-96, the mutual recognition of professional engineers was controversial and divisive. U.S. engineers were fearful they would lose their high-paying jobs to cheap Mexican engineers, whose salaries at the time were about one-tenth the U.S. engineers’ salary. The fear was real.

I saw something different. I saw an entire nation — an entire continent — that needed everything U.S. engineers create. Mexico, Central America and South America needed roads, bridges, structures and every manner of infrastructure upon which all markets depend. The problem was that infrastructure projects could not be financed. This was not for lack of money (NAFTA also liberated access to financial services) but for lack of insurance. Without a tip-to-toe insurance presence, Latin American economies continue to experience difficulties in bridging the capitalization gap.

The capitalization gap is that strange period between the time when money begins to flow into a project and the time revenue flows out of the project — where the asset isn’t an asset yet and falls off the balance sheet. There is no title and no recourse if something goes wrong; risk is very high, and so is the corresponding cost of capital.

In the U.S., it is well-known that soft costs can represent as much as 30% of the cost of a structure. We have also developed a professional engineering licensure system that serves as a financial instrument; a proxy for title, which fulfills the conditions of insurability. The combination of insurance and engineering is what maintains the asset as an asset on the balance sheet. Even when the shiny new office tower resembles nothing more than a pile of dirt, that pile of dirt is valued as a shiny office tower on the balance sheet.

Banks and insurance companies depend heavily on engineers to verify the design, materials, processes, components and performance of all subjects they finance. In general, the construction process breaks down into a long and complicated series of events that all must be contracted, negotiated, ordered in time and verified in a secure manner — while also triggering payments to stakeholders. This is a textbook perfect application for blockchain technology.

See also: Why Insurers Caught the Blockchain Bug  

The consortium between engineering and insurance is critical to convert existing engineering and construction contracts into blockchain-adjudicated smart contracts. Engineers would validate conditions of insurability throughout the design, construction and the life cycle of the asset.

The consortia between engineering and insurance already exists, and their impact on the cost of capital is abundantly clear. To formalize this on a blockchain initiative is not a radical position by any means. What is unique about this proposal is that insurance and engineering should be at the forefront of blockchain development, building the bridge that spans the capitalization gap upon which all derivative markets can travel, laissez-faire.

(Adapted from; Insurance: The Highest and Best Use of Blockchain technology, July 2016 National Center for Insurance Policy and Research / National Association of Insurance Commissioners Newsletter)

How Will Blockchain Affect Insurance?

Ever since the dawn of civilization, societies have organized around the technology of their time. Likewise, people and corporations will reorganize around this new type of data and value exchange system known as blockchain technology. Blockchain technology represents a new set of both positive and negative risk opportunities that may not pool appropriately with the common set of business perils upon which today’s insurance products are based.

See also: What Problem Does Blockchain Solve?  

The insurer is faced with four primary categories of concerns related to blockchain technology:

  1. How different would it be to insure a decentralized business or business processes than a centralized business? What historic data are still valid, what data needs to be collected anew? How much can the insurer rely upon a management system composed of nothing but software? How does an insurer assert dominion over economic value denominated in cryptographic tokens that are neither money nor property, according to the law? Who do you call when things go boom?
  2. The insurance industry itself is an administration-laden database – could it operate on a blockchain? What are the opportunities and implications of culling legions of brokers and staff? Ironically, would an insurer be willing to insure a company that had just culled legions of brokers and staff? If a company does not adopt blockchain technology and a competitor does, what perils are then imposed on the firm? How does the insurer preserve institutional knowledge in the wake of replacing brokers with software?
  3. The purpose of regulation of any kind should be to encourage or discourage specific types of human behaviors. If the human is taken out of the equation, what regulations are still needed? Are there any regulations that stand in the way? Are new regulations required? Can regulations be bypassed or shifted to another segment of a process? How fast can regulators respond to an unanticipated condition?
  4. Finally, everything about database management has very little to do with the thing actually being computed. Blockchain and crypto-currencies exist in a digital realm. Meanwhile, real people are doing real things in real life where real objects behave according to physical laws. How exactly will blockchain software reconcile or interact with the real world? How will risk transfer between machine and human and back again?

These are extremely important questions that are yet to be resolved. It is worth the time and effort to learn and understand the opportunities and implications of blockchain technology because the value of opportunities for adoption by the insurance industry are magnificent:

  • Insurers may achieve extreme efficiency with internal processes
  • Insurers may achieve great profitability insuring blockchain clients
  • Insurers may discover vast new markets that were previously unviable
  • Insurers may scale up or scale down (micro-insurance) at near zero marginal cost.

The insurer needs to know exactly what is being insured, the numerical probability that the peril will or will not manifest and the consequences of a failure or breakdown in the process. Problems may arise where an organization loses important institutional knowledge, adaptability and innovation due to the wholesale elimination of important administrative personnel. The insurance company must know the difference between what a blockchain can and cannot accomplish.

See also: How Blockchain Will Reorganize Society  

Most importantly, blockchain has the potential to augment people. Blockchain technology allows people — whether staff or clients — to be elevated to a higher order of productivity. This is where true wealth is generated. The net value of this technology cannot be achieved by just firing up some blockchain, knocking off staff and cherry picking risk classes.

The great opportunity for insurance will be to mitigate risk from fault-prone processes, thereby reducing the need for regulation and eliminating friction from the financial system. This will help bridge the capitalization gap that currently hinders the great innovations that humans are capable of.

Adapted from; Insurance: The Highest and Best Use of Blockchain technology, July 2016 National Center for Insurance Policy and Research / National Association of Insurance Commissioners Newsletter: http://www.naic.org/cipr_newsletter_archive/vol19_blockchain.pdf

Are Crypto-Currencies Money or Property?

Blockchains have a problem: They cannot exist in digital isolation; their value must be derived from the value of something else — something real.

There will always come a time when something real must be represented by data on a blockchain, or when data on a blockchain must represent something real. The tools that we use today for the storage, exchange and representation of value are money and title to property. This is the most over-looked peril in blockchain technology.

Are crypto-currencies actually money?

There are many prominent articles by many smart people discussing this topic. However, at the time of this writing, according to U.S. Uniform Commercial Code, article 9, a very explicit definition for money is provided as follows:

Money” means a medium of exchange currently authorized or adopted by a domestic or foreign government.

Therefore, the answer is clear. No, digital tokens are not money.

See also: Why Insurers Caught the Blockchain Bug  

While the destruction of digital tokens may represent an economic loss, that loss would need to be somehow quantified as something real. And we’re back to where we started; at some point, token must represent something real. The courts and law enforcement cannot be invoked to protect your bitcoin, and they struggle immensely to protect the value that the bitcoin is supposed to represent, except, notably, in money laundering.

While we may be able to identify the peril and even calculate the probability of loss, we cannot predetermine the consequence of the loss and therefore we cannot price the risk correctly. End of story.

Are crypto-currencies considered property?

There is some ambiguity here, as well. When we think of property, we think of discrete units that are largely inseparable. The title to an asset travels with the whole asset as it changes hands. A lien on the property would be needed to assert dominion on the asset. But bitcoins are quite easily divisible, almost fluid, lubricating a blockchain as a secondary artifact or its maintenance program. If I loaned you a car but kept the wheels as collateral, the utility of he car would be encumbered. Or it would be like holding a lien against the money to purchase the car, and not the car. This doesn’t make sense.

The answer for all practical purposes is that crypto-currencies cannot really be treated as property at least within the boundaries of law and are therefore uninsurable.

Are we stuck?

So, if bitcoins are not money and bitcoins are not property, what are they? How does one prove ownership? How does the owner assert dominion? How would liability be assigned for economic losses of another person in a transaction where all agreements are in the form of non-revocable contracts executed by software? Where do rights and responsibilities attach?

This is a deeply troublesome discussion if you are in the business of assuring or insuring blockchain-based enterprises.

More troubling is that these precise characteristics are what make crypto-currencies attractive for illegal activity, thereby increasing variance of expectations rather than reducing variance – the exact counter-effect of insurance. If assets can be converted to crypto-currency, they become difficult to seize or repossess. The extra-legal sector is categorically uninsurable by mainstream carriers.

Fortunately, some clever legal scholars at Harvard’s Berkman Center have suggested that perhaps ownership may be established with a claim against the cryptographic keys that open and close the contracts that contain the value articulated on blockchain. This is a very interesting idea. We have already established that these nodes and these keys are insurable. Logic may be built into key distribution to assign liability or limit liability and, thus, price risk correctly.

A Hybrid Approach

In earlier articles, we identified the problems that blockchain solves. We also identified the problems that blockchains cannot solve. Using a hybrid approach of decentralized computers and decentralized human interaction, we may be able to build a bridge that can cross the insurability gap between the virtual and the real world upon which everyone from banks, entrepreneurs and modern decentralized organizations may cross.

See also: What Is and What Isn’t a Blockchain?  

Some conceptualization of the hybrid approach may consider the following: a system of physical proofs that are interchangeable with the digital proofs in a blockchain — as needed or where appropriate.

For example:

  • Instead of a computer modeling a fake network of Byzantine generals, a network of real “generals” can be set up to model a computer network.
  • Instead of a solution to a trivial puzzle as a means of generating a digital token, the solution to a real life puzzle can also be used to generate a digital token.
  • Instead of a hashing program that generates a cryptographic key, a person’s résumé could be used as the algorithm to hash cryptographic keys that are authorized to open and close packets on the blockchain (see Curiosumé)
  • Etc…

As long as each component of the blockchain ecosystem is insurable, the entire system would remain insurable. There would otherwise be no limit to the number of blockchains that can exist nor the number or combination of analog and digital components that can be mixed as long as the tokens, in the end, can clear accounts.

(Adapted from: Insurance: The Highest and Best Use of Blockchain Technology, July 2016 National Center for Insurance Policy and Research/National Association of Insurance Commissioners Newsletter: http://www.naic.org/cipr_newsletter_archive/vol19_blockchain.pdf)

The Mechanics of Blockchains

Blockchain technology is like a three-trick pony. It essentially combines three slightly clumsy computer tricks to mimic decisions that a human administrator routinely makes. The difference is that, if done correctly, the computer can perform some of these decisions with great speed, accuracy and scalability. The peril is that, if done incorrectly, the computer can propagate an incorrect outcome with the same stunning efficiency.

1: The Byzantine General’s Dilemma

A scenario first described in 1982 at SRI International models the first trick. This problem simulation refers to a hypothetical group of military generals, each commanding a portion of the Byzantine Army, who have encircled a city that they intend to conquer. They have determined that: 1. They all must attack together, or 2. They all must retreat together. Any other combination would result in annihilation.

The problem is complicated by two conditions: 1. There may be one or more traitors among the leadership, 2. The messengers carrying the votes about whether to attack or retreat are subject to being intercepted. So, for instance, a traitorous general could send a tie-breaking vote in favor of attack to those who support the attack, and a no vote to those who support a retreat, intentionally causing disunity and a rout.

See also: Can Blockchains Be Insured?  

A Byzantine Fault Tolerant system may be achieved with a simple test for unanimity. After the vote is called, each general then “votes on the vote,” verifying that their own vote was registered correctly. The second vote must be unanimous. Any other outcome would trigger a default order to retreat.

Modern examples of Byzantine Fault Tolerant Systems:

The analogy for networks is that computers are the generals and the instruction “packet” is the messenger. To secure the general is to secure the system. Similar strategies are commonplace in engineering applications from aircraft to robotics to any autonomous vehicle where computers vote, and then “vote on the vote.” The Boeing 777 and 787 use byzantine proof algorithms that convert environmental data to movements of, say, a flight control surface. Each is clearly insurable in a highly regulated industry of commercial aviation. So this is good news for blockchains.

2: Multi-Key Cryptography

While the Byzantine Fault Tolerant strategy is useful for securing the nodes in a network (the generals), multi-key cryptography is for securing the packets of information that they exchange. On a decentralized ledger, it is important that the people who are authorized to access information and the people who are authorized to send the information are secured. It is also important that the information cannot be tampered with in transit. Society now expends a great deal of energy in bureaucratic systems that perform these essential functions to prevent theft, fraud, spoofing and malicious attacks. Trick #2 allows this to be done with software.

Assume for a moment that a cryptographic key is like any typical key for opening locks. The computer can fabricate sets of keys that recognize each other. Each party to the transaction has a public key and a private key. The public key may be widely distributed because it is indiscernible by anyone without the related private key.

Suppose that Alice has a secret to share with Bob. She can put the secret in a little digital vault and seal it using her private key + Bob’s public key. She then sends the package to Bob over email. Bob can open the packet with his private key + Alice’s public key. This ensures that the sender and receiver are both authorized and that the package is secured during transit.

3: The Time Keeper

Einstein once said, the only reason for time is so that everything doesn’t happen at once. There are several ways to establish order in a set of data. The first is for everyone to synchronize their clocks relative to Greenwich, England, and embed each and every package with dates of creation, access records, revisions, dates of exchange, etc. Then we must try to manage these individual positions, revisions and copies moving through digital space and time.

The other way is to create a moving background (like in the old TV cartoons) and indelibly attach the contracts as the background passes by. To corrupt one package, you would need to hijack the whole train. The theory is that it would be prohibitively expensive, far in excess of the value of the single package, to do so.

Computer software of the blockchain performs the following routine to accomplish the effective equivalent process: Consider for a moment a long line of bank vaults. Inside each vault is the key or combination to the vault immediately to the right. There are only two rules: 1. Each key can only be used once, and 2. No two vaults can be open at the same time. Acting this out physically is a bit of a chore, but security is assured, and there is no way to go backwards to corrupt the earlier frames. The only question now is: Who is going to perform this chore for the benefit of everyone else, and why?

Finally, here is why the coin is valuable

There are several ways to push this train along. Bitcoin uses something called a proof-of-work algorithm. Rather than hiding the combinations inside each vault, a bunch of computers in a worldwide network all compete to guess the combination to the lock by solving a puzzle that is difficult to crack but easy to verify. It’s like solving a Rubik Cube; the task is hard to do, but everyone can easily see a solution – that is sufficient proof that work has been done and therefore the solved block is unique and valid, thereby establishing consensus.

See also: Blockchain: No More Double-Entry Books?

Whoever solves the puzzle is awarded electronic tokens called bitcoin (with a lower case b). This is sort of like those little blue ticket that kids get at the arcade and can be exchanged for fun prizes on the way out. These bitcoins simply act as an incentive for people to run computers that solve puzzles that keep the train rolling.

Bitcoins (all crypto currencies) MUST have value, because, if they did not, their respective blockchain would stop cold.

A stalled blockchain would be the crypto-currency equivalent of bankruptcy. This may account for some amount of hype-fueled speculation surrounding the value of such digital tokens. Not surprisingly, the higher the price, the better the blockchain operates.

While all of this seems a bit confusing, keep in mind that we are describing the thought patterns of a computer, not necessarily a human.

The important thing is that we can analyze the mathematics. From an insurability standpoint, most of the essential ingredients needed to offer blockchain-related insurance products exist as follows.

1. The insurer can identify the risk exposures associated with generals, traitors, locks, vaults, trains and puzzles.

2. The insurer can calculate probability of failure by observing:

  • The degree of Byzantine fault tolerance.
  • The strength of the cryptography
  • The relative value of the coins (digital tokens)

3. The consequences of failure are readily foreseeable by traditional accounting where the physical nature of the value can be assessed, such as a legal contract.

We can therefore conclude that each of the tricks performed by this fine little pony are individually insurable. Therefore, the whole rodeo is also insurable if, and only if, full transparency is provided to all stakeholders and the contract has physical implications.

Markets are most efficient when everyone has equal access to information – the same is essential for blockchains. So much so that any effort to control decentralized networks may, in fact, render the whole blockchain uninsurable. It is fundamentally important that the insurer is vigilant toward the mechanics of the blockchain enterprise that they seek to insure, especially where attempting to apply blockchain to its own internal processes.

Adapted from: Insurance: The Highest and Best Use of Blockchain Technology, July 2016 National Center for Insurance Policy and Research/National Association of Insurance Commissioners Newsletter: http://www.naic.org/cipr_newsletter_archive/vol19_blockchain.pdf

The Great Blockchain Dilemma

Many insurance companies have a deep sense they should be part of the blockchain movement, but they are not quite certain how to approach its implementation. Once you pull back the curtains, there appear to be two sets of mutually exclusive incentives underpinning the blockchain technology movement. One of them could be the greatest thing that has ever happened to insurance; the other may be systemically toxic to everything insurance stands for.

A productive and sustainable economy requires stability — i.e., low volatility or no volatility. The insurance industry, by definition, must be able to identify predictable events over a long period. The value proposition of all insurance products depends on the ability to pool risk exposures appropriately and to lay off risk. These conditions limit the insurer only to those products where conditions are assured. The incentives of the insurance business seek to reduce volatility, categorize risk exposures appropriately and mitigate risks (where applicable). Anything less is called gambling.

See also: Why Insurers Caught the Blockchain Bug  

On the other hand, speculation may be needed to maintain efficiency and grow the blockchain. Speculation is often the sole basis of valuation for digital tokens and depends on high volatility to attract gamblers (for lack of a better term) to bridge the capitalization gap. Yet the creation and distribution of digital tokens is only a residual artifact of the blockchain use case, not the core use case. For the blockchain to maintain itself, the value of the digital token must exceed the cost of maintaining the blockchain. By contrast, a centralized organization would simply pay an IT department from operating revenue to maintain the system, whereas a decentralized organization, by definition, must be autonomous.

The Great Blockchain dilemma is clear: Volatility and stability are mutually exclusive.

The current blockchain/crypto-currency landscape is plagued by this dichotomy. Incentives are laid out to encourage speculation, yet the great vision of blockchain is one of a new economic paradigm ushering in an era of economic fairness and stability. Both of these things cannot happen at once.

For example, investment banking and corporate decision-making is driven by quarterly profits. The incentives on Wall Street have become tragically short-term. The current view of blockchain is a miracle drug that can eliminate large swaths of human administrators while also increasing the performance of data structures.

Not surprisingly, large banks have come together to form a consortium to define blockchain standards for transferring value within their industry. But this may be short-sighted.

The hallmark of a great society is the ability to capitalize on its needs, not its arbitrage opportunities.

While the case for creating a shiny new super currency is compelling, the primary objective should be to induce stability in the outcomes of events articulated on a blockchain. The value of the tokens must represent true human productivity of a physical nature. Otherwise, nobody else would be willing to perform work in exchange for it. With a broad social agreement, digital currency can achieve a state of mutual reciprocity and be traded widely across an economy without friction.

See also: What Problem Does Blockchain Solve?

Therefore, the highest and best use for blockchain technology is in the insurance industry and not necessarily the banking industry, because insurance can eliminate volatility. Properly deployed, blockchain technology can reduce the cost of capital by decentralizing risk. A developed economy is distinguishable from a less developed economy by the stabilizing force of insurance, not by the volatile nature of money.