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Is It Possible to Insure Bitcoin Technology?

In the mid- to late 1990s, the insurance industry was struggling with “the Y2K crisis,” not only in connection with its own systems but, more importantly, with the systems of all its policyholders. As the chief underwriting officer of one of the largest subsidiaries of one of the largest insurance companies in the world, AIG, I had to determine our potential exposure if the computer systems of our policyholders failed. My conclusion: hundreds of millions of dollars of potential liability payouts.

Y2K — a problem that threatened to confuse computers about chronology beginning on Jan. 1, 2000, because years had historically been represented in software with just two digits, meaning that the year 2000 (represented as “00”) was indistinguishable from 1900 (also “00”) — was the insurance industry’s introduction to the hazards of insuring technology. To reduce that exposure, we had to figure out a way to motivate our corporate policyholders to take reasonable steps to manage their Y2K problem. Because one of the central purposes of an insurance policy is to motivate specific risk-reducing behavior, such as wearing a seat beat, the question became how to motivate risk reduction in connection with the impending problem.

So we created “Y2K insurance” and made it available only to those companies that took the right steps.

Well, the Y2K crisis came and went, and the insurance industry was relatively unscathed. Whether the introduction of a new insurance product helped, we will never know. What we do know is that the Y2K experience inspired the insurance industry to contemplate other technology risks we might insure. In the year 2000, the answer was immediately clear: yhe Internet. Many of us realized that the Internet presented a permanent change in the sociological and economic system; that life would never be the same. But how does one insure a new technology and a completely new way of conducting business? It was scary thing to contemplate.

Fundamental to the insurance business is an analysis of historical actuarial information about frequency and severity of loss. We have decades of data on automobile accidents, broken down in every way imaginable. But how do you determine the right premium for a risk that has never existed?

For most carriers, the answer was, “You don’t.” But for a few, a different response emerged. A response that arose from a different culture—a risk-taking culture. A culture of innovation. “Cyber insurance” was born.

It took a while, but eventually we became comfortable with underwriting the frequency and severity of potential cyber attacks against our policyholders’ computer systems. Today, 15 years later, cyber insurance is a robust $1.3 billion industry, with more than 45 carriers providing some type of cyber insurance. And, despite the almost daily reports of cyber attacks, the industry is somehow making enough money to stick around.

Bitcoins 

Once again, the insurance industry is faced with a new risk in the technology space. Once again, the global economy is being transformed with a new way of conducting transactions. Once again, the insurance industry is faced with a dilemma: Do we ignore this new risk or face it head on?

There are more than 8 million Bitcoin “wallets” in existence today, and this is expected increase to 12 million by the end of the year. The total value of Bitcoins worldwide is around $4 billion. There are more than 100,000 Bitcoin transactions happening every day. More than 80,000 companies, from Microsoft to Dell to Expedia.com, accept Bitcoins as payment.

But how do you insure Bitcoins? More specifically, how do you insure the theft of the electronic private keys that are used to access Bitcoins? A smart insurer realizes that such a task is an exercise in both the familiar and the foreign. A private key is, after all, an electronic file. In many ways, the policies and procedures used in the network security space to protect any computer system holding any file are the same as those used to protect an electronic private key file. Equally true is that a good portion of private keys are stored in “cold storage,” meaning that they are not held in a computer that has access to the Internet. Some are actually stored in a bank vault. Storing valuables in a bank vault is also a well-understood risk and insurable. Finally, many companies that would be interested in purchasing Bitcoin theft insurance are themselves technology providers. Insurance for technology companies has existed for some time.

However, that’s where the analogy ends, and things begin to become difficult. First, the “cyber” insurance policies provided today actually do not insure the intrinsic value of the electronic file stolen. The policies do not cover the “value” of a Social Security number, for example. Furthermore, best practices in the securing of private keys in “hot storage” (computers connected to the Internet) rely upon the multisig, or multiple signature, technology, something with which insurance underwriters are generally unfamiliar. At best, underwriting the theft of Bitcoins requires coordination of multiple underwriting departments within an insurance company. More likely, it means creating new underwriting techniques and protocols.

Will the insurance industry be able to respond to the call? The insurance industry historically has not been known for innovation. So, how will we respond when we are faced with a new and potentially important risk, for which there is no historical actuarial data? Do we run away, or do we embrace a new need and a new opportunity as we did 15 years ago?

In February 2015, one company successfully designed the first true Bitcoin theft insurance policy along with a global “A”-rated insurance carrier for the benefit of BitGo, a leader of multi-sig technology. Will this policy be the only of its kind? Or, as with cyber insurance 15 years ago, will that be only the first of hundreds of thousands of “Bitcoin theft” policies.

Only time will tell.

What the Apple Watch Says About Innovation

Now that the dust has settled on the long-anticipated unveiling of the Apple Watch, a major obstacle to its success is coming into view: the iPhone.

The Apple Watch has been the subject of breathless anticipation for years because, as Tim Cook said at its introduction, it represents “the next chapter in Apple’s story.” Conceived three years ago, shortly after Steve Jobs’ passing, the Watch is the embodiment of multiple dramatic arcs and aspirations.

It is the first major product developed under Tim Cook and Jony Ive outside of Jobs’ shadow—and thus has huge personal and legacy implications for both men.

The Watch is also Apple’s attempt to catalyze and dominate the wearables category. Given the intense competition in the smartphone market and the widespread view that new killer products, platforms and ecosystems will emerge somewhere at the intersection of the Internet of Things and wearable computing, the Watch is central to Apple’s post-iPhone strategy.

It might seem that the iPhone should be the Apple Watch’s greatest asset. Apple is positioning the Watch as a jaw-dropping, must-have peripheral to the iPhone. Millions of iPhone-toting Apple fans are sure to queue up upon the Watch’s 2015 launch to buy it. But do not mistake early adopters for market validation. For billions of other potential customers, the Watch’s close linkage and tethering to the iPhone could be a fundamental weakness.

In the short term, Apple must convince existing customers that they need a Watch in addition to their iPhone. Apple, however, has yet to offer a convincing case for this.

Long-rumored groundbreaking health apps built on Watch-mounted sensors have not materialized—disappointing many healthcare watchers (including me). That leaves Apple competing against more narrowly focused wearable devices like the Fitbit and Pebble—but at multiple times the price and fractions of the battery life.

Apple is also touting Apple Pay as a killer app that will attract consumers to the Watch. But, while Apple Pay is an intriguing service-oriented strategy for Apple, there is no need for consumers to buy an Apple Watch to use it. Apple Pay will work fine with just the iPhone.

For now, it seems that Apple has higher hopes for the Watch as a fashion accessory than as a category-defining killer app. But even that highbrow aspiration has ample skeptics who question the Watch’s fashion chops and business potential.

In the long term, when and if compelling apps emerge for the Watch, Apple will have to convince Watch enthusiasts that they need an iPhone in addition to the Watch.

This might not seem like a limiting factor given that there are more than 300 million active iPhone users. But imagine if the iPhone were just a peripheral to the Mac, thereby limiting its addressable market to Mac owners. Or imagine if the iPhone had to be tethered to the iPod. Do not such scenarios, in retrospect, sound implausibly shortsighted?

Both the Mac and the iPod were great products with loyal followings at the iPhone’s introduction. Apple, however, did not limit the iPhone to its predecessors’ market niches. As shown in Figure 1, the result was a blockbuster that lifted Apple far beyond those earlier products. The iPhone has grown to represent more than half of Apple’s revenues and perhaps even more of its profits.

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Figure 1 — Apple Device Sales

Now the iPhone has a loyal following but a small share of the smartphone market. Will Tim Cook limit the Apple Watch’s success to iPhone owners, or will Cook free it to dominate the potentially larger wearable devices space?

Freeing the Watch is a strategic imperative.

History tells us that market-leading technology products like the iPhone inevitably fade. The companies that depend on them must innovate into the succeeding categories or fade as well. Kodak, Polaroid, IBM, DEC, Nokia, Motorola, Blackberry, Intel, Sony, Dell and Microsoft are among those fading or faded companies.

All of those other companies underutilized disruptive advances in information technology for (at best) incremental enhancements to their dominant products. By doing so, they missed out on new killer products, business models and industries that coalesced around the new platforms enabled by those technology advances.

Thus, Kodak wasted decades trying to deploy digital photography (which it invented) as an enhancer to its dominant film-driven businesses. Microsoft was slow to the web and the cloud and killed its early e-reader and tablet devices because of internecine struggles over how those new categories related to its Windows and Office businesses. The list goes on: IBM did not lead in minicomputers. DEC and every other leading minicomputer maker missed out on personal computers. Motorola and Nokia were killed by smartphones, and Blackberry is near death.

Limiting the Watch to a peripheral role in the iPhone-centric ecosystem would repeat the same mistake made by those earlier market-leading technology companies.

That’s not to say there is not a lot of money to be made in the defend-the-cash-cow approach. Just look at the more than $650 billion in revenue and nearly $250 billion in earnings that Steve Ballmer delivered in his tenure as Microsoft CEO. Ballmer achieved those impressive numbers by defending and milking Microsoft’s dominant Office and Windows products. Ballmer, Microsoft and its investors missed out, however, on the market value created by Google, Apple, Facebook, Twitter and others that capitalized on search, big data, cloud computing, mobile devices and social media. Ballmer’s inability to grow beyond the core products that he inherited stagnated Microsoft’s market value for a decade.

Likewise, Tim Cook could nurse Apple’s iPhone-driven revenue stream for a long time. I doubt, however, that Tim Cook would be satisfied with a value-creation legacy comparable to Steve Ballmer’s.

It is too early to dismiss the Apple Watch’s potential to transcend the iPhone. We’ll get a measure of Apple’s foresight when it releases the software development kit (SDK) for the Watch. That will show how fundamentally tethered the Watch is to the iPhone and whether Apple has laid the groundwork for the Watch to be standalone at some point.

The real gut check for Tim Cook is further out in time, when technology and creativity enables wearable devices like the Watch to not only stand alone from the iPhone but also to replace it.

Will Tim Cook allow the Watch to cannibalize iPhone sales—as Apple previously allowed the iPhone to eat away at the iPod and risked the iPad’s doing the same to the Mac? Or will Apple stagnate as competitors and new entrants out-innovate it? Will Apple fade away as the riches from new killer apps, devices, ecosystems and business models that coalesce around emerging wearables-centric platforms flow to others?