Tag Archives: Ripple

Blockchain: Bad Tech, Worse Vision

Blockchain is not only lousy technology but a bad vision for the future. Its failure to achieve adoption to date is because systems built on trust, norms and institutions inherently function better than the type of no-need-for-trusted-parties systems blockchain envisions. That’s permanent: No matter how much blockchain improves, it is still headed in the wrong direction.

This December, I wrote a widely circulated article on the inapplicability of blockchain to any actual problem. People objected mostly not to the technology argument, but, rather, hoped that decentralization could produce integrity.

Let’s start with this: Venmo is a free service to transfer dollars, and bitcoin transfers are not free. Yet, after I wrote an article last December saying bitcoin had no use, someone responded that Venmo and Paypal are raking in consumers’ money, and people should switch to bitcoin.

What a surreal contrast between blockchain’s non-usefulness/non-adoption and the conviction of its believers! It’s so entirely evident that this person didn’t become a bitcoin enthusiast because he was looking for a convenient, free way to transfer money from one person to another and discovered bitcoin. In fact, I would assert that there is no single person in existence who had a problem he wanted to solve, discovered that an available blockchain solution was the best way to solve it and therefore became a blockchain enthusiast.

The number of retailers accepting cryptocurrency as a form of payment is declining, and its biggest corporate boosters, like IBM, NASDAQ, Fidelity, Swift and Walmart, have gone long on press but short on actual rollout. Even the most prominent blockchain company, Ripple, doesn’t use blockchain in its product. You read that right: The company Ripple decided the best way to move money across international borders was to not use Ripples.

A blockchain is a literal technology, not a metaphor

Why all the enthusiasm for something so useless in practice?

People have made a number of implausible claims about the future of blockchain—like that you should use it for AI in place of the type of behavior-tracking that Google and Facebook do, for example. This is based on a misunderstanding of what a blockchain is. A blockchain isn’t an ethereal thing out there in the universe that you can “put” things into; it’s a specific data structure, a linear transaction log, typically replicated by computers whose owners (called miners) are rewarded for logging new transactions.

There are two things that are cool about this particular data structure. One is that a change in any block invalidates every block after it, which means that you can’t tamper with historical transactions. The second is that you only get rewarded if you’re working on the same chain as everyone else, so each participant has an incentive to go with the consensus.

The result is a shared definitive historical record. What’s more, because consensus is formed by each person acting in his own interest, adding a false transaction or working from a different history just means you’re not getting paid and everyone else is. Following the rules is mathematically enforced—no government or police force need come in and tell you the transaction you’ve logged is false (or extort bribes or bully the participants). It’s a powerful idea.

So in summary, here’s what blockchain-the-technology is: “Let’s create a very long sequence of small files — each one containing a hash of the previous file, some new data and the answer to a difficult math problem — and divide up some money every hour among anyone willing to certify and store those files for us on their computers.”

See also: How Insurance Can Exploit Blockchain

Now, here’s what blockchain-the-metaphor is: “What if everyone keeps their records in a tamper-proof repository not owned by anyone?”

An illustration of the difference: In 2006, Walmart launched a system to track its bananas and mangoes from field to store. In 2009, Walmart abandoned the system because of logistical problems getting everyone to enter the data, and in 2017 Walmart re-launched it (to much fanfare) on blockchain. If someone comes to you with “the mango-pickers don’t like doing data entry,” “I know: let’s create a very long sequence of small files, each one containing a hash of the previous file” is a nonsense answer, but “What if everyone keeps their records in a tamper-proof repository not owned by anyone?” at least addresses the right question!

Blockchain-based trustworthiness falls apart in practice

People treat blockchain as a “futuristic integrity wand”—wave a blockchain at the problem, and suddenly your data will be valid. For almost anything people want to be valid, blockchain has been proposed as a solution.

It’s true that tampering with data stored on a blockchain is hard, but it’s false that blockchain is a good way to create data that has integrity.

To understand why this is the case, let’s work from the practical to the theoretical. For example, let’s consider a widely proposed use case for blockchain: buying an e-book with a “smart” contract. The goal of the blockchain is, you don’t trust an e-book vendor, and the vendor doesn’t trust you (because you’re just two individuals on the internet), but, because of blockchain, you’ll be able to trust the transaction.

In the traditional system, once you pay you’re hoping you’ll receive the book, but once the vendor has your money the vendor doesn’t have any incentive to deliver. You’re relying on Visa or Amazon or the government to make things fair—what a recipe for being a chump! In contrast, on a blockchain system, by executing the transaction as a record in a tamper-proof repository not owned by anyone, the transfer of money and digital product is automatic, atomic and direct, with no middleman needed to arbitrate the transaction, dictate terms and take a fat cut on the way. Isn’t that better for everybody?

Hmm. Perhaps you are very skilled at writing software. When the novelist proposes the smart contract, you take an hour or two to make sure that the contract will withdraw only an amount of money equal to the agreed-upon price, and that the book — rather than some other file, or nothing at all — will actually arrive.

Auditing software is hard! The most heavily scrutinized smart contract in history had a small bug that nobody noticed — that is, until someone did notice it and used it to steal $50 million. If cryptocurrency enthusiasts putting together a $150 million investment fund can’t properly audit the software, how confident are you in your e-book audit? Perhaps you would rather write your own counteroffer software contract, in case this e-book author has hidden a recursion bug in his version to drain your ethereum wallet of all your life savings?

It’s a complicated way to buy a book! It’s not trustless; you’re trusting in the software (and your ability to defend yourself in a software-driven world), instead of trusting other people.

Another example: the purported advantages for a voting system in a weakly governed country. “Keep your voting records in a tamper-proof repository not owned by anyone” sounds right — yet is your Afghan villager going to download the blockchain from a broadcast node and decrypt the Merkle root from his Linux command line to independently verify that his vote has been counted? Or will he rely on the mobile app of a trusted third party — like the nonprofit or open-source consortium administering the election or providing the software?

These sound like stupid examples — novelists and villagers hiring e-bodyguard hackers to protect them from malicious customers and nonprofits whose clever smart-contracts might steal their money and votes?? — until you realize that’s actually the point. Instead of relying on trust or regulation, in the blockchain world, individuals are on-purpose responsible for their own security precautions. And if the software they use is malicious or buggy, they should have read the software more carefully.

The entire worldview underlying blockchain is wrong

You actually see it over and over again. Blockchain systems are supposed to be more trustworthy, but in fact they are the least trustworthy systems in the world. Today, in less than a decade, three successive top bitcoin exchanges have been hacked, another is accused of insider trading, the demonstration-project DAO smart contract got drained, crypto price swings are 10 times those of the world’s most mismanaged currencies and bitcoin, the “killer app” of crypto transparency, is almost certainly artificially propped up by fake transactions involving billions of literally imaginary dollars.

Blockchain systems do not magically make the data in them accurate or the people entering the data trustworthy; they merely enable you to audit whether the chain has been tampered with. A person who sprayed pesticides on a mango can still enter onto a blockchain system that the mangoes were organic. A corrupt government can create a blockchain system to count the votes and just allocate an extra million addresses to cronies. An investment fund whose charter is written in software can still misallocate funds.

How then, is trust created?

In the case of buying an e-book, even if you’re buying it with a smart contract, instead of auditing the software you’ll rely on one of four things, each of them characteristics of the “old way”: Either the author of the smart contract is someone you know of and trust, the seller of the e-book has a reputation to uphold, you or friends of yours have bought e-books from this seller in the past successfully or you’re just willing to hope that this person will deal fairly. In each case, even if the transaction is effectuated via a smart contract, in practice you’re relying on trust of a counterparty or middleman, not your self-protective right to audit the software, each man an island unto himself. The contract still works, but the fact that the promise is written in auditable software rather than government-enforced English makes it less transparent, not more transparent.

The same for the vote counting. Before blockchain can even get involved, you need to trust that voter registration is done fairly, that ballots are given only to eligible voters, that the votes are made anonymously rather than bought or intimidated, that the vote displayed by the balloting system is the same as the vote recorded and that no extra votes are given to the political cronies to cast. Blockchain makes none of these problems easier and many of them harder—more importantly, solving them in a blockchain context requires a set of awkward workarounds that undermine the core premise. So we know the entries are valid, let’s allow only trusted nonprofits to make entries—and you’re back at the good old “classic” ledger. In fact, if you look at any blockchain solution, inevitably you’ll find an awkward workaround to re-create trusted parties in a trustless world.

A crypto-medieval system

Yet absent these “old way” factors—supposing you actually attempted to rely on blockchain’s self-interest/self-protection to build a real system—you’d be in a real mess.

Eight hundred years ago in Europe — with weak governments unable to enforce laws and trusted counterparties few, fragile and far between — theft was rampant, safe banking was a fantasy and personal security was at the point of the sword. This is what Somalia looks like now–and what it looks like to transact on the blockchain in the ideal scenario.

Somalia on purpose. That’s the vision. Nobody wants it!

Even the most die-hard crypto enthusiasts prefer in practice to rely on trust rather than their own crypto-medieval systems. 93% of bitcoins are mined by managed consortiums, yet none of the consortiums use smart contracts to manage payouts. Instead, they promise things like a “long history of stable and accurate payouts.” Sounds like a trustworthy middleman!

See also: Collaborating for a Better Blockchain

Same with Silk Road, a cryptocurrency-driven online drug bazaar. The key to Silk Road wasn’t the bitcoins (that was just to evade government detection), it was the reputation scores that allowed people to trust criminals. And the reputation scores weren’t tracked on a tamper-proof blockchain, they were tracked by a trusted middleman!

If Ripple, Silk Road, Slush Pool and the DAO all prefer “old way” systems of creating and enforcing trust, it’s no wonder that the outside world had not adopted trustless systems either!

In the name of all blockchain stands for, it’s time to abandon blockchain

A decentralized, tamper-proof repository sounds like a great way to audit where your mango comes from, how fresh it is and whether it has been sprayed with pesticides. But actually, laws on food labeling, nonprofit or government inspectors, an independent, trusted free press, empowered workers who trust whistleblower protections, credible grocery stores, your local nonprofit farmer’s market and so on do a way better job. People who actually care about food safety do not adopt blockchain because trusted is better than trustless. Blockchain’s technology mess exposes its metaphor mess — a software engineer pointing out that storing the data as a sequence of small hashed files won’t get the mango pickers to accurately report whether they sprayed pesticides is also pointing out why peer-to-peer interaction with no regulations, norms, middlemen or trusted parties is actually a bad way to empower people.

Like the farmer’s market or the organic labeling standard, so many real ideas are hiding in plain sight. Do you wish there was a type of financial institution that was secure and well-regulated in all the traditional ways, but also has the integrity of being people-powered? A credit union’s members elect its directors, and the transaction-processing revenue is divided up among the members. Move your money! Prefer a deflationary monetary policy? Central bankers are appointed by elected leaders. Want to make elections more secure and democratic? Help write open source voting software, go out and register voters or volunteer as an election observer here or abroad! Wish there was a trusted e-book delivery service that charged lower transaction fees and distributed more of the earnings to the authors? You can already consider stated payout rates when you buy music or books, buy directly from the authors or start your own e-book site that’s even better than what’s out there!

Projects based on the elimination of trust have failed to capture customers’ interest because trust is actually so damn valuable. A lawless and mistrustful world where self-interest is the only principle and paranoia is the only source of safety is a not a paradise but a crypto-medieval hellhole.

As a society, and as technologists and entrepreneurs in particular, we’re going to have to get good at cooperating — at building trust and at being trustworthy. Instead of directing resources to the elimination of trust, we should direct our resources to the creation of trust—whether we use a long series of sequentially hashed files as our storage medium or not.

Shifting Balance in Risk Markets (Part 4)

In the opening segment of this series on complexity, I discussed the three network graphs that have emerged in the risk markets and which business models embody them. For quick reference:

In the second segment, I discussed the emergence of peer-to-peer insurance, which will accomplish the three core functions of the risk markets that currently exist in a “black market” unformalized state by using distributed managerial methods, which are:

  • Risk transfer;
  • Escrow of funds for a defined purpose; and
  • Management of reallocation of escrowed funds.

In the third segment, on distributed ledger technology, I looked at how it can be configured as a cohesive platform that would embody all three network graphs. I discussed how the roles of individual peers, along with carriers and agents, can work together to formalize the P2P methods in the risk markets. For a quick reference:

In this final segment, I will look at the current balance of the market share of each graph type in the risk markets, how the balance may change and what the new equilibrium state might look like in the risk markets.

Before doing that, I would like discuss an important idea that emanates from the blockchain and cryptocurrency communities: the idea that there could be “one ledger to rule them all,” or, asked another way, “Could a single ledger be an all-encompassing ledger, accounting for all value?” The simple answer here is “no.”

No single ledger, technology or network will ever be all-encompassing. That would be silly, as it would reintroduce the systemic weakness inherent in centralized system structures, namely the risk that by taking out a single central node (or ledger, in this case), the whole system could collapse.

See also: 4 Marketing Lessons for Insurtechs  

Just as was realized in the blockchain and cryptocurrency communities, the idea of a “risk ledger to rule them all” is not a desired structure; in the risk markets, a single distributed risk ledger to account for all funds escrowed against all risk types is not a desired structure. Because of the nature of risk and the diverse set of risk exposures in the world, there will need to be a diverse set of risk ledgers. We may see something materialize that looks like the following as an example of four distributed risk ledgers, each for a specific category of risk exposure.

Hold on to that thought for now….

I would like to again reference some of the work done by the Ripple team and their thought leadership toward a solution to address the concern of “one risk ledger to rule them all.” The Ripple team has introduced a protocol that will enable value to move in a cryptographically secure way between two or more distributed ledgers. It is called the Interledger Protocol, and more information can be found on their site here.

Using the Interledger Protocol, the Ripple team has articulated how various types of distributed ledgers, each engineered for a specific strength, can be networked together to create a term they have coined the “Internet of Value.” Without a single shred of doubt, it is a true statement that “finance is getting its internet,” and it is already here, albeit in a state of maturity similar to the internet circa the late 1990s. Unlike the slow pace of the internet’s growth, however, finance’s internet will not take as long to mature — mainly because it received an advantage from the preexistence of the internet itself and all that has been learned. Insurance and the risk markets of all the various financial services are the lowest-hanging fruit.

This might seem like a stretch in today’s environment, but it is not hard to imagine that by connecting many risk ledgers (each escrowing funds against a specific risk type) and using the methods outlined with Interledger protocol, that we will see the emergence of an internet of risk. Just like with the internet of value we see emerging today, the internet of risk will be made of many different distributed risk ledgers networked together.

I would define the internet of risk as a network of distributed risk ledger networks. The technical name for a “network of networks” in complexity science is a “multiplex.” Risk markets have been operating with an informal and non-digital multiplex structure for some time. Because each insurance company manages a risk ledger and because reinsurance companies function to connect insurance companies’ risk ledgers together, the reinsurance industry effectively embodies a decentralized network of insurance companies — and both graphs combine to embody a multiplex of risk ledgers.

In all likelihood, over the coming years we will observe the digitization of the existing multiplex of risk ledgers that is the risk market into a network of digitally connected distributed risk ledgers, with each individual risk ledger serving the specific needs of a specific risk exposure.

KarmaCoverage is intended to be this “multiplex of risk,” organizing the connections between the risk ledgers of all types of P2P risk sharing. And it aims toward the goal of insuring that, as the P2P segment of the risk market grows, it maintains a high degree of resilience, enabling society to transfer risk efficiently among individual peers, successfully addressing the various risk exposures of those peers. You would expect to ultimately see this play out and create an internet of P2P risk ledgers that looks something like this:

To be fair, it is not possible to know the ultimate structure (or graph) of this multiplex of risk. It will emerge by a process of self-assembly. It must employ distributed managerial methods to avoid reintroducing the fragility inherent with its centralized structure. That said, many portions of it can (and should) be centralized for efficiency purposes. Distributed systems have weaknesses, as well, one of which is the introduction of some degree of inefficiency. We would not want to act out that behavior where “if all you have is a hammer, everything looks like a nail.” The functions that should be centralized combine a make the business case for something like KarmaCoverage.

Now, let’s take a look at how this may have an impact on the existing balance of market share where each graph serves as a percentage of total risk. Using data on the currently formalized methods of total risk and by assigning a percentage to each graph in the risk markets, you find that the graphs settled at roughly these percentages:

  • Reinsurance: 40%
  • Insurance: 60%
  • P2P coverage: 0% (This does not account for all the risk transfer activity that occurs informally in the black market of P2P risk transfer.)

There are two factors to consider when thinking about how the equilibrium state of the risk markets will balance out in the information age. To answer this, first we need to consider market growth and look at how the size of the risk markets will grow as a result of formalizing the P2P black market activity. Second, we need to consider the market share split among the three graphs, given that P2P will no longer continue to be 0% of the formalized market.

Let’s look at Uber and the taxi market for a benchmark.

Uber CEO Travis Kalanick, speaking at the 2015 DLD conference in Munich, said the taxi market in San Francisco was about $140 million per year, while Uber’s revenues in San Francisco were running at $500 million per year and still growing at 200% per year. Ignoring the continued growth, these numbers indicate roughly a 350% growth in market size.

See also: How to Outfox Our Brains About Risk  

Approaching this question about the growth in market size from another angle, and after reviewing various sources, the global formalized taxi market size is roughly $20 billion in revenue per year, while Uber’s annual revenue is only about $5.5 billion. These numbers would indicate roughly a 25% growth in market size.

While this is a simple and quickly obtained benchmark, it would be easy to conclude that the process of formalizing the P2P segment of the risk markets will drive somewhere between 25% and 350% growth to the size of the risk markets. This would take the roughly $5 trillion in global annual premiums of the combined insurance and reinsurance industries and, after adding the P2P industry segment, bring the size of the risk markets to somewhere between $6.35 trillion (on the low side) and $17.5 trillion (on the high side).

Reality check: There is a big difference between risk and taxi rides! Taxi rides are more prone to growth in market demand because of economic activity and population growth than the risk markets are.

Risk, on the other hand, is more prone to shrinking demand because of improved mitigation of actual risk because of safer technology and other factors driving the reduction of risk. As one example, let’s look at auto risk as we make the transition into driverless cars, which stand to make a very significant dent in auto risk exposure. We are already seeing a 40% decrease in accident rates from mere “accident-less” cars equipped with accident-avoidance technologies.

Using these benchmarks (and my crystal ball), the fact that the frequency of small loss events is much higher than large and catastrophic loss events leads me to predict that the formalizing of P2P methods in the risk markets will result in the doubling of the size of the formalized risk market at some ambiguous point in the future. I will also assume that the ratio between insurance and reinsurance shown above does not change. This would end up with risk markets growing to nearly $10 trillion, with the market share being split among the three segments like this:

  • Reinsurance: 20%
  • Insurance: 30%
  • P2P coverage: 50%

Surely these assumptions and predictions are wrong, but this is more of an exercise in trend observation, not an attempt to actually predict the state of the risk markets at some specific future point.

There will be other drivers that will have an impact on the shifting balance. One easy-to-understand but powerful and potentially market-driven force would be consumers voluntarily choosing significantly higher deductibles. This trend is already in motion. One indication of this trend on home insurance policies is that in California, on policies covering more than a million dollars, the lowest deductible that is compliant with regulatory rules is for $10,000. While that example is imposed on the industry, here in Florida, we saw the industry self-impose an increase in deductibles from hurricane losses after the 2004-05 seasons — while, at the same time, many large carriers simply pulled out of the state, leaving a vacuum to be filled by newer, smaller Florida domestic carriers.

Using formalized P2P “networked self-insurance” methods, it is possible for consumers to achieve an average of $10,000 in coverage on an annual basis for less than $100 per month and to simultaneously fill the deductible gap all the way down to the first dollar of loss, fully addressing total risk exposure. That could easily lead to enabling consumers to request $10,000 deductibles on all their insurance policies, which would have a material impact on gross premiums.

On home and auto insurance losses, more than 90% of claims are less than $10,000. If the consumer behavior of requesting ever-higher deductibles on their traditional insurance policies occurs, it becomes easy to consider that premiums on traditional insurance may currently be at or near their historical high.

See also: 4 Steps to Integrate Risk Management  

Obviously, this process of formalizing the P2P segment of the risk markets will face headwinds, but since I entered the industry with an eye on the intersection of risk markets and crowdfunding methods back in 2013, we have seen the number of P2P insurance companies grow from one to dozens all over the world. It seems like the moment for the formalization of P2P methods in the risk markets is here.

Because of the convergence of factors discussed in this series (and a few others), I believe we will see a Napster-, an Uber- or an AirBnB-type of service emerge for the risk markets in the coming years.

I have started a LinkedIn group for discussion on blockchain, complexity and P2P insurance. Feel free to join here.

The whole mini-series is available for download at KarmaCoverage.com.

Distributed Ledgers in the Risk Markets (Part 3)

In the opening segment of this series on complexity, I discussed the three network graphs that have emerged in the risk markets and which business models embody them.

For quick reference:

In the second segment, we discussed the emergence of P2P insurance, which will formalize the three core functions of the risk markets that currently exist in a “black market,” unformalized state. These functions are:

  • Risk transfer;
  • Escrow of funds for a defined purpose; and
  • Management of reallocation of escrowed funds.

This formalization will occur via the emergence of a platform that enables all of these functions to be accomplished by the users of the platform, bringing the existing P2P economic activity out of its black market state and into the light of day.

Risk is the killer app for distributed ledgers!

The focus of the blockchain community on banking has been an interesting side effect of the timing of the Bitcoin innovation that coincided with the collapse of the U.S. banking industry. The blockchain technology software went open source in January 2009, while the markets (DJIA, S&P 500 and NASDAQ) bottomed out in March 2009.

The term “distributed ledger” is synonymous with blockchain. Both refer to the technology of a shared digital ledger, upon which transactions are validated by a distributed set of servers using chronological, public and cryptographically secure methods. I prefer the term “distributed ledger” because, at its core, this technology is an accounting tool that enables a set of capabilities not previously attainable.

In a distributed ledger:

  • All transactions — or, in accounting vernacular, “ledger entries” — are validated using a distributed method, without requiring users to trust in a central authority who has control over all entries on the ledger.
  • There will be lower transaction costs — both in terms of less time and lower labor costs — because there will no longer be a need to coordinate a multitude of private, centralized corporate ledgers.
  • It will create an ability for end users to publicly escrow value on a platform that enables them to connect directly with each other, creating a P2P distributed graph and enabling both the trusted communication of and individualized control over the reallocation of their escrowed value.

I would like to introduce the idea of a “risk ledger,” which is any ledger where value is escrowed as a hedge against a risk so that the risk can be safely carried through time. Currently, insurance carriers operate risk ledgers as they escrow money against a risk over a segment of time. (I wonder if this is why insurance companies are called “carriers.”) The same goal can be easily accomplished using distributed ledger technology, albeit with some advantages over private, opaque, centrally controlled corporate ledgers.

See also: 5 Steps to Profitable Risk Taking  

Distributed ledgers enable individuals to escrow value in the light of day against a risk, carrying the risk safely through a segment of time until a loss event necessitates the reallocation to the user who experienced a loss event and the removal of that value from the distributed ledger. Risk is the killer app for distributed ledger technology; as such, I believe the timeline for adoption in the risk markets will be shorter than observed in the banking markets, where the technology itself needed time to mature.

Trust is a fundamental ingredient in all financial services, and trust is something that distributed-ledger technology has a unique ability to enable. Because all money that is escrowed on a distributed ledger as well as the movement of that money is visible to all, users can trust in the system without needing to trust any single validator, company or peer participating in the network.

It must be understood that all distributed ledgers are, inherently, a network. There are many distributed ledger networks out there, but I will use Ripple’s to exemplify how a P2P distributed risk ledger platform may look. Thankfully, Ripple spearheaded acceptance by international regulatory bodies on issues associated with distributed ledger technology. Another reason I choose to use Ripple is because of its two technical features: 1) It has built-in “trust lines,” which enable individuals to create an explicit network of other peers whom they trust, and 2) it has the built-in ability of order books, which can be used to make markets between different stores of value. There are other technical advantages of Ripple, but these two elements combine to make a powerful and open-source solution.

Trust lines function as roads upon which value can move around the ledger. If I trust you, then you can send me value. If I do not trust you, then you cannot send me value because there is no path for the value to travel upon. This capacity for individuals to control who they are willing to trust enables individual peers to self-assemble a “trust graph” mirroring and to document the reality of who is trustworthy. Because all financial services are predicated on trust, this can be thought of as the finance industry’s equivalent to Google’s link graph, Facebook’s social graph and LinkedIn’s colleague graph, etc. Whoever ends up building this “trust graph” will likely be capable of creating much more value for society than those other graph types because of the significant role that finance plays in society.

Peers can extend trust lines to other peers they personally know, trust and are willing to help. These trust line connections create a trust graph in the same way as friend connections on Facebook create the social graph. In this way, a P2P distributed trust graph can be self-assembled and emerge out of the actions of the individual peers. Building a distributed graph of roads and creating many paths upon which value can travel across the distributed risk ledger network is an example of a distributed managerial process.

To give some example of how escrowed funds would flow through this distributed trust graph, let’s look at a hypothetical loss event. When a loss event occurs, a user documents the loss, and other peers who trust that user can choose to send a small amount their own escrowed funds to help their friend. (There is a formalized financial model  I will not detail.) However, I was surprised to discover, after working out the model’s details, that the model actually existed 1,000 years before modern insurance methods came about in the mid-1600s.

Order books — and the ability to make markets — enable agents and insurance carriers to retain their relative roles as they exist in the industry today.

The platform can be set up in a way that agents can capture a fixed fee as a spread or a percentage of the money that flows through the users that trust the agent by extending the agent a trust line. This is akin to commissions.

The platform can be set up in a way that carriers can manage the funds, which users put on escrow, and can control which agents are allowed to access the carrier’s gateway. This enables carriers to essentially mirror the same function that the appointment process accomplishes today. Carriers can do this activity without invoking the regulatory burden of insurance laws; they only need to comply with MSB regulations. This would also enable carriers to earn float income on the newly escrowed balance.

Phase change innovations typically emerge to address an order of magnitude more complex than what preexisting methods could in the prior industrial age paradigm. Consider how much economic activity and the number of actors Uber can organize on a global scale versus the top-down methods of an industrial-age taxi company. In the risk markets, coming out of the industrial age, we can see many companies operating independently in each of the three graphs (which are intentionally siloed). To achieve an order of magnitude improvement, we must encompass and coordinate all three graphs structures onto a single platform.

See also: Are Portfolios Taking Too Much Risk?  

Currently, agents function as a hub of client trust. Agents enable clients to navigate the complicated insurance product space and achieve the distribution of insurance products backed up by carriers. On a Ripple ledger, the agent would be a centralized hub of trust lines, and the graph would show that many users trust the agent node.

Currently, carriers function as an access point and product provider, lifting the burden of regulatory compliance, administration and product creation from agents. Engaging with the platform, each carrier can independently escrow client money without hampering the client’s ability to connect with other peers who they trust but who may not be clients of the same insurance carrier. With order books, the carriers can trade escrowed funds to enable a user who has experienced a funded loss event to receive a single check from the carrier that that user does business with, even though many of the peers funding the coverage are not clients of that carrier and do not have funds escrowed with the carrier issuing the check. Via these order book connections, carriers’ relationships will create a decentralized graph on the platform.

Combining the peer-to-peer distributed trust line graph, the centralized graph that is the hub of trust connections surrounding the agent and the decentralized graph of carrier-to-carrier order book connections, the platform can facilitate the coordination of all three graphs within a single system — all while relinquishing ultimate control of the flow of funds to the individual peers of the platform. This achieves a distributed managerial method of the reallocation process applied to the escrowed funds. This also alleviates the cost of adjusting claims and the exposure to fraud from the participating carrier’s perspective, as well as the distribution of the costs associated with the adjusting process across the peers participating in the network.

As is explained in his book “Why Information Grows: The Evolution of Order from Atoms to Economies,” MIT’s Cesar Hidalgo argues that we are at a point when firms need to network if they desire to continue to create value for society in excess of what any single firm can create alone.

Via a distributed risk ledger network, many carrier firms can run the servers that maintain the whole ledger. This gives each carrier an equal vision into the ledger and removes the need for any carrier to submit control to another carrier that is tasked with running the entire system. Most importantly, these methods function as a shared back office so that no single firm bears the burden of the costs associated with managing all of the small loss events. Additionally, the cost of the system’s management does not need to be duplicated and absorbed by each participating firm. This is essentially how Ripple is being implemented in the banking industry to reduce the costs of international payments and increase the speed of international flow of funds.

Some examples:

  • Firms in the home and auto insurance business can network to facilitate a ledger with other home and auto insurance firms, helping homeowners who experience losses that are under the deductible or excluded from the policy form.
  • Life insurance firms can facilitate their own ledger networking with other life insurance firms, enabling coverage for clients who do not meet underwriting requirements, such as those over the age of 75 or with a terminal disease.
  • Firms in health insurance can network to facilitate a ledger with other health insurance firms to better enable users to cover high deductibles, only invoking their traditional insurance contracts for unexpected, large incidents.

By networking, firms can enable the existing P2P risk transfer behavior to occur with less friction and bring this important economic activity out of its black market state and into the light of day on a formalized platform. Once the economic activity is occurring on a formalized platform, one would expect to see, like was observed with Uber and AirBnB, a resulting boom in the aggregate amount of the economic activity, growing the entire risk market’s pie and improving the risk market’s value add to society.

See also: 4 Steps to Integrate Risk Management

In the next segment of this series, I will consider possible changes to the risk market’s current equilibrium state and what that equilibrium may look like after the phase change has occurred.

What Blockchain Means for Analytics

I recently had the pleasure of attending #CityChain17 (blockchain conference) at IBM’s SouthBank offices.

Chaired by Paul Forrest (chairman of MBN Solutions), the conference was an opportunity to learn about blockchain and how it is being applied.

In the past, I viewed the hype about blockchain (following excitement about Bitcoin its most famous user) as just another fad that might pass.

However, as more businesses have got involved in piloting potential applications, it’s become obvious that there really is something in this – even if its manifestations are now much more commercial than the hacking by Bitcoin fans.

CityChain17 brought together a number of suppliers and those helping shape the industry. It was a great opportunity to hear voices, at times contradictory,and see what progress has been made toward mainstream adoption. There was so much useful content that I made copious notes and will share a series of two blog posts on this topic.

So, without further ado, as a new topic for our blog, here is part 1 of my recollections from this blockchain conference.

Introducing blockchain and why it matters

The first speaker was John McLean from IBM. He reviewed the need that businesses have for a solution to the problem of increasingly complex business and market networks, with the need to securely exchange assets, payments or approvals between multiple parties. He explained that, at core, blockchain is just a distributed ledger across such a network.

In such a scenario, all participants have a regulated local copy of the ledger, with bespoke permissions to approve blocks of information.

However, he also highlighted that today’s commercial applications of blockchain differ from the famous Bitcoin implementation:

  • Such applications can be internal or external.
  • Business blockchain has identity rather than anonymity, selective endorsement versus proof of work and wider range of assets vs. a cryptocurrency.
  • Blockchain for businesses is interesting because of the existing problems it solves. Broader participation in shared ledger reduces cost and reconciliation workload. Smart contracts offer embedded business rules with the data blocks on the ledger. Privacy improves because transactions are secure, authenticated and verifiable. So does trust because all parties are able to trust a shared ledger – all bought in.
  • Several sectors are currently testing blockchain implementations, including financial services, retail, insurance, manufacturing and the public sector.

Finally, John went on to outline how IBM is currently enabling this use of blockchain technology (including through its participation in the Hyperledger consortium and its Fabric Composer tool).

See also: 5 Main Areas for Blockchain Impact  

Comparing blockchain to databases, anything new?

As someone who was involved in the early days of data warehouses and data mining, I was delighted to hear the next speaker (Dr. Gideon Greenspan from Coin Sciences) talk about databases. Acknowledging that a number of the so-called unique benefits of blockchain can already be delivered by databases, Gideon began by suggesting there had been three phases of solutions to the business challenges of exchanging and coordinating data:

  1. Peer-to-peer messaging
  2. Central shared database
  3. Peer-to-peer databases

He had some great examples of how the “unique benefits” of blockchain could be achieved with databases already:

  • Ensuring consensus in data (B-trees in relational databases)
  • Smart contracts (the logic in these equal stored procedures)
  • Append-only inserts (database that only allows inserts)
  • Safe asset exchanges (the ACID model of database transactions)
  • Robustness (distributed and massively parallel databases)

Even more entertaining, in a room that was mainly full of blockchain advocates, developers or consultants, Gideon went on to list what was worse about blockchain vs. databases:

  • Transaction immediacy (ACID approach is durable, but blockchains need to wait for consensus)
  • Scalability (because of checks, blockchain nodes need to work harder)
  • Confidentiality (blockchains share more data)

After such honesty and frankly geeky database technology knowledge, Gideon was well-placed to be an honest adviser on sensible use of blockchain. He pointed out the need to consider the trade-offs between blockchain and database solutions. For instance, what is more important for your business application:

  • Disintermediation or confidentiality?
  • Multiparty robustness or performance?

Moving to more encouraging examples, he shared a few that have promising blockchain pilots underway:

  1. An instant payment network (using tokens to represent money, it’s faster, with real-time reconciliation and regulatory transparency)
  2. Shared metadata solution (as all data added to the blockchain is signed, time-stamped and immutable – interesting for GDPR requirements, even if the “right to be forgotten” sounds challenging)
  3. Multi-jurisdiction processes (regulators are interested)
  4. Lightweight financial systems (e.g. loyalty schemes)
  5. Internal clearing and settlements (e.g. multinationals)

But a final warning from Gideon was to be on the watch for what he termed “half-baked blockchains.” He pointed out the foolishness of:

  • Blockchains with one central validator
  • Shared state blockchains (same trust model as a distributed database)
  • Centrally hosted blockchain (why not a centralized database?)

Gideon referenced his work providing the multichain open platform, as another source for advice and resources.

Blockchain is more complex, hence the need for technical expertise

A useful complement (or contradictory voice, depending on your perspective) was offered next. Simon Taylor (founder of 11:FS and ex-Barclays innovation leader), shared more on the diversity of technology solutions.

Simon is also the founder of yet another influential and useful group working on developing/promoting blockchain, the R3 Consortium. He credits much of what he has learned to a blogger called Richard Brown, who offers plenty of advice and resources on his blog:

One idea from Richard that Simon shared is the idea that different technology implementations of blockchain, or platforms for developing, are best understood as being on a continuum, from more centralized applications for FS (like Hyperledger and Corda) being at one end and the radically decentralized Wild West making up the other end (Bitcoin, z-Cash and Ethereum). He suggests the interesting opportunities lie in the middle ground between these poles (currently occupied by approaches like Stellar and Ripple).

Simon went on to suggest a number of principles that are important to understand:

  • The shared ledger concept offers better automated reconciliation across markets.
  • But, as a result, confidentiality is a challenge (apparently Corda et al. are solving this, but at the expense of more centralization).
  • No one vendor (or code-base/platform) has yet won.
  • It is more complicated than the advertising suggests, so look past the proof of concept work to see what has been delivered (he suggests looking at interesting work in Tel Aviv and at what Northern Trust is doing).

To close, Simon echoed a few suggestions that will sound familiar to data science leaders. There continues to be an education and skills gap. C-Suite executives recognize there is a lot of hype in this area and so are seeking people they can trust as advisers. Pilot a few options and see what approach works best for your organization.

He also mentioned the recruitment challenge and suggested not overlooking hidden gems in your own organization. Who is coding in their spare time anyway?

In his Q&A, GDPR also got mentioned, with a suggestion that auditors will value blockchain implementations as reference points with clear provenance.

See also: Why Blockchain Matters to Insurers  

Time for a blockchain panel

After three talks, we had the opportunity to enjoy a panel debate. Paul Forrest facilitated, and we heard answers on a number of topics from experts across the industry. Those I agreed with (and thus remembered) were Tomasz Mloduchowski, Isabel Cooke and Parrish Pryor-Williams.

I took the opportunity to ask about the opportunity for more cooperation between the data science and blockchain communities, citing that both technology innovations needed to prove their worth to the C-suite and had some overlapping data needs. All speakers agreed that more cooperation between these communities would be helpful.

Isabel’s team at Barclays apparently benefits from being co-located with the data science team, and Parrish reinforced the need to focus on customer insights to guide application of both technologies. What panelists appear to be missing is that, in most large organizations, blockchain is being tested within IT or digital teams, with data science left to marketing or finance/actuarial teams. This could mean a continued risk of siloed thinking rather than the cooperation needed.

An entertaining, question concerned what to do with all the fakes now rapidly adding blockchain as a buzzword to their CVs and LinkedIn profiles. Surprisingly, panelists were largely positive about this development. They viewed it as an encouraging tipping point of demand and a case that some will need to fake it ’til they make it. There was also an encouragement to use meetups to get up-to-speed more quickly (for candidates and those asking the questions).

The panel also agreed that there was still a lack of agreement on terms and language, which sometimes got in the way. Like the earlier days of internet and data science, there are still blockchain purists railing against the more commercial variants. But the consensus was that standards would emerge and that most businesses were remaining agnostic on technologies while they learned through pilots.

The future for blockchain was seen as being achieved via collaborations, like R3 and Hyperledger. A couple of panelists also saw fintech startups as the ideal contenders to innovate in this space, having the owner/innovator mindset as well as the financial requirements.

It will be interesting to see which predictions turn out to be right.

What next for blockchain and you?

How do you think blockchain develops, and do you care? Will it matter for your business? Have you piloted to test that theory?

I hope my reflections act as a useful contact list of those with expertise to share in this area. Let us know if this topic is something you would like covered more, on Customer Insight Leader blog.

That’s it for now. More diverse voices on blockchain in Part 2….

Blockchain Technology and Insurance

What if there was a technological advancement so powerful that it transforms the very way the insurance industry operates?

What if there was a technology that could fundamentally alter the way that the economics, the governance systems and the business functions operate in insurance and could change the way the entire industry postulates in terms of trade, ownership and trust?

This technology is here, and it’s called the blockchain, best known as the force that drives Bitcoin.

Bitcoin has gotten a pretty bad rap over the years for good reason. From the collapse of Mt. Gox and the loss of millions –  to being the de facto currency for pedophilia peddlers, drug dealers and gun sellers on Silk Road and the darling of the anarcho-capitalist community – Bitcoin is not doing well in the public eye. Its price has also fluctuated wildly, allowing for insane speculation, and, with the majority of Bitcoins being owned by the small group that started promoting it, it ‘s sometimes been compared to a Ponzi scheme.

Vivek Wadhwa writes in the Washington Post that Chinese Bitcoin miners control more than 50% of the currency-creation capacity and are connected to the rest of the Bitcoin ecosystem through the Great Firewall of China, which slows down the entire system because it is the equivalent of a bad hotel Wi-Fi connection. And the control gives the People’s Army a strategic vantage point over a global currency.

Consequently, the Bitcoin brand has been decimated and is thought by too many to be a kind of dodgy currency on the Internet for dodgy people.

The blockchain, a core technology behind what drives Bitcoin, has been slow to enter the Zeitgeist because of this attachment to Bitcoin, the bête noire of the establishment.

But that is changing fast. Blockchain as a tool for disintermediation is simply too powerful to ignore.

People are now beginning to really look at the blockchain as an infrastructure for more than monetary transactions and what it has done for Bitcoin. Just as Bitcoin makes certain financial intermediaries unnecessary, innovations on the blockchain remove the need for gatekeepers from a number of processes, which can really grease the wheels of any business, including insurance companies.

How blockchain works and can work for the insurance industry

Because of the way it distributes consensus, the blockchain routes around many of the challenges that typically arise with distributed forms of organization and issues such as how to cooperate, scale and collectively invest in shared resources and infrastructures.

In the blockchain, all transactions are logged, including information on the date, time and participants, as well as the amount of every single transaction in an immutable record.

Each trust agent in the network owns a full copy of the blockchain, and, in the case of a private consortium blockchain (more relevant to the insurance industry), the transactions are verified using advanced cryptographic algorithms, and the “Genesis Block” sits within the control of the consortium.

The mathematical principles also ensure that these trust agents automatically and continuously agree about the current state of the blockchain and every transaction in it. If anyone attempts to corrupt a transaction, the trust agents will not arrive at a consensus and therefore will refuse to incorporate the transaction in the blockchain.

Imagine there’s a notary present at each transaction. This way, everyone has access to a shared, single source of truth. This is why we can always trust the blockchain.

Imagine a healthcare insurance policy that can only be used to pay for healthcare at certified parties. In this case, whether someone actually follows the rules is no longer verified in the bureaucratic process afterward. You simply program these rules into the blockchain.

Compliance in advance.

Automation through the use of smart contracts also leads to a considerable decrease in bureaucracy, which can save accountants, controllers and insurance organizations in general an incredible amount of time.

While the global bankers are far out of the blocks when it comes to learning, understanding and now embracing blockchain technology, the insurance industry is lagging. Between 2010 and 2015, a mere 13% of innovation investments by insurers were actually in insurance technology companies.

There are some efforts to tap innovation, as the Financial Times in the UK recently wrote. European insurers such as Axa, Aviva and Allianz, along with MassMutual and American Family in the U.S. and Ping An in Asia are setting up specialist venture capital funds dedicated to investing in start-ups that may be relevant for their core businesses.

Aviva recently announced a “digital garage’ in Singapore, a dedicated space where technical specialists, creative designers and commercial teams explore, develop and test new insurance ideas and services that make financial services more tailored and accessible for customers.

And others are sure to follow in the insurance industry, particularly because both the banking industry and capital markets are bullish on investing in innovation for their own sectors – and particularly because they are doing a lot of investment in and around blockchain.

Still, the bankers and capital markets are currently miles ahead of the insurance industry when it comes to investing in blockchain research and startups.

Competitors in the capital markets and banking industries in terms of blockchain solutions include: the Open Ledger Project, backed by Accenture, ANZ Bank, Cisco, CLS, Credits, Deutsche Börse, Digital Asset Holdings, DTCC, Fujitsu Limited, IC3, IBM, Intel, J.P. Morgan, London Stock Exchange Group, Mitsubishi UFJ Financial Group (MUFG), R3, State Street, SWIFT, VMware and Wells Fargo; and the R3 Blockchain Group, whose members include the likes of Barclays, BBVA, Commonwealth Bank of Australia, Credit Suisse, Goldman Sachs, J.P. Morgan, Royal Bank of Scotland, State Street and UBS.

Then there are start-ups like Ripple and Digital Asset Holdings, led by ex-JPMorgan exec Blythe Masters, who turned down a job as head of Barclays’ investment bank to build her blockchain solution for banking.

There are others in the start-up world moving even faster in the same direction, some actually operating in the market, such as Billoncash in Poland, which is the world’s first blockchain cryptocash backed by fiat currency and which passed through the harsh EU and national regulatory systems with flying colors. Tunisia is replacing its current digital currency eDinar with a blockchain solution via a Swiss startup called Monetas.

There are both threats and opportunities for the bankers… so what about the global insurance industry?

Every insurance company’s core computer system is, at heart, a big, fat centralized transaction ledger, and if the insurance industry does not begin to learn about, evaluate, build with and eventually embrace blockchain technology, the industry will leave itself naked and open to the next Uber, Netflix,  AirBnB or wanna-be unicorn that comes along and disrupts the space completely.

Blockchain more than deserves to be evaluated by insurers as a potential replacement for today’s central database model.

Where should the insurance industry start?

Companies need to start to experiment, like the bankers and stock markets, by not only working with existing blockchain technologies out there but by beginning to experiment within their own organizations. They need to work with blockchain-focused accelerators and incubators like outlierventures.io in the UK or Digital Currency Group in the U.S. and tap into the latest start-ups and technologies. They need to think about running hackathons and start to build developer communities – to start thinking about crowdsourcing innovation rather than trying to do everything in-house.

Apple, Google, Facebook and Twitter have hundreds of thousands of innovators creating products on spec via their massive developer communities. Insurance companies that don’t start lowering their walls might very well find themselves unable to innovate as quickly as emerging companies that embrace more open models in the future and therefore find themselves moot. Kodak meet Instagram.

The first step for insurance companies with blockchain technology will likely be to look at smart contracts, followed by looking for identity validation and building new structural mechanisms where parties no longer need to know or trust each other to participate in exchanges of value.

Blockchain technology, for instance, can also allow for accident or health records to be stored and recorded in a decentralized way, which can open the door for insurance companies to reduce friction in the current systems in which they operate.

Currently, the industry is highly centralized, and the introduction of new blockchain-fueled structures such as mutual insurance and peer-to-peer models based on the blockchain could fundamentally affect the status quo.

As comedian and writer Dominic Frisby once penned, “The revolution will not be televised. It will be cryptographically time stamped on the blockchain.”

Some of the many questions that the industry should explore:

  • What kind of effect will blockchain technology adoption in markets have on the the public’s perception of risk?
  • Today, the insurance industry is centralized, but what could it look like if it were decentralized?
  • How could that affect how insurance companies mutualize?
  • Can the blockchain improve customer relations and confidence?
  • Can smart contracts built on the blockchain automate parts of the process in how business is done in the insurance industry?

If you want to explore further, sign up to express interest here about our coming event in London: Chain Summit Blockchain Event for Insurance.