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Understanding Blockchain and its Impact on Insurance
Now and then, a disruptive technology comes along and changes everything. Blockchain is a good example. While it is currently best known as the platform behind Bitcoin, there are an infinite number of applications for blockchain technology.
What is blockchain?
Blockchain can be defined as a distributed public ledger designed to record transactions in a trusted environment. In other words, it is a type of database for recording transactions that is copied to all computers participating in the network.
To truly understand what this means, let`s remind ourselves of the inefficiencies in existing transaction processes. To illustrate how a typical transaction occurs in today`s world, let`s take an example of John, who is buying a shirt in Jane`s store.
- John isn`t carrying enough cash with him to pay for the shirt, and John and Jane don`t know each other, so a trusted third party (such as a bank or credit card company) is required to validate John`s ability to pay before the transaction is complete.
- John swipes his debit or credit card in the terminal in Jane`s clothing store, the purchase is approved, and John leaves with his new shirt. Simple enough, right? Well, not really.
- On average, five institutions need to be involved in a routine transaction like this one: John`s bank, Jane`s bank, Jane`s merchant service provider, card processors, and, in some cases, the credit card company.
- With so many players involved in the transaction, it could take up to a week for Jane to get her money and there are many points along the way that are subject to fraud and theft. For obvious reasons, this process is both expensive and inefficient.
What if there was a better way to execute John and Jane`s transaction? Blockchain technology eliminates the need for the trusted third-party intermediaries and allows John to transfer payment to Jane directly in a way that is cheaper, faster and safer.
How does it work?
In any transaction system, there must be a ledger with everyone`s balance in it. In today`s world, these ledgers are isolated and closed to the public. Trusted third parties (e.g. governments, banks, trusts, accountants, notaries, and paper money) are required to facilitate and approve transactions.
Blockchain technology is free, open-source software distributed worldwide that eliminates the need for trusted third parties by enabling a network of computers to maintain a collective ledger via the internet. This collective ledger is public and fully distributed across a network of “nodes” that all own a full copy of the ledger or blockchain. While we will focus on “public” or “open” blockchain structures in this article, it should be noted that “private” or “permissioned” blockchains also exist.
In a blockchain, all new transaction details are logged, time stamped, and verified by “miners” who compete in solving complex mathematical problems for the ability to post the next block of transactions to the ledger (or chain of historical transactions). Miners are rewarded for their efforts through some type of financial reward like bitcoins.
Let`s revisit our example of John and Jane, but this time we will use blockchain technology to process their transaction.
- John uses a digital wallet app (like a mobile banking app) on his smart phone by entering Jane`s public key obtained by scanning a QR code from her phone or by having her email him an encrypted payment address.
- The app alerts the “miners” around the world that John wishes to execute a specific transaction with Jane.
- The miners validate that John has enough money in his wallet to make the payment.
- John`s transaction is grouped with many other transactions that are requested within a ten‑minute period and the block of pending transactions is submitted for verification.
- All the miners around the world compete for the right to post the block of transactions to the shared ledger by solving a complex cryptographic computation.
- When a miner solves the mathematical challenge, they announce it to the rest of the network.
- The winning miner is issued a financial reward (e.g. newly minted bitcoins) and the new block is added to the front of the blockchain.
- Within ten minutes of the initiation of the transaction, Jane receives payment for John`s purchase (compared to one week in our previous example).
In this basic example, the terms of John and Jane`s agreement for the purchase of the shirt are straightforward. However, the type of details that can be included in the transaction details are limitless. Welcome to smart contracts.
How does it apply to insurance?
By allowing for smart contracts, a blockchain can store contract terms (and be programmed to execute those terms through automated money flows) for a wide range of complex transactions, including mortgages, options and futures, employment contracts… and insurance contracts.
Blockchain technology will drive significant changes in the insurance industry because of the role smart contracts will play in simplifying, improving, error-proofing and generating substantial cost savings for the most intricate insurance products, including premium payments, claims handling and data management.
In addition, blockchains can accelerate the emergence of peer-to-peer models of insurance and help insurers understand the provenance of antiques, art, and other insurable items. However, there are countless other opportunities for insurance companies to use blockchain to optimize processes and improve services.
“A new social interaction paradigm is driving different consumer needs and expectations. Also, the nature of risk is changing,” says Magdalena Ramada, senior economist at Willis Towers Watson and an expert on insurance technology and emerging models based on blockchain. “That is why the complete financial services ecosystem is going through a transformation. Big players and start-up firms alike are investing heavily in new technologies like blockchain to create significant value down the road and unlock new opportunities. It`s important for insurers to find ways to harness disruptive technologies like blockchain.”
Is blockchain secure?
Given the shared and public nature of the blockchain, it is only natural to question the security of transacting on such a network. In fact, blockchain is more secure than existing transaction networks. According to Judd Bagley from Overstock.com, the distributed nature of the network that verifies the integrity of the transactions and associated account balances makes a successful attack mathematically impossible. Estimates show that it would require 200 of the world`s largest super computers combined to hack the system, according to Future Bank Today.
What challenges lie ahead?
While having the potential to power a paradigm shift in how the world does business, blockchain is not without its challenges. Some of the primary challenges associated with the adoption of this young technology are buy-in, cost, regulatory issues, energy consumption, and standardization issues. Indeed, several efforts are underway to help standardize distributed ledger technology, including R3, Ethereum Foundation, Interledger, and the Hyperledger project.
We believe blockchain technology has the potential to change the insurance landscape and become an asset for the industry. As a result, EquiSoft formed an internal blockchain task force to better understand the technology and how it can be leveraged by our clients.
Regardless of when (or even if) blockchain technology becomes mainstream, it does warrant our attention today. After all, weren`t the mainframe, PC, internet, and social media once emerging technologies that had uncertain futures?