From Mutual Aid to On-Chain Insurance 【Insurance Evolution and the Potential of web3: Part 2】
This week on insurance
Good morning.
I am mitsui, a web3 researcher.
Every Saturday and Sunday at noon, we update the web3 Basics Report. This week we will discuss Insurance.
1. Introduction
2.Basic structure of on-chain insurance
3. representative projects
4. strengths and challenges of on-chain insurance
5. insurance and the token economy
6. possibilities in Japan
7. summary
1. introduction
What web3 tries to solve is "transparency" and "automatic enforcement"
In the first part of this report, we examined how the ancient spirit of mutual aid has evolved into the modern insurance system. In the process, we described the challenges of the modern insurance model: opacity, payment delays, and information asymmetries. It is against the backdrop of these challenges that many people feel that insurance is necessary, but is shrouded in mistrust.
web3 proposes a new blockchain-based solution to this longstanding challenge. Specifically, it seeks to fundamentally redefine insurance with two powerful weapons: transparency and automated execution.
The data recorded in the blockchain can be viewed by anyone and cannot be tampered with, making the pooling of premiums and payment history completely transparent. In addition, smart contracts allow for a system in which insurance claims are automatically paid without human intervention if certain conditions are met.
What kind of insurance is reinvented on-chain?
So what exactly is "on-chain insurance"? It is a system that automates the entire process of contracting, collecting premiums, and paying claims through a series of smart contracts on the blockchain, without the need for a centralized insurance company.
This new model automates many of the roles traditionally filled by insurance companies and reduces intermediate costs. Above all, by increasing transparency and reliability, the new model aims to provide "peace of mind," the essence of insurance, in a purer form.
2. basic structure of on-chain insurance
Smart Contracts Automate Contract Terms
At the core of on-chain insurance is the smart contract. For example, the terms of the contract can be written in code, such as "If Smart Contract X is hacked and more than $1 million in user funds are stolen, insurance will be automatically paid from this pool according to the amount of damage.
Once this contract is deployed on the blockchain, it cannot be tampered with by third parties. In addition, since the contract can be viewed by anyone, the policyholder can be confident that the contract will be executed correctly. This significantly eliminates information asymmetries between the policyholder and the insurance provider, thereby eliminating distrust.
Funding and risk sharing for insurance pools
In on-chain insurance, a central entity does not collect premiums as a traditional insurance company does. Instead, multiple people contribute crypto assets to a common pool of funds called an "insurance pool. This contribution is not simply a premium payment, but an investment to underwrite the risk.
Participants who contribute funds to the pool are called "underwriters". They receive a commission or token incentive from the pool for covering the risk. In return, if a claim payment is required, the funds in the pool will be used. This mechanism is a direct replication on the blockchain of the spirit of mutual aid, where risk is shared jointly by multiple participants.
Automated claims payment (Oracle determines conditions)
The most innovative aspect of on-chain insurance is that it automates the payment of insurance claims. With traditional insurance, after an accident occurs, the policyholder files a claim with the insurance company, and the company investigates and examines the claim before making payment, which takes a lot of time and effort.
On-chain insurance, on the other hand, uses oracles to determine claim payment terms. An oracle is a mechanism for securely incorporating real-world data outside the blockchain into the blockchain.
For example, in the case of aircraft delay insurance, Oracle, in conjunction with an API that provides flight information, detects that a delay has occurred and passes this information to the smart contract. Upon receiving this information, the smart contract automatically transfers the insurance proceeds to the policyholder's wallet once it confirms that the pre-defined conditions (e.g., "if the flight is delayed for more than two hours") have been met. This eliminates cumbersome procedures and payment delays, allowing for immediate and transparent insurance payments.
3. representative project
Nexus Mutual: Mutual aid model ported to blockchain
Nexus Mutual is one of the oldest and leading projects in the field of on-chain insurance. They stand for a mutual assistance model built on Ethereum. Users can insure (underwrite) the risk of smart contracts and protocols by staking "NXM" tokens.
If damage occurs to the guaranteed smart contract, insurance payments will be made from the pool, but the decision on whether or not to make such payments will be made by DAO governance by the NXM token holders. This is a mechanism that goes back to the origins of mutual aid, where things are decided by consensus of the community, just as ancient "orchestras" and "associations" were managed through democratic procedures.
InsurAce: Multi-chain insurance marketplace
InsurAce is a multi-chain insurance marketplace that supports multiple blockchains (Ethereum, BSC, Polygon, etc.). Users can choose from a selection of insurance products that cover the risks of various DeFi protocols to suit their needs; InsurAce aims to make on-chain insurance more widely available to more users by offering relatively inexpensive premiums and supporting multiple chains.
Parametric Insurance (indexed insurance): triggered by weather data and on-chain indicators to pay
In the context of web3, parametric insurance is of particular interest. insurance is of particular interest in the web3 context.
For example, an agricultural insurance policy would be triggered by weather data (precipitation, temperature, etc.) provided by Oracle. Or, in the case of DeFi insurance, the insurance payout could be made automatically when a particular stable coin loses its peg ($1 value). This method is extremely compatible with on-chain insurance because it eliminates the need for loss assessment and allows for immediate payment of insurance claims.
4. strengths and challenges of on-chain insurance
Strengths: Transparency, immediate payment, global access
One of the greatest strengths of on-chain insurance is its transparency. Anyone can see on the blockchain how much money is in the premium pool, to whom, and how much was paid. This eliminates the distrust in traditional insurance models.
Next is immediate payment. With the combination of Oracle and smart contracts, insurance claims are automatically paid the moment pre-defined conditions are met. This eliminates cumbersome procedures and payment delays.
And then there is global access. On-chain insurance can be purchased from anywhere in the world, as long as you have access to the Internet. This gives people in countries and regions that are not served by traditional insurance services the means to cover their risks. This has great potential in terms of financial inclusion.
Issues: oracle risk, fraudulent claims, regulatory issues
On the other hand, there are a number of issues that need to be resolved for on-chain insurance.
The first is oracle risk. On-chain insurance relies on the oracle to provide external data, but if the oracle provides incorrect data or is hacked, there is a risk that incorrect payments could be made automatically. The development of a reliable, distributed oracle is essential.
Second, fraudulent billing. This is a major problem in traditional insurance, but fraudulent claims can also occur in on-chain insurance. An example of such fraud is deliberately taking certain actions (moral hazard) in order to meet insurance payment requirements. Community-driven DAO governance for screening and more sophisticated detection systems are required.
Third, there is the regulatory issue. In many countries, insurance is subject to strict regulation. On-chain insurance does not fit into existing insurance business laws or financial regulatory frameworks. In order for on-chain insurance to spread in the future, dialogue with regulators in each country and new legislation will be required.
5. insurance and the token economy
Designed to share risk with tokens (staking + underwriting)
Tokens in on-chain insurance are more than just a means of payment. They can serve as underwriters of risk by holding certain tokens and staking them in pools, for example, Nexus Mutual's NXM tokens.
They receive a portion of the premium as compensation for underwriting this risk. This structure is designed to provide an incentive to earn a return for taking on the risk and allows the risk underwriting function, which is traditionally carried out by insurance companies, to be delegated to a decentralized community.
DAO-type governance for "payment determination"
Many on-chain insurance policies are administered by DAOs. This means that the decision of whether or not to pay an insurance claim may also be determined by a vote of the community. For example, when a claim for payment arises, the token holder reviews the claim for legitimacy and approves it through a vote. This mechanism eliminates the traditional unilateral decisions of insurance companies and creates a transparent and democratic process.
Hybrid model with existing insurance companies
There are still many challenges before on-chain insurance can completely replace existing insurance companies. Therefore, a hybrid model is being considered as a realistic vision of the future.
For example, an existing insurance company could be responsible for premium calculation and sales activities, leaving only the payment of insurance claims to smart contracts. Another possibility is for insurance companies to tokenize their insurance products so that they can be traded in a more liquid market. This would combine the transparency and immediacy of web3 with the reliability and capital strength of existing insurance companies.
6. possibility in Japan
Affinity with a culture of mutual aid (lectures, mutual aid associations)
Japan has a long-established culture of mutual support through "ko" or mutual aid associations, which has a high affinity with the concept of on-chain insurance. The spirit of local communities and professional groups taking the initiative to share risks overlaps with the on-chain insurance of the web3 era. This cultural background will be a major strength for the spread of on-chain insurance in Japan.
Relationship with Japanese insurance regulations (Insurance Business Law, FSA guidelines)
However, in order to fully develop on-chain insurance in Japan, it is important to deal with strict insurance regulations (e.g., Insurance Business Law). The Insurance Business Law requires insurance companies to have sound management and appropriate information disclosure from the perspective of consumer protection.
How on-chain insurance will fit into this regulation or what new legislation will be required is a major issue for the future. Through dialogue with the FSA and other regulators, we need to find a way to reconcile innovative technology with a sound market.
Local Mutual Aid on the web3 (Local DAO x Insurance)
While Japan's rural areas are facing challenges such as declining and aging populations, there are still many areas with long-established communities. In the future, these communities may use web3 to establish local currencies and local DAOs, and introduce on-chain insurance to protect against disasters and illnesses, thus "web3-izing local mutual aid" may become a reality. This may allow local residents to proactively share risks and build sustainable communities.
7. summary
The Essence of Insurance = "Sharing Peace of Mind" Mechanism
Throughout the preceding and following sections, we have explained that insurance is not merely a financial product, but a human mechanism for "sharing security" that has existed since ancient times. From the ancient merchant corps to the firemen's guilds of the Edo period to the insurance companies of the modern era, the essence of insurance has remained consistent, namely, to diversify individual risks through the power of a group.
web3 could extend it transparently and globally
And on-chain insurance offered by web3 has the potential to extend this essence of "sharing peace of mind" more transparently and globally through the power of blockchain. It has the potential to dispel opaque processes and distrust and provide an immediate and fair insurance service that is accessible to all.
The value of on-chain insurance is to "return to the roots of mutual aid."
On-chain insurance does not deny the traditional insurance company model. Rather, it is an attempt to return to the "origin of mutual aid," which was nearly lost in the process of its development. A society where people can proactively share risks and help each other through the power of technology. This is the future that On-Chain Insurance aims for, and its true value.
Disclaimer：I carefully examine and write the information that I research, but since it is personally operated and there are many parts with English sources, there may be some paraphrasing or incorrect information. Please understand. Also, there may be introductions of Dapps, NFTs, and tokens in the articles, but there is absolutely no solicitation purpose. Please purchase and use them at your own risk.
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Author
mitsui
A web3 researcher. Operating the newsletter "web3 Research" delivered in five languages around the world.
Contact
The author is a web3 researcher based in Japan. If you have a project that is interested in expanding to Japan, please contact the following:
Telegram：@mitsui0x
*Please note that this newsletter translates articles that are originally in Japanese. There may be translation mistakes such as mistranslations or paraphrasing, so please understand in advance.