New Models of Insurance: Parametric Insurance

This is the third in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and the application of blockchain-based smart contracts for simple insurance contracts. We will now examine the use of blockchain-based smart contracts for parametric insurance. You can read the full article here.

As discussed in our last post, life insurance and final expense insurance are good examples of simple “if-then” arrangements that can be digitized into blockchain-based smart contracts in relatively straightforward ways. But could other types of insurance that are currently reliant on more subjective factors be restructured into products with more firmly defined parameters, enabling their digitization and administration through blockchain’s transparent processes? Parametric insurance policies offer such potential. By pairing parametric insurance with blockchain-based smart contracts, insurers can reinvent the manner in which classes of insurance are offered.

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Efficiency Gains in the Insurance Industry

This is the second in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. We previously discussed the enforceability of blockchain-based smart contracts under ESIGN and UETA and will now look at the application of blockchain-based smart contracts for simple insurance contracts. You can read the full article here.

Even though basic insurance contracts can often be boiled down to an agreement to make payment upon the occurrence of a discrete event, administration can quickly become complex. Claims adjusters are needed to assess a claim and its validity and disagreements can arise if parties later disagree about the interpretation of the terms or relied on representations outside of the policy. In addition, parties are often mistrustful of one another because of the potential for fraud, abuse, or denial of claims. In either event, insurance companies incur costs administering even the simplest of contracts, and those costs are often passed along to consumers in the form of higher premiums. However, reducing basic insurance contracts to “if-then” statements and digitizing administration would reduce the cost of administering these products and help overcome challenges of trust and transparency.

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The Enforceability of Smart Contracts

This is the first in a series of posts that breaks down our article, “Smart After All: Blockchain, Smart Contracts, Parametric Insurance, and Smart Energy Grids,” recently published in the Georgetown Law Technology Review. First, we will discuss the enforceability of blockchain-based smart contracts followed by four use cases: simple insurance contracts, parametric insurance, smart meters, and microgrids. You can read the full article here.

Smart contracts have the potential to impact a range of industries, and some are even calling 2017 “The Year of Smart Contracts.” Smart contracts can be used not only to automate existing processes, but also to create new industries and reach new markets. By providing a digital platform for coding “if-then” statements, providing a secure and resilient environment for value transactions, and preserving a detailed and immutable transaction history, the blockchain provides an ideal platform for smart contracts.

With companies and industries continuing to explore new blockchain-based smart contract applications, it is important to establish their enforceability.

Numerous questions have already been raised as to whether a contract on the blockchain is binding and enforceable. Vermont, for instance, has made multiple attempts to pass a law that would make blockchain evidence self-authenticating, and has finally succeeded in enacting one. Arizona recently passed a law clarifying that signatures obtained through blockchain technology are valid electronic signatures. We believe that the federal Electronic Signatures in Global and National Commerce Act (“ESIGN”) and state laws modeled on the Uniform Electronic Transaction Act (“UETA”) provide sufficient legal foundation for blockchain-based smart contracts to be enforced under current law.

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Best Practices for Limiting Liability Arising from Smart Contract Vulnerabilities

It is no secret that smart contracts have vulnerabilities.  Today’s post suggests a mix of best practices to limit potential liabilities that may arise when vulnerabilities interfere with smart contract performance.

But first, some background:  One recent survey of 19,366 Ethereum-based contracts found vulnerabilities in 45% of them.  Perhaps the most publicized example of a vulnerability was the DAO hack in June of last year, but hacking is certainly not the only way that smart contracts may be compromised.  There is potential for manipulation by insiders, which is of particular concern for smart contracts that operate based on “proof of stake” protocols, given the ongoing concerns that those protocols will not be effective in ensuring that the parties play by the rules.  Even without intentional interference by hackers or insiders, smart contracts may have software bugs that disrupt performance, and there is the possibility of unintended outcomes if the smart contract’s code fails to anticipate an unusual situation.  (Consider, for example, a complicated contractual pricing formula that depends on several variables and may cause the price to drop or skyrocket simply because the variables align in unanticipated ways.)

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Tips for Drafting Arbitration Clauses in Smart Contracts

We have suggested previously that arbitration may be a preferable alternative to court for smart contract disputes to (i) ensure a knowledgeable decision-maker handles the dispute, (ii) protect proprietary information, (iii) gain flexibility in scheduling and procedures, and (iv) pre-select the right forum.  Of course, arbitration doesn’t happen on its own – it typically requires a properly drafted arbitration clause.  This article provides several suggestions to consider on that point.

Notwithstanding all the hype associated with smart contracts, the real-world applications on the immediate horizon make use of distributed ledger technology (DLT) in ways that are not likely to necessitate fundamental changes in the dispute resolution procedures in those contracts.  Consider the example of commercial lending.  A smart contract may include protocols for the use of DLT to disburse loan proceeds and manage payments, but the inherent limits of the technology make it ill-suited to resolve a borrower’s default, leaving that circumstance to be addressed by the legal terms in the contract in the same way a default would be addressed under a traditional contract. That said, there are some aspects of the arbitration clause that should be re-considered when dealing with smart contracts:

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Tax Coalition Forms to Address Digital Asset Uncertainty

The Chamber of Digital Commerce and Steptoe & Johnson LLP today announce the formation of the Digital Assets Tax Policy Coalition, a Washington, DC-based coalition created to help develop effective and efficient tax policies for the growing virtual currency markets.  The move comes in response to a lack of recent guidance from the Internal Revenue Service, which since 2014 has considered digital currencies to be property, not currency, for tax purposes.

The Digital Assets Tax Policy Coalition intends to help develop policies that work for both the industry and government.  Developing these policies will allow the IRS to implement the recent recommendations by the Treasury Inspector General for Tax Administration (TIGTA) that the IRS develop a strategic plan for its virtual currency program and create third-party tools to allow for greater compliance, while minimizing the need for aggressive and burdensome enforcement actions.

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Four Reasons to Put an Arbitration Clause in Your Company’s Smart Contracts

Many in the blockchain industry expect smart contracts to enjoy significant (perhaps exponential) growth in real-world applications beginning this year.  This was the general consensus at the industry’s first ever Smart Contract Symposium in New York City this past December.  More than 250 leaders in blockchain, finance, law, and other industries gathered at the Microsoft Technology Center to discuss and promote the adoption of smart contracts for commercial use.  The Digital Chamber of Commerce followed up with a whitepaper identifying twelve business use cases for this technology, ranging from simple identity verification and payment processing to more complex processes like supply chain management and even cancer research.

The bottom line is smart contracts are coming (and may have arrived already for some).  No doubt smart contracts will offer many benefits in terms of decreased transaction costs and increased transparency and security, but even the best-designed smart contracts may deviate at times from the outcomes anticipated by the parties and may have vulnerabilities that can be exploited by the parties or outsiders.  So what happens when contract disputes arise?  Particularly if you are in-house counsel (or if you count in-house counsel among your clients), how can you be sure that the historical best practices for dispute resolution will continue to yield optimal results?  Or even tolerable results?

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Steptoe joins the Global Blockchain Business Council (GBBC)

The Bitfury Group, the leading global full-service Blockchain technology company, in conjunction with Steptoe & Johnson LLP, issued a press release today that Steptoe will serve as the legal services partner of the Global Blockchain Business Council (GBBC). Jason Weinstein was also listed as one of the 32 founding members of the GBBC, which was launched around the World Economic Forum 2017 Annual Meeting in Davos, Switzerland. See the full press release below.

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Alan Cohn on Blockchain in 2017

CoinDesk quoted Alan Cohn in a December 30 article titled “A Slow Awakening: 2016 in US Blockchain Policy.” In the article, which discusses blockchain regulatory developments of the past year and what may lie ahead in 2017, Alan Cohn says: “If 2016 was the year that the blockchain burst into public view, 2017 is the year that blockchain pilots and proofs-of-concept begin to permeate the mainstream of industry.” With a number of new projects announced within the first few weeks of 2017 such as a collaboration between IBM and the FDA and Deloitte‘s new blockchain research lab, he may have hit the nail on the head.

Alan also predicts that in 2017 there will be a stronger focus on using blockchain technology “to solve real-world problems, starting with digitizing processes that have resisted technological solutions or automation because of fears around non-trusted counter-parties, multi-party transactions, insecure transaction records, and high rates of fraudulent activity, areas where blockchain technology offers stair-step advantages.” While only time will tell how the regulatory landscape will change, the activity in the past two weeks makes 2017 look like a promising year for the blockchain.

 

Insurance with Assurance

In the last installment of our five-part blockchain series, we focus on the insurance industry.  Insurance and reinsurance companies are actively exploring and developing applications for blockchain technology.  And for good reason – distributed ledger technology has the potential to revolutionize the way insurance companies operate and engage with their policyholders and to open a window into new products and new markets.

At the retail level, the blockchain promises to benefit both the consumer and insurer by simplifying the claims process, increasing efficiency of underwriting and claims handling, improving risk management, and reducing operational costs.  The blockchain will help ensure the security of private or confidential information, improve auditability and transparency, and increase effectiveness in fraud detection.  These enhancements will also help lead to an improved customer experience.

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