For the last decade, blockchain innovations have been gaining traction and legitimacy, most recently with Decentralized Finance, or DeFi. DeFi refers to the entire blockchain-enabled ecosystem of products and services that have replaced more traditional financial intermediaries with software. Blockchain’s transparency and trustlessness are both foundational to all DeFi applications, as DeFi makes its financial products available to anyone, with banks and brokers no longer essential to facilitate a transaction. These DeFi products may also include other financial service activities, like insurance underwriting. Now, as innovations in blockchain continue and global demand for transparent and automated insurance products are also on the rise, smart contract technology is helping accelerate experimentation (and generate some real world use cases) within DeFi.
What are smart contracts?
A smart contract refers to an insurance contract or cover that pays out when certain, predefined conditions have been satisfied. Smart contracts are similar to traditional parametric insurance in their data-driven approach, with payouts occurring only after a clearly defined event takes place (for example, a flood, an earthquake or even a flight delay). Smart contracts are hosted in a decentralized environment with no possibility of tampering and no intermediaries, meaning these contracts can be settled entirely on the blockchain, with full transparency and zero human involvement. In addition to increased transparency, there are several other benefits to smart contracts, as the absence of a third party means quicker payouts, lower admin costs, and lower premiums.
What’s next for smart contracts?
Only very recently has it been possible for smart contracts to connect securely with any off-chain data, through innovations like blockchain middleware (aka Oracles). This is a particularly notable advancement, as connecting off-chain and on-chain data would make it possible to trigger smart insurance contracts using data from real-time insurable events.
Smart Contracts in Parametrics
Amid today’s volatile global landscape of economic uncertainty, climate catastrophe and public health crises, insurance incumbents are working to evolve their approach and meet demand for products that address loss prevention, mitigation and disaster financing. Parametric insurance, which uses triggers or indexes rather than claims to payout after a specific event has occurred, continues to show the industry the potential value of flexible, novel, and quick protections that can handle underwriting unusual risk types. To date, adoption and consumer interest in parametric insurance has lagged, as it lacked the kind of necessary infrastructure for executing payouts in a timeless, secure manner. However, with these recent blockchain middleware advancements, parametric insurance powered by smart contracts shows particular promise with disruptive potential for the entire insurance industry.
Smart Contracts in Decentralized Insurance
Additionally, within DeFi, decentralized insurance protocols are gaining notice for their ability to act as a kind of safety net for the entire crypto industry. The Smart Contract Cover is an evolving use case which covers crypto loans in the event of hacking or funding issues.
While the technology to execute smart contracts already exists, industry incumbents, insurtechs, start ups and other venture-backed companies are still in the early stages of creating blockchain-powered insurance products. Right now there are very few products available, and smart contracts remain fairly limited in the types of events and contingencies they can address. With sizable challenges ahead (particularly around data protection, regulation, privacy, and legacy infrastructure), there’s much work to be done for smart contracts to truly scale. However as blockchain technology continues to evolve and DeFi matures, there is a general understanding within the insurance industry around the massive potential for adoption, growth and expansion in the smart contract space.