Blockchain Demystified
You may have heard the word "blockchain" for a few years now. It entered the lexicon within the past 10 years and has bubbled to the surface of reporting and financial website conversations on an almost daily basis. But what is a blockchain? In the most basic terms possible, it is a "distributed ledger." The concept of "distributed" relates to the definition "dispersed over a large area." In a blockchain, a network of computers maintains and secures the database, and each participant, or "node," stores a copy of the blockchain records. The opposite of this is centralized. In a centralized system there is one master database.
A "ledger" is simply a record of transactions. A general ledger is a very common accounting term used in business to keep up with financial information for a company. In a blockchain, this ledger can be used to include a record of all sorts of transactions and their associated information.
We now have a rudimentary definition of a blockchain. But, in order for it to be useful, there needs to be some sort of application for it. In October 2008, the application appeared. A mysterious user, Satoshi Nakamoto, published a paper describing bitcoin in an online cryptocurrency forum. The paper proposed a system built on a blockchain that could be used to digitally send payments between any two willing entities without the need for a third-party intermediary. No one knows the identity of Satoshi Nakamoto to this day.
The announcement in 2008 spawned an entire industry revolving around cryptocurrency and launched new interest in ways that blockchain could revolutionize business. However, if you are like me, the fact that the first use of blockchain revolved around bitcoin led to some assumption that blockchain and bitcoin are synonymous. This is not true.
A blockchain is built on three technologies. In 2008 they were combined in a new way to bring about the advent of bitcoin. Blockchain is, in fact, the backbone for cryptocurrency. Let's briefly explore the three technologies that make up blockchain. They are:
1) An identity mechanism – This is usually a public and private key cryptographic key combination. It is used to establish a valid transaction and secure your digital identity. When used together, the keys act as your digital signature and provide authorization to complete the action requested.
2) A protocol – This is the set of rules that defines what constitutes a valid transaction. The protocol also establishes when a new group of transactions will be made into a block. These blocks are chained together and cannot be changed unless every block before it was also changed.
3) A distributed network – As discussed above, this is a group of computers, or nodes that each have a record of all the transactions on the blockchain. When presented with a transaction, each node will compare it with the previous records for consistency. The node will also process the requested action against the blockchain protocol. If the rules are met, the node will validate the transaction and it will become part of a new block.
Great! Now we have some understanding of what a blockchain is, but why is it important? As actuaries of the future we need to know the potential impact that blockchain has on the way that our companies interact with their customers. Listed below are some of the ideas.
Control of personal data – Using a blockchain for identity verification could give individuals more control over who has access to what information about them. It has the potential to eliminate repetitive data entry, maintain patient privacy (in health-care applications) and keep a record of who has accessed which pieces of data. In practice this would help minimize identity theft as well.
Smart contracts – These are contracts whose terms are embedded in the code on the blockchain. The contract would be executed automatically when certain conditions are satisfied. A simple example relates to crop insurance: A smart contract to pay crop damages could use various meteorological data sources to determine factors that trigger claim payment automatically. Smart contracts have the potential to reduce the friction of claims handling, thereby lowering loss adjustment expenses and speeding up settlement time.
Fraud detection – Much of today's claims handling process is still very labor intensive and involves layer upon layer of bureaucracy. The use of the distributed ledger in blockchain technology to keep track of claims has great potential. Benefits include eliminating processing of multiple claims from the same accident and reducing counterfeiting, while still protecting the privacy of customers' personally identifiable information. Trends and patterns of fraud can be more easily detected with more claims data being managed collaboratively.
These benefits looming on the horizon make it seem that blockchain is here to stay. AIG is using blockchain to execute and manage multinational coverage for banks. AXA is using blockchain to automate flight insurance payments. Undoubtedly there are still many hurdles to widespread adoption of industry-wide blockchain applications, but the technology is available. It is only a matter of time before we begin to see advances in technology disrupting the way the insurance industry functions. Blockchain is one of those tools. Get ready!
