Web3 insurance

Web3 insurance refers to the use of Web3 enabling technologies and concepts, such as blockchain protocols, smart contracts, decentralized applications (dApps), and decentralized autonomous organizations (DAOs) to create new insurance products and policies to cover exchange exploits, smart contract hacks, and other concerns in the emerging Web3 internet and adjacent economies. These technologies, namely blockchain and smart contracts, offer a chance to develop trustless insurance products, in which neither party needs to trust the other. Approvals for claims would occur across validator nodes in a proof-of-stake network, and these validator nodes remove the need or ability for any one party to decide whether they want to honor an agreement or not.

At the same time, the agreement between both parties can be permanently recorded on the distributed ledger, and claims payments can be auto-activated, reducing frictions for both the insurer and the insured. These technologies offer new ways of transferring risk to the market, an opportunity to reduce operating costs, and a chance to reduce the opaqueness of policies and the common problem of information asymmetry that occurs in the market. This can reduce costs to the insurance company, such as claims processing or reducing claims fraud, and improve the end-user experience.

Web3 concepts, such as the metaverse, tend to involve questions of ownership, but also work to change the way people interface with a digitally mirrored and augmented reality. The technology promises to merge the physical reality closer to digital and virtual spaces, if those virtual spaces do not entirely mimic the physical reality. The assets developed in these digital and virtual spaces, such as cryptocurrencies or NFTs, to digital real estate, suggest individuals will experience real, non-physical losses, which will be able to be covered by specific cyber or Web3 insurance policies. Web3 includes technologies such as distributed ledger technology (blockchain), smart contracts, claim automation, and real-time data collection, and these can change the way traditional insurance works, creating both opportunities for new insurance products and using Web3 to increase the transparency and connectivity in traditional insurance products.

Web3 is marked by decentralized applications (dApps), decentralized finance (DeFi), blockchain, and play-to-earn games (GameFi), with the benefits of anonymity, privacy, freedom in transactions, and lack of centralization and centralized controls offered by the technologies. This has led to the recognition of specific parts of the emerging Web3 economy as asset classes, such as NFTs, which offer a unique digital representation of ownership of a digital "thing" (such as a tweet, game asset, digital art, or digital real estate), and a chance to use NFTs in insurance products, where an NFT could represent an agreement between the insurer and the insured. The metaverse and crypto-based digital economy offer a neutral space in which censorship and centralized data control are discouraged, which requires the establishment of trust, privacy, and safety to get users to spend time and capital in these virtual environments. Insurance in these cases presents a chance to secure these digital assets and environments.

For example, Web3 insurance could cover data breaches, hacking attacks, or data theft when a user moves between metaverse environments. Network outages could require connectivity insurance. And an avatar's death could represent an actual loss to a user, which could be insured against. Especially where assets are traded, insurers will create cyber policies or Web3 policies to cover specified, non-physical losses within these categories, and more. Web3 technologies also offer a chance to change the way insurers think about traditional financial products and services and how Web3 technologies can increase transparency and connectivity in digital spaces.

This opportunity to create new kinds of insurance products and to insure digital assets has led to companies like Nexus Mutual or Etherisc developing Web3-based solutions. For example, Nexus Mutual uses the Ethereum blockchain to have users shoulder risk together without the need for an insurance company. All member decisions are recorded and enforced by smart contracts, and only members can decide which claims are valid. And Etherisc has developed solutions to cover the risk of crypto wallets in the case of an attack. For their platform, the use of blockchains and smart contracts creates an agreement codified in digital logic, which executes in a tamper-proof manner based on predefined conditions.

While there is a growth of Web3 organizations and companies developing insurance products for Web3 environments and risks, the insurance industry, or the incumbent insurance providers, are not meeting these new challenges and technologies with inflated premiums or non-existent coverage. Further, many of the traditional insurance companies are offering terms that are not appropriate for the emerging Web3 environment. Instead, the companies that are growing out of the Web3 environment are the companies that seem to be making better insurance products than their traditional peers. For example, there are traditional insurance companies insuring cold storage of private keys against theft and charging multiples of what would be charged to traditional financial companies.

Meanwhile, a small group of insurance companies is pioneering the use of Web3 technology to their advantage. This has included the use of tokens as a means of insurance, which offers end-user transparency and automated settlements for various types of claims. This has led some to suggest that if the traditional insurance industry does not work to keep up and compete in this new and growing landscape, the more the industry will be perceived as stagnating and outdated.

Some traditional insurance companies have approached Web3, such as CoverCompared, a company offering traditional insurance policies in exchange for payments made with cryptocurrencies through partnerships with global insurers such as Nexus Mutual and Protect4Less.

Insurance providers developing out of the decentralized finance DeFi and Web3 environments and offering insurance products for those environments tend to work on the same principles they work to insure. For example, a Web3 insurer could cover losses on a DeFi platform or protocol in the event of a hack. The premium paid for this kind of coverage would vary depending on the cover type, duration, and provider. As an example, an insurance provider could cover 1 ETH for a year against a hack on a decentralized exchange, and the insurance provider could charge 0.0259 ETH for the coverage.

This insurance could be provided in a decentralized way, meaning a person would buy coverage from a platform, in which the coverage is purchased from a pool of coverage providers, rather than purchasing the coverage from a single person or company. This allows anybody to act as a coverage provider; more correctly, this allows individuals to stake currency in a capital pool and become a liquidity provider, with the liquidity being used in turn to provide coverage to users.

Generally, the users providing capital will have some control over what types of policies or coverage they are covering. For example, if the person staking capital to a capital pool is confident in one exchange over another, they could specify the exchange as something they are willing to insure over others. In the case of a claim, to ensure the claim is valid, the community will be put to work, generally in a decentralized autonomous organization (DAO) structure, which gives a protocol token holder governance rights and allows those with governance rights to participate in the vote to accept or deny claims. Claims could also be verified automatically, using smart contracts and oracles, which can be established to track the outcome of certain events and distribute this information to the protocols, in turn minimizing disputes and automating payments on policies.

Web3 insurance products can offer protection for DeFi deposits, hedge risk against cryptocurrency volatility and flash crash, and provide security against the risk of theft and attack on cryptocurrency wallets. Further, they can secure users against possible risks, cover technical and financial risks, and bring a sense of safety and security to the Web3 financial environments. And as mentioned above, these technologies can make the process of submitting, claiming, processing, and paying out on a policy safe, reliable, and transparent in a system of trustless claim and risk assessments.

With the history of smart contract hacking, cyber-attacks on exchange platforms, and malware attacks on cryptocurrency wallets, there have emerged plenty of use cases for Web3 products that can be insured. Even DAOs have proven incapable of preventing malware attacks that have caused losses in the billions. These use cases include the following:

Web3 insurance companies and providers have worked to develop solutions to cover the risk of theft of cryptocurrency wallets in the case of attacks. The majority of users, when surveyed, have agreed that there is a need for wallets to be insured, but so far, few options have been available on the market. One such provider, Etherisc, developed a cryptocurrency wallet insurance solution capable of covering a large sum in a wallet.

One class of insurance that is rising in blockchain is cryptocurrency-based financial insurance. This could include lender insurance to hedge against default and systemic risk for on-chain loans. Numerous on-chain protocols specialize in connecting cryptocurrency lenders and borrowers, with borrowers putting up a certain amount of collateral, often greater than the borrowed amount due to the lack of financial data and personal accountability while paying interest at a regular rate to the lender, while the lender earns a steady, relatively low-risk yield for lending funds. Multiple Web3 insurance providers have provided insurance for the collateral provided by the borrower to safeguard and secure these cryptocurrency-backed loans, which works to further decrease the risk of Web3 loans.

For Web3, smart contracts are an important concept for the infrastructure, and Web3 insurance providers have developed Smart Contract Cover, an insurance product that covers the loss if a designated smart contract address is hacked. This kind of hack can be used for manipulation, such as loss of funds from the investor account or if funds are moved to another address that does not belong to the original investor. This kind of insurance policy can also cover losses in which funds are permanently lost and cannot be recovered. Thus, investors and lenders can lend cryptocurrency loans on an exchange without worrying about repayment or losses.

Although not (strictly speaking) an insurance product, on-chain or Web3 insurance requires high-quality and trusted data sources for smart contracts and works to keep the underlying infrastructure secure. Through this, any data provider can monetize web APIs and begin selling their data to the blockchain applications that need them, representing a new opportunity and market. Additionally, the data developed from traditional insurance agencies can be used to enable blockchain insurance projects to have better pricing models and to underwrite insurance contracts.

A growing area for Web3 insurance is parametric insurance, which has been recognized as a means to provide a lifeline for traditionally underserved communities, especially those facing increasing disruption due to extreme weather. This type of insurance, when used in Web3, can be understood as an "if/then" equation, automatically executed via a smart contract. Parametric insurance, especially with the use of smart contracts, has been suggested for use for crop insurance, flight insurance, hurricane insurance, and other types of insurance products in which the conditions for the insurance product can be either confirmed or denied.

For example, in a crop insurance scenario, if a given area experiences rain of 5 inches within 24 hours, the insured farmers can receive an immediate payout according to the previously agreed upon contract for flood-related damages. This removes the expensive insurance assessment process and with automated payout processes, parametric insurance further reduces transaction costs and claim cycles. Further, parametric insurance claims can be made with a basic phone and a network connection, which can enable remote locations with access to only basic technology to still avail themselves of Web3 or blockchain-based insurance policies.

Microinsurance offers security against specific perils for regular premium payments, which are far less than traditional insurance products. These are policies developed to be delivered in large volumes. However, with lower profit margins, and higher distribution costs, microinsurance policies do not get the deserved traction in the insurance industry. Web3 and blockchain offer opportunities, especially with peer-to-peer and DAO mechanisms, to automate microinsurance products and reduce the associated costs with claims processing, premium collection, plan management, and claim payments. These platforms, with new inputs for data, also offer a chance to increase the products covered through microinsurance. And many Web3-specific insurance products can be considered microinsurance as well.

Decentralized autonomous organizations (DAOs) allow Web3 insurance to develop organizations capable of combining peer-2-peer (P2P) insurance models with the self-regulated blockchain models for managing policy and claims, specifically through smart contracts. The DAOs would be created for groups of policyholders, in a similar way to P2P group model, in which no single body or organization would control the DAO; it would be equally "controlled" by its policyholders within each group. All premiums paid to the DAO create a pool of capital used to pay claims. And because it is self-governing with little to no overheads, any float at the end of the year can be redistributed back amongst policyholders.

This would make any such a DAO a non-profit organization and materially increases the capital reserves for claims costs. The question mark for such kinds of insurance and DAO technology is the regulation. This includes questions about who maintains the blockchain code in each DAO when regulations change. However, if those questions are answered, DAOs offer insurance providers new products or services that have not existed previously and open those organizations to insurance to new markets.

Another use case for Web3 insurance is the development of insurance platforms on which users can pick and choose from a plethora of insurance protocols customized according to their needs, and in exchange for cryptocurrencies. These platforms allow users to pay for traditional and Web3 insurance policies using cryptocurrencies rather than fiat currencies. Platforms such as CoverCompared and INS3.Finance have already implemented these kinds of platforms, with both platforms adding new insurance products as they become available.

Multi-chain insurance aggregators offer a chance for commercial insurance to cover blockchain protocols, and a chance for decentralized organizations to provide similar insurance products for various encrypted digital asset scenarios. In the case of INS3.Finance, the company is working to develop tools to help the traditional insurance market build insurance policies for NFT contracts. This could help in the formation of decentralized autonomous organizations, where the NFT and smart contracts that make the infrastructure of the company could be further insured against.

In the case of CoverCompared, the platform has partnered with insurers such as Nexus Mutual, InsurAce, and Protect4Less to offer coverage for traditional and crypto-based assets. This is with the goal of developing a platform offering ease of access to insurance products for a larger audience.

One example of a Web3-based insurance company, with a focus on decentralization in its coverage and its structure, is Bridge Mutual. Bridge Mutual is a decentralized coverage platform that allows users to purchase or underwrite insurance for crypto assets, decentralized protocols, and various centralized services. Their services allow users to protect their portfolios from hacks, bugs, exploits, and rug pulls, or earn high yields on stablecoins as insurance underwriters.

Bridge Mutual works by connecting coverage providers with policy purchasers. Coverage providers underwrite insurance policies by depositing collateral in USDT to specific coverage pools. In return for providing liquidity, these underwriters earn revenue from token rewards and the premiums paid by the insurance purchasers. These rewards are paid out in Bridge Mutual's native token.

On the other hand, for users seeking to purchase coverage, they are required to pay the required premium based on the coverage pool. In exchange, they receive a receipt token that represents the insurance policy. Because Bridge Mutual is a decentralized and permissionless protocol, it lets anyone provide insurance coverage and earn a relatively high yield.

One of the factors enabling the development of Web3 insurance products and policies is the smart contract. Smart contract technologies are underpinned by blockchain technologies, which mediate the performance of smart contracts. The smart contract works through rules-based operations and related technology, without relying on a human third party or central operator, and they offer automatic and irrevocable transaction outcomes. Once initiated, the coded outcomes for the smart contract cannot be stopped, unless the outcome depends on unmet conditions or specific rules are provided to the contrary.

As smart contracts are built on blockchain, the transactions around or involving the smart contract are maintained on the block and any data that is altered can be seen to be altered as the blockchain is transparent to all participants of the blockchain. This results in an indelible record. This concept makes some of the benefits of smart contracts in insurance clear, as, in theory, they should reduce insurer costs and lower premiums for policyholders while also improving the customer experience for those products.

Many of the benefits of smart contracts and their cost savings suggest that as the technology continues to prove its security and capability, hybrids between traditional and smart contracts are likely to be used more widely. This can be connected to the already wide range of IoT-related insurance products, where developers can use smart contracts to connect the IoT devices to the underlying insurance policy, thereby simplifying the claims process.

Where current insurance agreements rely on the interpretation of a claims processor, a smart contract is executed automatically and from data. This means a smart contract will rely on an automatic, relevant data trigger rather than waiting for a manual confirmation of an event. This shifts the traditional information asymmetry existing between the insurer and the insured closer to information parity. The insurance provider is able to receive verifiable proof that a claim occurred, triggered as the smart contract is from a trusted data-source or entity. This also reduces the manual claim process, which can be costly, and offers definitive and verifiable answers regarding claims and their legitimacy, removing the need for unverifiable information from either party and offering a shared source of truth.

With smart contracts automated and redundantly stored across distributed networks, they are faster, cheaper, and less prone to error than a manual claims process. Automation allows claims processing to be streamlined and digitally verified, with numerous insurance agreements that can replace the back-end work with the Boolean logic of smart contracts. This would, as mentioned above, further reduce costs associated with claims processing, administration, legal, and manual labor for data entry. These savings could be passed on to consumers in the form of lower premiums and faster settlements, thereby increasing customer satisfaction.

Most insurance contacts, especially corporate insurance contracts, are legal contracts signed between parties. This creates a need for dynamic contracts that are human and machine-readable, often referred to as Ricardian contracts. Not only do Ricardian contracts bring physical contracts to the digital world, they further enable quicker and composable amendments to further streamline the process and allow codable and non-codable clauses to exist.

As mentioned above, blockchain and smart contracts offer an opportunity for the insured to have access to reliable insurance, especially those disenfranchised and underinsured workers, such as fishermen or smallholder farmers. And blockchain and smart contract technology increase the reliability and predictability of the claims process and the legal terms of the insurance agreement; further, they offer lower cost to make the insurance products within reach for those disenfranchised and underinsured workers. This is especially important in areas where there may be poor access to a reliable source of insurance in nations with unreliable financial or legal infrastructure to help enforce agreements.

To develop advanced capabilities in smart contracts that are able to replace and improve upon traditional insurance structures, there needs to be secure, transparent, and privacy-preserving connections to external data. This is because blockchains are intrinsically unable to connect to external systems on their own, a limitation commonly known as the blockchain oracle problem. An insurance smart contract operates through the consumption and pushing of external data. The smart contract requires data inputs to be able to trigger other systems for claims processing and settlement processing. This means the external connection has to maintain the same properties of the smart contract, including its security and reliability. These oracles can give insurance smart contracts access to data inputs such as IoT sensors, web APIs, and satellite or drone imagery that can trigger the smart contract.

Data passed to smart contracts through oracles, while offering external connectivity, also offer a high degree of transparency, which helps to further bridge the transparency gap between insurance providers and policyholders for all forms of insurance. This would mean insurance providers no longer rely on the policyholder's word; instead, they have a definitive source of truth established based on connected IoT devices and trusted data feeds. While policyholders receive insurance contracts with greater transparency, from pricing and policy parameters to claims approvals and denials. The smart contract details how it will run its course, without obfuscation, and offers shorter wait times, increased security in payouts, and a fair and transparent process both parties agree upon.

Traditionally the insurance industry relies on trusted intermediaries to execute transactions. The third party makes the process slower and more expensive, and even uncontested claims can take months to be processed. While a smart contract helps with this, mitigating risk of manipulation by the mediator while also increasing transparency, smart contracts still have limitations. For instance, they are best suited for the most primitive types of insurance. This is as smart contracts operate on the conditional pattern of "if X, then Y". Meaning the smart contract is only viable if the conditions of the insurance agreement can be wholly coded. This is a rare scenario, with most insurance contracts filled with nuance. For example, industry concepts such as "good faith" or "reasonableness" cannot be expressed in the simple rules that smart contracts are based on. To capture these concepts would take innumerable amounts of code and resources to describe all possible contingencies and complex scenarios.

Moreover, the insurance industry tends to be a conservative industry, with many hesitating to trust technology over a third party. Smart contracts can be considered a substitution of the human factor for computer code, with the code being at little risk of being hacked, but the code itself can be flawed. This in part is why smart contract security audits have become a common, outsourced service. Further, smart contracts are likely to introduce new legal challenges in the industry. Especially as the automation value of the smart contract cannot be altered, which can complicate the process.

For example, in a traditional scenario, if a party claims there was no enforceable contract or the terms of a contract were not fulfilled, the party would withhold payment while the other party would open a dispute. With a smart contract, the funds would be automatically transferred, which would require one party to file a lawsuit to alter the transfer. With growing attention on smart contracts, though, there could be some legal adoption. In 2019, European Insurance and Occupational Pensions Authority set up Insurtech, which works to analyze smart contracts in the legal context. A formulation of a solid legal framework would enable the widespread of smart contracts throughout the insurance industry and would go a long way toward reducing distrust of these contracts in both the conservative insurance industry and for policyholders.

With the traditional insurance industry not generally quick to respond to and exploit the value of technological innovations, there has been some interest in the possible applications of smart contracts.

One of the most typical and immediate possible applications is in the use of smart contracts for the automation of the claims handling process. This is especially as the claims process uses the same conditional logic that smart contracts use, which can be easily automated in line with the "if/then" schema. Pilot projects into the use of smart contracts in traditional insurance have focused on property and casualty insurance, but the relevance is there for any insured event capable of being represented in a binary data form. Further, they could reduce the claims process even in cases when a third party, such as an assessor, mechanic, or technician is required, such that these entities could interact with the smart contract and add relevant transactions under the terms of the insurance contract.

In parametric insurance products, triggers or indexes are used in place of claims to payout after a specific event has occurred. The products have shown the potential value of flexible, novel, and quick protections that can handle underwriting unusual risk types and could be further automated and increased in their transparency and handling of insurance procedures with smart contracts. Smart contracts and the blockchain could be used to build the necessary infrastructure to execute payouts in a timeless and secure manner and further push the potential of this insurance category.

Within decentralized finance (DeFi), Web3 insurance protocols are gaining interest as a safety net for the cryptocurrency and Web3 industry. The Smart Contract Cover is such a case where cryptocurrency loans are covered in the event of hacking or funding issues. While the technology exists to execute the smart contracts that underpin these kinds of Web3 insurance products, there are few of these such products available. And despite their benefits, the binary conditional logic of the smart contract means the types of events and contingencies they can address remain limited. And with the challenges ahead for Web3 and DeFi—especially around data protection, regulation, privacy, and legacy infrastructure—there remains further complexity for smart contracts before they will be able to truly scale for Web3 and DeFi.

In Peer-to-Peer (P2P), smart contracts offer a chance to create a truly trustless insurance product and remove the need for familiarity in providing P2P insurance products. Rather, a group of strangers— rather than those with a certain degree of familiarity and affinity—can collaborate to insure an individual, or individuals, with the smart contract offering improved efficiency and transparency. The smart contract can also hold the written premiums in a secure escrow account, further removing the need for the insured to trust that the collaborators will have the necessary funds in the case of a payout. In the case of a claim, the smart contract's code can require multiple members of a pool to provide signatures to validate the claim and release the payment, further increasing the trustless environment for both sides.

Microinsurance products are generally products that allow low-income people in developing nations to access insurance services. Smart contracts offer the potential for a large benefit for such insurance products, especially as the nature of microinsurance products calls for low transaction costs and simplicity in claims processing. Payouts triggered by publicly available weather data already exist in crop insurance or weather-based insurance. Moreover, index-based agricultural insurance permits to determine payouts using indexes are correlated with losses caused by insured risks such as floods or pests, which can increase the availability for smallholder farmers. Further, relying on these indexes, insurers can issue payments without having to assess the loss at the single farm level, automating the entire process. This decreases the costs associated with the claims process and can enhance trust between provider and client. The reduction in cost can also provide less expensive and more readily available microinsurance products, increasing the pool of insurable smallholder farmers.

The vast majority of DeFi applications, whether they are decentralized insurance products, liquidity aggregators, or derivatives protocols, use oracles. They connect the smart contracts and blockchains to outside resources. Oracles enable formerly closed networks to consume external information and interact with legacy systems, which results in smart contracts able to react to real-world events and integrate with established business processes. However, more than data feeds, oracles also work as filtration systems, verifying the trustworthiness of the off-chain external data before delivering, further increasing the value of the transaction.

Without oracles, blockchain systems have been compared to computers without internet access. Oracles provide external information or bring off-chain data to the blockchain, but they also work to verify the trustworthiness of the data and have to potential to enable parametric insurance products, by bringing the trusted, real-world data to the blockchain. However, they also present a potential weak point for malicious actors, which can feed the blockchain with manipulated data and fraudulent insurance claims.

For Web3 to enter traditional insurance markets, there are two major approaches: the first is the extension of Web3 insurance companies to cover traditional insurance products; and the second would see traditional insurance companies using Web3 technologies to change their products and introduce new products, while also offering products for Web3 related assets. This is especially, as explored above, as traditional insurance models experience high operating costs, lack of transparency, information asymmetries, and major principled-agency problem. Each of these with solutions in blockchain technology, smart contracts, and decentralized autonomous organizations.

Traditional insurance companies have tended to be laggards in technological transformation and are an industry that has long seen ripe for that transformation. In the United States alone, the industry is nearly worth $6 trillion and has been dominated by legacy market leaders and legacy processes and systems. For example, in 2019, StateFarm, the United States leader in property and casualty, accounted for more than $65 billion in premiums, and MetLife, a leader in life insurance, accounted for $95 billion. Web3 offers a chance for these companies to develop new insurance products and unlock further billions of users. And this has seen some traditional insurers look towards Web3 as an opportunity.

When it comes to entering this new market, these traditional insurance companies have a powerful competitive advantage. After years of activity, these companies often have a strong reputation, trust, and come with historical, and at times, loyal client bases. However, the investments necessary for these traditional insurance companies to understand and develop products for the decentralized market are expected to be non-negligible. This is not helped by many leaders of these companies not believing that cryptocurrency, DeFi, and Web3 have staying power and treating them as a fad. That is despite Web3 expecting to present a multi-trillion opportunity to insurance companies as they begin to enter the markets. And as McKinsey estimates that roughly 35 percent of total insurance premiums are lost to frictional costs, blockchain and related technologies are expected to cut 18 percent of those frictional costs.

For traditional insurers, Web3 and its related technologies also offer a way to enhance the mechanisms that power the industry and solve some of the issues the traditional insurance industry has suffered from. These include the overreliance on trust, information asymmetry, cumbersome processes, and opaque practices.

However, many of those issues have proposed solutions in Web3 technologies. Lacking real technological challenges for much of its history, traditional insurance giants have been able to employ these frustrating and, for some, outdated characteristics. However, blockchain and Web3 provide the industry a chance to change some of that. The benefits of blockchain for the traditional industry include the following:

• Speed—typically there can be a week or month-long process of filing a claim, interacting with the insurer, and receiving a payout. Smart contract, on-chain data, and blockchain infrastructure can, theoretically, settle claims within minutes of an event.
• Transparency—traditional insurance providers are incentivized to keep information, such as risk models and policy details, secret. Were policies held on blockchain, the policyholder would have access to an unprecedented degree of information about their policy, the financial health of the underwriters, and the open-source code dictating the protocol's rules.
• Second and third-order innovations—blockchain-native insurance also offers a chance for insurance policies to be tokenized, creating new possibilities, such as allowing users to trade policies in the case that they no longer need them, or bundling policies with other digital assets.

As explored above, smart contracts also offer a scenario in which traditional insurers can simplify and automate many of their processes. As well, this can remove the cycle of distrust described above as the smart contracts are paired with data oracles that are trusted by both the insurer and the insured. Smart contracts also offer a chance to further expand insurance markets to previously disenfranchised customers, as decentralized insurance protocols offer faster, less expensive, and trust-minimized operational abilities. And these smart contracts offer fairer conditions for the insured, as the policies are more transparent, are tamper-proof, and, by removing trust between parties, the policy itself becomes more trustworthy.

The risks of smart contracts to the traditional insurance industry come in some part from the reliance on code and binary logic. For code, this can expose the insurer to critical coding bugs, transaction completion failure, flash loan exploits, oracle attacks, wallet hacks, and collateral liquidation, besides other risks. Smart contracts remain the first and most widely-adopted use case of Web3 insurance despite these concerns. In addition, blockchain allows insurance companies to benefit from fast settlements, no KYC or AML process, and end-user transparency. But it still offers potential to the traditional insurance industry.

There are various hypothetical use cases, or use cases in which there have been experiments done to build various Web3-based traditional insurance products that work to combine both traditional insurance products with Web3 technologies. One of those cases comes from health and life insurance companies, where they could realistically use blockchain and related technologies in order to:

• move towards interoperable, comprehensive health records, with the added security and trust established between entities are two reasons why blockchain can solve this problem better than other technologies
• support administrative and strategic imperative with smart contracts, which would allow for the automatic collection of records of agreements, transactions, and other valuable information sets, and link the information together to allow smart contracts to act on the data
• detect fraud, where fraudulent information submitted to a life or health insurer through false claims, false applications, or other channels can be determined if the submission is valid
• improve director accuracy, where a unique provider directory could leverage decentralized consensus protocols to allow providers and insurers to update listings more quickly and easily
• simplify the application process to make it more client-centric, and provide easier-to-access medical records on a blockchain, while also building a more comprehensive set of records on the blockchain
• help facilitate a more dynamic insurer and client relationship as electronic health records securely stored on the blockchain can be a foundation for integrating a variety of wellness-related behaviors into the insurer and client dynamic

CAIPY, which stands for CAr Insurance PolicY framework, is based on the Ethereum blockchain, which uses tamper-resistant sensors to create an "if/then" binary for car insurance. This means the consumer is offered a transparent policy, while the insurer benefits from automated damage detection based on the installed tamper-resistant sensors. However, the paper in which the hypothetical CAIPY system was presented noted that the availability of reliable data is crucial to whether or not to reimburse a policyholder. Unfortunately, many traditional sensors and electronic control units, deployed in most cars for driver-assistance or safety systems, are not designed for transferring data between the insured and their respective insurer in a non-manipulable manner.

The system has also struggled with the challenges of data reliability, especially as even tamper-resistant sensors can be tampered with and readings can still be occasionally erroneous. Cost efficiency is also a challenge, as automation of insurance products reduces costs, and Web3 technologies and environments remain volatile places with some blockchains remaining costly in their transaction fees. Finally, customer privacy is a challenge, as blockchain data is inherently public to all participants; this requires that sensitive data, such as customer information or event location, remains private. Data could otherwise be leaked. Meanwhile, storing encrypted data requires access control so only authorized parties can decrypt and further process event data, reducing the automation in the system.

One real-world example of the use of Web3 technologies for insurance products includes Lemonade's Crypto Climate Coalition. As part of the charitable arm of the insurance company, and working with Avalanche and Chainlink, the company built a decentralized weather insurance product. The insurance product was created as a decentralized autonomous organization (DAO), called the Lemonade Crypto Climate Coalition. It was administered by the Lemonade Foundation, which works to turn real-world data provided by Chainlink and Tomorrow.io (a real-time weather information provider) into an insurance product that can insure smallholder farmers against incidents of inclement weather, such as flooding or drought.

The product was initially rolled out in Nigeria, with further rollouts in sub-Saharan Africa expected, and with the aim of providing insurance to subsistence farmers. This has traditionally been an underserved area, especially as claims can be as small as tens of dollars, which would be incredibly difficult for insurers to underwrite and process a claim against while still being profitable. Servicing the claim could often cost more than the claim itself. This insurance product takes the weather data and, if the conditions are met, such as a drought in a specific region that exceeds a certain threshold, the policyholder can automatically receive the value of their lost crops.

In April 2022, OneDegree announced a strategic partnership with Munich Re to launch OneInfinity, a digital insurance product designed for digital asset trading platforms, custodians, asset managers, and technology providers. As part of the partnership, Munich Re provides reinsurance capacity and supports OneDegree's technical underwriting. Furthermore, the solution is bundled with Cymetrics's solutions. Cymetrics helps companies examine cyber, blockchain, and digital asset risk from the perspectives of hackers and insiders in an agile and flexible way.

Across Europe, Allianz launched a Web3 solution to streamline international motor insurance claims. The blockchain platform was deployed across twenty-three European subsidiaries, with staff processing over 10,000 international accident claims six weeks into the launch. Through this system, a customer insured by Allianz Hungary involved in a car accident in France would trigger a claim communication within minutes instead of the weeks it would previously take.

While many Web3 insurance companies are developing products for Web3 and decentralized finance, and as traditional insurance companies begin offering similar products for Web3 and DeFi, there has been a similar movement of those Web3 insurers towards traditional insurance products, bringing many of the concepts of Web3 to those products, such as smart contracts, data oracles, blockchain-based governance, and peer-to-peer protocols. Many of the products that have been launched by Web3 insurance platforms are aimed at offering low-cost insurance products, particularly those products that would not have been previously available given the costs of claims processing. This has included insurance products such as flight delay insurance, hurricane protection, and crop insurance.

Decentralized or Web3 insurance promises to solve a pain point for many of the users of Web3 ecosystems, but they also offer a chance to extend into real-world events to create lower-cost insurance products and new insurance products, based on the technologies and so long as capable data are available. For example, Etherisc offers insurance for droughts, floods, and hurricanes; Nexus Mutual was originally founded to insure earthquakes; Insureum offers ski resorts with snow cover, in addition to other niche real-world events; and Arbol offers over twenty blockchain-based insurance contracts that range from loss of fertilizer application days to rice crop damage. At the same time, platforms are experimenting with "social insurance" as a way of pooling funds to distribute those funds to individuals based on specific rules. For example, protecting digital assets, such as NFT, could be applied to traditional forms of title insurance.

There are several proposed applications of Web3 in traditional insurance, some of them explored above, but they tend to include insurance products for otherwise disenfranchised or underinsured communities. These include using blockchain, data oracles, and smart contracts for weather-based microinsurance products. This product would take temperature updates from an external provider, with the insurance contract paying out as the temperature reaches a specified threshold, often for a specified number of days, which would provide smallholder farmers in various areas, specifically sub-Saharan Africa, to receive the payout to cover damages to their farm.

Another example, in India, has been microinsurance products for farmers to protect them against crop failures and natural calamities such as droughts, hurricanes, and floods. This crop insurance would work on Web3 technology. In India, this is an especially important insurance product, as crop failure from natural calamities is a leading cause of suicide on farms. As part of this product, a smart contract would monitor the weather (similar to weather-based microinsurance), and when the conditions (water levels, lack of water, wind speed, heat, etc.) reach a certain level, the contract could payout to help the farmer with their losses and to replant their fields.

Another often-touted example of Web3 insurance product is flight insurance. Under the Web3 model, a policyholder would purchase a flight insurance product built on smart contracts, and the moment a flight is delayed or canceled, the contract would payout immediately, as the data would be fed to the blockchain as it happens, and the money could flow frictionlessly without a bank involved. The model could use predictive analytics as well to better understand if a flight has a higher chance of being delayed or canceled and change the price of the premium based on this data. As well, those providing liquidity to the pool, while risking their liquidity in the case of a policy being paid out, also have a chance to make money through the policy. And policyholders have a greater chance of receiving a payout without needing to file claims, which is not the case with traditional products.

One example of a Web3 insurance organization offering real-world insurance products is Etherisc. Etherisc is a protocol to collectively build insurance products, offering product templates and insurance-as-a-service to allow anyone using the platform to build their own insurance products. One such product was FlightDelay Insurance, which, as explored above, allows users to automatically receive a payout in the case of a delayed flight. Etherisc also offers crop insurance and is developing Hurricane Protection and Social Insurance (death or illness) products.

Etherisc launched the FlightDelay insurance product in January 2022, using Chainlink data to check the flight data on whether a flight has been delayed or canceled, and using that data to trigger policy payments. All policy payments are processed through the Gnosis Chain. The policies are also used to provide policyholders with transparent and secure end-to-end solutions, based on the blockchain and smart contract technologies.

Many of the real-world insurance products offered by Web3 insurance platforms and organizations are offered in specific geographic areas, with many of the products focusing on Africa, which has been a largely underinsured area. This is, in part, due to the insurance laws and the regulatory authority that enforces and monitors compliance with those laws, which makes offering an insurance product on a nationwide basis in the United States require a compliant operating model. The following are important considerations in structuring an insurance provider's operations:

There are various state laws for insurance across the United States that require a person who transacts an insurance business to be licensed as an insurance company unless there is a state-specific exemption. The scope of activities that constitute "transacting" insurance is typically broad; for example, issuing or delivering an insurance contract in a US state would generally be considered "transacting" an insurance business in that state and would require the person engaging in such an activity to be licensed as an insurance company. While there have been some arguments that insurance offered through a smart contract should not constitute an "insurance contract," there is a greater belief that state insurance regulators would view such arguments with skepticism, with the form of a smart contract "insurance contract" typically satisfying the definition of an insurance contract.

Depending on the US state insurance laws, certain licensing requirements may apply for activities such as marketing insurance products, adjusting or settling insurance claims, receiving compensation in the form of insurance premiums, underwriting insurance products, receiving insurance premiums, and a variety of other activities related to insurance. These licensing requirements are enforced by state insurance regulators. For example, a cloud-based platform offering insurance solutions to its customers was licensed by an insurance agency, but failed to ensure that its employees had the appropriate insurance licenses and failed to comply with certain other state insurance laws. It became subject to multi-state investigation and was required to pay millions of dollars in fines.

Many assume these licensing requirements may be applicable to the decentralized insurance provider or to its partners or investors. For example, if a decentralized autonomous organization offers insurance products and has members voting on whether an insurance claim should be paid, state insurance regulators may take the position that these voting rights permit DAO members to adjust or settle claims, therefore requiring them to be licensed as independent adjusters. As well, the marketing and selling of those insurance products can be considered by insurance regulators to be selling, soliciting, or negotiating insurance which requires a person performing those actions to be properly licensed.

Most US states have enacted insurance laws that prohibit insurance companies, agents, brokers, and licensees from paying a rebate of an insurance premium to an insured or providing any special advantage or favor to any insured that is not specified in the insurance policy. These laws have been interpreted to prohibit a decentralized insurer from, for example, offering lower insurance premium rates to holders of the platform's token or to members of its DAO, and would restrict them from offering free or discounted products or services (including token "airdrops") to the platform's insureds or applicants for its insurance products.

The state insurance laws tend to require insurance companies to maintain reserves for purposes including the payment of losses and claims and the expense of adjusting and settling claims. If a decentralized insurance provider is using a liquidity pool model for some or all of its reserves, while liquidity pool participants are compensated for providing liquidity to the pool, state insurance regulators may assert the liquidity pool is not sufficiently large to ensure the insurer is adequately reserved, and that the liquidity pool does not constitute the insurance provider's assets to the extent liquidity may be withdrawn at any time.