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Demystifying Blockchain for Life Insurance

Alexander F. L. Sand, Eversheds Sutherland

May 7, 2018

I. Agenda

A. What is a Distributed Ledger?

B. Building the Chain

C. Powering Transactions

D. Building Consensus

E. Promises of Blockchain

F. Risks of Blockchain

G. Questions

II. Bitcoin Basics

A. Some Basics on Bitcoin

1. Where do you get Bitcoin? – There are companies that specialize in

buying and selling bitcoin. They operate exchanges that offer

exchange rates between USD/BTC and other digital currencies,

similar to exchanging money at an airport.

2. What gives Bitcoin value? – Like many investments, Bitcoin’s value

derives from people’s willingness to accept it as having value. The

fact that there are liquid markets that are constantly willing to

exchange money for Bitcoin means it has value. What gives gold

value?

3. Where do you keep Bitcoin? – Bitcoin only exists as a balance on a

shared ledger, so you can’t really hold Bitcoin in your hand like you

can a dollar. What you can hold is the code that proves you own the

balance of bitcoin associated with an address. Software and services

that help you store this code and make it easy for you to transfer

Bitcoin are called a bitcoin “wallet.”

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B. Bitcoin and Criminality

1. Bitcoin did prove popular on “dark markets” in its early days.

2. It enables users to provide instant payment anywhere in the world.

i. As it would be to any internet business, this is useful if for

selling illegal things on the internet, and has the added benefit

of not having to deal with banks.

3. It was often billed as being “anonymous” and so buyers and sellers

thought it would be safer to use Bitcoin than another form of

payment.

4. Turns out Bitcoin isn’t nearly as anonymous as people thought.

5. Law enforcement has been able to shut down multiple dark markets

and arrest their operators across jurisdictions.

6. In the most famous case, Ross Ulbricht, who had run the “silk road”

dark market, was arrested by the FBI in San Francisco. He received a

life sentence.

7. Cash will always be king for crime.

III. Bitcoin vs. Blockchain

A. What’s the difference?

1. Bitcoin

i. The first “cryptocurrency”

ii. A distributed electronic payment system that does not rely on

central banks or other counterparties

iii. Enables global peer to peer payment with no single central

depository or processor

iv. Powered by the first ever blockchain

2. Blockchain

i. The technology underlying bitcoin and many other projects

ii. A new system to arrange, process, store and share information

electronically

iii. Leverages existing and widely used cryptography

iv. Just one kind of “distributed ledger technology”

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IV. Blockchain

A. Capabilities

1. Blockchain is a digital ledger system for recording business

transactions and events.

i. Near immediate settlement – Enables the near immediate

settlement of recorded transactions, reduces risk and limits the

ability to cancel transactions.

ii. No intermediary – There is no need for a trusted third party.

because the technology is based on cryptographic proof.

iii. Distributed ledger – The distributed ledger is maintained

through the list of blocks providing a secure source of proof

that the transaction occurred.

iv. Resistant to manipulation – The distributed network and

distributed ledger mitigates the risk of double-spending, fraud,

abuse and manipulation of transactions.

There is nothing magical about the blockchain. It is a database or ledger.

B. Why are people excited about ledgers?

1. Ledgers are where ownership lives.

i. We don’t actually possess most things we own.

ii. United States total money supply is roughly $75 trillion.

(a) Only 6% ($4.5 trillion) is currency in circulation

(b) 94% ($70.5 trillion) is sitting on ledgers

iii. What else is on ledgers?

(a) Money

(b) Identity

(c) Voting

(d) Education and certification

(e) Land and buildings

(f) Intellectual property

C. A Distributed Ledger

1. What is a distributed ledger?

i. An asset database shared across a network on multiple sites or

geographies.

ii. All participants can have access to the ledger via a copy or

connection to other databases.

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iii. Any changes made on any one of the ledgers will be reflected

on all ledgers.

iv. It’s a technological means of keeping accurate, up-to-date

records in multiple locations.

D. Types of Networks

Centralized Decentralized Distributed

• One authority/failure • Several authorities • No central authorities

• Easy to maintain • More stable • Quicker evolution

• Can be unstable • Medium scalability • Infinite scalability

• Slow scalability/evolution • Quicker evolution • Difficult to maintain

• Most resilient

E. A Peer-to-Peer Distributed Network

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F. A Function of the Network

1. Validation

i. Anything that happens on a blockchain is a function of the

entire distributed network as a whole.

ii. Each node has a copy of the blockchain (all logged

transactions), and every copy must be consistent with all other

copies; otherwise the transaction will not be incorporated into

the blockchain.

G. What is it really?

1. Some ways to think about Blockchain?

i. The great chain of being sure about things

ii. Single source of truth with many copies

iii. A tool for organizing, tracking, and using large sets of ever-

changing data

H. What is a block?

1. If a blockchain is a ledger then a block is a page of that ledger.

2. A block contains:

i. A record of some or all recent transactions broadcast to the

network but not yet confirmed (at least one transaction, but

may contain thousands)

ii. A unique identifier (the “hash”) for the current block

iii. A reference to the unique identify (the hash) from the previous

block of transactions in the chain

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3. The ledger is kept through the long list of blocks, known as the

blockchain.

I. Building the Chain – If anyone can write a page in the ledger, how do we

make sure they all work together?

1. Hashes

i. When a block is created, the transactions listed in the block

are processed through a mathematical formula to transform the

information into a hash.

ii. The answer is hard to guess but easy to verify.

iii. Hashes can be used to verify that the information has not been

changed in any way.

iv. If a single character is changed in the block, it will completely

change the hash.

J. Hashing – A Cryptographic Fingerprint

1. A one-way function that is not reversible.

2. Each transaction has a unique fingerprint that cannot be changed.

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3. The hash of each block will be used in the next block. This is what

makes it a chain. If data is changed, all the hashes will fail. This

makes the ledger immutable.

4. Hashes

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K. Powering Transactions – If anyone can submit a transaction, how do we

know the person submitting the transaction has authority to initiate the

transaction?

1. Public-key cryptography powers transactions.

i. Blockchain relies on public-key cryptography: it is built on

pairs of public and private keys.

ii. Every account on the ledger has an “address” (public key or

account number).

iii. Only the owner of the account gets the corresponding private

key.

iv. The public and private keys are mathematically linked.

v. It is computationally easy to derive a public key from the

private key, but hard to derive a private key from the public

key.

vi. The public key is used as an account number that holds assets.

vii. The private key is used to prove ownership of the assets

associated with the public key.

viii. The owner of the account mathematically signs a transaction

with the private key to authorize the transaction in the account.

ix. The private key never needs to be shared or shown to anyone

else.

x. Everyone else on the chain can mathematically prove that

whoever authorized the transaction had the private key, and

therefore it is a valid transaction.

xi. Whoever holds the private key owns the account (like a bearer

bond).

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2. Remember this?

Let’s zoom in on a transaction…

3. Asymmetric Keys – Public and Private Keys

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4. Pseudonymous Transactions

i. Sending and receiving an asset is similar to writing under a

pseudonym.

ii. On blockchain, the owner of an asset is identified by their

address.

iii. If your address is linked to you, then every transaction

involving your address will also be linked to you.

iv. Your address is a version of your public key.

L. Building Consensus – If anyone can submit a new page to the ledger at

any time, how do all the parties agree which pages are valid?

1. Why consensus?

i. In a centralized network, no need for consensus; it is done by

the central authority.

ii. In a distributed or decentralized network, how do you agree on

what is true?

iii. Goal: The aim of the consensus approach is to secure the

network, predominantly through economic means: it should be

too expensive to attack the network, and more profitable to

help protect it.

2. Byzantine Fault Tolerance

i. Byzantine Fault Tolerance (BFT) is the ability to tolerate

byzantine failures in a system which is a crucial part of

blockchains’ ability to maintain reliable records of

transactions in a transparent, tamper-proof way.

ii. BFT is a solution to the Byzantine Generals’ Problem, a

logical dilemma that researchers Leslie Lamport, Robert

Shostak and Marshall Pease described in a paper in 1982.

M. Byzantine Generals’ Problem

1. The Problem

i. Each division of the Byzantine army is commanded by its own

general, and the general communicate with each other via

messenger. Some of the generals are traitors who can attempt

to sabotage the army’s strategy by submitting bad messages to

the network of generals.

2. Solution Requirements

i. All loyal generals decide on the same plan of action.

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ii. A small number of traitors cannot cause the loyal generals to

adopt a bad plan.

iii. The loyal generals will all do what the plan (algorithm) says

they should do, but the traitors may do anything they wish.

iv. The plan (algorithm) must guarantee that the plan executes

successfully even with a small number of traitors trying to

subvert the plan.

v. The traitors cannot convince the rest of the group to adopt a

bad plan.

N. Byzantine Fault Tolerance and Blockchain

1. BFT is essential on a blockchain.

i. Most traditional distributed computing environments have

central configuration databases or authorities that can fix

things in the event of a Byzantine failure.

ii. On a blockchain, because there is no central authority,

transactions are confirmed based on community consensus

alone, which is what makes it so powerful.

iii. Most blockchain technology, including Bitcoin, has relied on a

concept called proof of work (PoW).

iv. Under this model, anyone who wants to add to the blockchain

must perform a work-intensive task using information from

the existing blockchain in order to add new information.

v. In the case of Bitcoin, PoW is produced using a hashing

algorithm that, by its nature, takes a fair amount of time to

execute.

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O. BFT vs. Bitcoin

P. Consensus in Bitcoin

1. Proof of Work

i. In a PoW system, data can’t be added to the blockchain

without a significant time investment on the part of the party

adding the data.

ii. This provides a practical protection against manipulation of

the blockchain because, in order to undermine group

consensus, a malicious party would need to invest a great deal

of time producing sufficient PoW to exert a meaningful

influence on the blockchain.

iii. On a blockchain that is sufficiently large, the PoW

requirement effectively provides BFT.

iv. This approach also has a limitation. It requires the expenditure

of a large amount of computational effort for no purpose other

than fault tolerance.

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Q. Mining for Bitcoins

1. Computers compete to find a hash with specific properties.

2. The computer that finds the answer first—the proof that it has done

the necessary work—is allowed to add a new block of transactions to

the blockchain.

3. It is rewarded with a tranche of newly minted bitcoins (currently 12.5

BTC per block, or roughly every 10 minutes), plus all of the small

transaction fees users have paid to send coins.

4. In addition to building consensus, this also serves to incentivize

participation, which makes the blockchain bigger, and which makes

the blockchain more secure.

R. Building Consensus

1. Consensus Concepts

i. Proof of Work

ii. Proof of Stake

iii. Leased Proof of Stake

iv. Delegated Proof of Stake

v. Proof of Importance

S. Recap of What Makes It Work

1. Key Elements of Blockchain

i. Many participants always agree on what a single version of

what is valid and true (distributed peer to peer network).

ii. Every transaction is securely and permanently linked together

(a chain of hashes).

iii. All participants can verify transactions, but only authorized

parties can initiate transactions (powered by public key

cryptography).

iv. The ledger is trustworthy, even if a few bad actors are actively

trying to deceive it (fault tolerant consensus).

V. Promises of Blockchain

A. Potential Benefits of Blockchain

1. Reduce choke-points – Ability to verify and process transactions

without third-party involvement.

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2. Data reconciliation – The information is transparent and the data is

complete, accurate and consistent across all locations and databases.

3. Data Access – Data from many sources can be instantly available

across the network.

4. Automated transactions – Transaction processing can be nearly

instantaneous and can leverage automation.

5. Cost reduction – Costs associated with third-party intermediaries,

governance and audits can be greatly reduced.

B. A Tool for Business

1. Public vs. Private

i. Public blockchain – Anyone can join and see transaction

records.

ii. Private blockchain – Only those who are authorized may join

or see certain information.

(a) In many cases, businesses will set up a private

blockchain for increased privacy and security.

VI. Many Different Flavors

A. There are many different blockchain and distributed ledger products.

1. Cryptocurrencies

i. Bitcoin

ii. Litecoin

iii. Monero

2. Something else

i. Ethereum (Ether)

ii. Ripple (XRP)

iii. Hyperledger

iv. Corda

VII. Promises of Blockchain Beyond Payment

A. Smart contracts – A “smart contract” has the potential to automate value

transfer based on defined conditions through the blockchain.

B. Clearing and settlement – The use of blockchain technology could enable

T+0 trade settlement, eliminating settlement risk.

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C. Insurance claims processing – The transparency and irrefutable record

provided by blockchain could help streamline claims information sharing and

reconciliation.

VIII. Smart Contracts

A. What is a smart contract?

1. A smart contract is basically just computer code.

2. Today’s legal contracts have no real relationship with the computer

code that executes them.

3. Smart contracts are when business terms are recorded in code instead

of legal language.

4. Some think they could replace written contracts.

5. Alternatively, can think of as a way to automate performance of

contractual obligations.

6. Transactions are really just changes.

i. E.g. State 1 = Alice has $10, and Bob has $5. Alice pays Bob

$5. State 2 = Alice has $5 and Bob has $10.

7. This change of state can be anything, not just value transfer.

i. (E.g. Has Alice Filed an insurance claim in the last 12

months? What is Alice’s credit rating? What is Alice’s mailing

address?)

8. Transactions can be caused by an action in code so they happen

automatically.

9. Instead of manually recording or triggering a transaction, code that

sits on top of a blockchain can automate the change.

10. That change will then be replicated instantly across the entire

blockchain network.

B. Smart Contract Example

1. A customer buys a new car, and needs immediate proof of insurance

to drive the new car off the lot.

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2. The customer could fill out a form online, selects policy features,

provide payment, and submits contact information.

3. The payment verification and results of the credit check could then be

automatically fed directly into a smart contract.

4. If the payment clears and the credit check matches predefined

characteristics, the smart contract could then immediately generate

and send proof of insurance to the customer.

5. Simultaneously, the record generated of the customer’s transaction

could be instantly propagated and accessible across enterprise

systems.

6. Every other database (node) connected to the blockchain network

would immediately have an immutable and accessible record of all

that policy and transaction information

7. Beneficiary, date and time of issuance, when payment was received,

when coverage became active, etc.

8. All without human involvement.

IX. Other Kinds of Blockchain Products

A. Ethereum – Enabling automation

1. Ethereum is not a digital currency.

2. Ethereum is a decentralized platform built to run “smart contracts”;

you can think of smart contracts essentially as applications.

3. The open-source software platform provides users and developers

with tools to deliver on some of the promises of blockchain.

4. Includes a Turing-complete scripting language that sits on top of

distributed ledger technology.

5. Applications can run exactly as programmed without any possibility

of downtime, censorship, fraud or third-party interference.

6. Value transfer is done via “ether,” a native cryptocurrency.

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7. Ethereum apps run on a custom built blockchain, on shared global

infrastructure.

8. Like Bitcoin, Ethereum provides a global decentralized ledger for

moving around value.

9. Unlike Bitcoin, the Ethereum network can support and power many

different blockchain ledgers, for many different crypto-assets,

simultaneously.

10. The network will also support and run smart contracts (applications)

using the distributed computing power of the network itself.

B. What is a token?

1. A token is any crypto-asset that lives on a blockchain that supports

multiple assets, most commonly Ethereum.

2. These are the “different blockchains” or “crypto-assets” that we

mentioned.

3. The tokens do not have to be set up to function like currency, like

bitcoin is.

4. A token can represent pretty much anything, and can have any desired

feature.

i. For example, a token can function as a security, including

automated distribution of dividends.

X. Other Kinds of Blockchain Products

A. What is an ICO?

1. An “initial coin offering” is selling a crypto-token in order to raise

funds to support a blockchain startup.

2. The funds you pay for the token are used to build the platform/service

associated with the token.

3. The token entitles buyers to a share of future profits.

4. It may also enable buyers to interact or use the platform/service once

built.

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5. Unsurprisingly, the SEC is now regulating these as securities.

B. Example of Token

1. Decentralized Autonomous Organization (DAO)

i. A DAO is a smart contract that codifies the rules and decision-

making apparatus of an organization.

(a) Step 1: A group of people write a smart contract.

(b) Step 2: There is an initial coin offering (ICO) which is

the funding period where people add funds to the DAO

in exchange for tokens that represent ownership.

(c) Step 3: The DAO will begin operations after the

funding period.

(d) Step 4: Those who have the ownership tokens can vote

on how to spend the money raised during the ICO.

XI. Promise But Also Risk

A. The DAO Hack

1. A DAO (confusingly named the DAO) raised more than $100 million

by the end of its ICO.

2. A vulnerability was located in the DAO’s code.

3. The attack exploited a logical flaw in the governing rules of the DAO.

Some argue that the hacker could be entitled to the money because he

used the code that was presented.

4. By using the vulnerability in the code, the attacker was able to drain

more than $3.6 million.

XII. Possibilities in Life Insurance

A. Potential Uses for Blockchain in Life Insurance

1. Power an enterprise wide, transparent and auditable record of all

policies that includes easy access to all related information from

multiple legacy systems.

2. Combine separate death registration and claims processes into a single

streamlined process.

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3. Create a permissioned end-to-end record keeping and claims

processing system for reinsurance transactions across stakeholders.

B. Example 1: Streamlining Death Claims

1. Death claim processing is often still manual in many respects.

2. Blockchain could be used to add in additional automation.

3. Blockchain and smart contracts could be used to automatically scan

the Death Master File for matching insureds. This could be done

entirely on chain, or by connecting to existing systems.

4. A smart contract could then automatically determine whether a claim

has already been filed by a beneficiary, based on information

submitted through the claims department.

i. If no, the smart contract could automatically generate a letter

to the beneficiaries of the identified policy regarding making a

claim.

ii. If yes, the smart contract could verify to the claims system that

the insured appeared in the Death Master File.

5. So, in this example, blockchain is used to connect distributed systems

that may not talk to each other currently, and add in automation for

processes that may currently require manual input.

C. Example 2: Reinsurance Recordkeeping

1. Reinsurance transactions inherently involve a lot of data coordination

and tracking across multiple parties.

2. The ceding insurer, broker, reinsurer, and even regulators will all need

access to some of the same data in order to understand, price, and

transfer the risk. This generally requires duplicative data entry and

data reconciliation.

3. A permissioned (private) blockchain could be used to put all these

stakeholders on one connected network. Each would have access to

the information needed, but only when given permission by the

ceding insurer.

4. No re-entry of data or reconciliation would be required, as it would all

be done automatically by the blockchain.

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5. Claims made to the ceding insurer on a policy could automatically

trigger claims made to the reinsurer, with each policy mapped through

the blockchain to all the reinsurers used by the ceding insurer, and

even secondary reinsurers.

6. This potentially helps with regulatory compliance issues as well (e.g.

breach notification under the NAIC Data Security Model Law)

XIII. Some Risks to be Aware of

A. Data security – You need to know what data you have, where it is, and who

has access to it.

B. Blockchain offers immutability, but this also means it is harder to undo

mistakes. Transactions are irreversible.

C. All blockchain transactions are traceable back to genesis. This can both be

good and bad. How much information are you sharing with your competitors

and counterparties?

D. Regulatory risk – While you may be able to build it, that doesn’t mean

regulators will allow you to do it.

E. IP – Who owns the data in a distributed ledger?

F. Important to think about the details of what is being done and how it is being

done.

G. Don’t be blinded by buzzwords.