Lynn Johannson, Advisor, Sustainability and ESG
January 4th, 2024
Lynn Johannson, President of E2 Management Corporation and Catalyst for THE Collaboration
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A New Frontier: Decentralized Insurance
Mayer / Brown | Joseph C., Yevgeniy M., Elliott S. | Mar 15, 2022
The volume of transactions that take place in the DeFi space is massive and is continuing to grow exponentially, as measured by the overall value of cryptocurrency assets deposited in DeFi protocols (i.e., “total value locked” or “TVL”). Given the growth experienced by the DeFi market, it is not surprising that DeFi users have sought to take advantage of risk allocation devices similar to those used in other markets and industries.
One such risk allocation device is insurance. Given the fact that DeFi is—by its nature—decentralized and its users are accustomed to decentralized financial products, it makes sense that insurance solutions provided to DeFi users would likewise have decentralized characteristics. Indeed, we have seen a number of providers established recently in the emerging decentralized insurance space for the purpose of offering decentralized insurance solutions. However, insurance coverage of events that affect the DeFi ecosystem (e.g., cybersecurity coverage for DeFi exchanges) need not be decentralized—which provides ample opportunity for existing providers of such insurance coverage to expand their current offerings into the DeFi market.
See: InsurAce Founder at DeFi Insurance Protocol Explains the Difference between Traditional and Decentralized Insurance
In either case, insurance providers will need to ensure that their operations are in compliance with the insurance regulatory framework in the United States, which is complex and nuanced. These nuances will be familiar to current insurance industry participants but may not be as obvious to new entrants to the market, such as decentralized insurance providers.
Each US state has its own code of insurance laws and its own insurance regulatory authority that enforces and monitors compliance with those laws. This means that offering an insurance product on a nationwide basis in the United States—regardless of whether the insurance product is decentralized or not—requires an operating model that is compliant with the insurance laws of over 50 US states and other jurisdictions. Some considerations that are important in structuring an insurance provider’s operations—including providers of coverage to DeFi—include the following:
Licensable Activities: These licensing requirements may be applicable to the decentralized insurance provider itself or to its partners or investors. For example, if a decentralized insurance provider has organized a decentralized autonomous organization (DAO) whose members have the authority to vote on whether a particular insurance claim should be paid, state insurance regulators might take the position that these voting rights permit DAO members to adjust or settle claims and therefore require them to be licensed as independent adjusters. As another example, a third party engaged by a decentralized insurance provider to market its products may be considered by state insurance regulators to be selling, soliciting or negotiating insurance—activities that typically require the person performing them to be licensed as an insurance producer.
See: OECD Report: Why DeFi Matters and Policy Implications
Rebates and Inducements. Most US states have enacted insurance laws prohibiting insurance companies, insurance agents, insurance brokers and other licensees from paying any 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 would typically prohibit a decentralized insurance provider from, for example, offering lower insurance premium rates to holders of its DeFi token or to the members of its DAO or from offering free or discounted products or services (such as token “airdrops”) to its insureds or to applicants for its insurance products.
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