web3 Finance ～Opportunities and Threats for Insurers Brought by DeFi

The web is a standardized system for publishing and viewing documents on the Internet. With the emergence of blockchain technology, it developed into the concept of web3 in 2021. Before that, in Web 1.0, when the Internet was born in 1991, anyone could distribute information through homepages and e-mail magazines without relying on mass media such as TVs, radios, newspapers, and magazines. In Web 2.0, the Internet further developed in the 2000s, enabling interactive communication on platforms such as social networking services (SNS) and blogs, enriching people's lives. As a result, such service platforms have become indispensable to people's lives.

The Internet was initially created to democratize information for people to access quickly. However, it is dominated by a few giants, and personal data is collected and utilized in the way unintended by its owner. As a result, a few big Internet platformers, called BigTechs, monopolize wealth.^*2

As a counterculture against the current state of the Internet, the concept of web3 has been arising since 2021, with the emergence of blockchain technology. In web3, we can manage data in a decentralized (not centralized) way and own digital content as NFT (Non-Fungible Token). NFT is unique, non-fungible data/token recorded on the blockchain.^*3As a result, companies and investors focus on the realization of web3 where creators own digital contents. (Figure 1).

As web3 attracts excellent attention, its market proliferates, as seen in the figures (Figure 2). And it is comparable to the size of the Japanese economy^*4.For example,  the market capitalization of the top 30 crypto assets which play the role of money and stocks in web3 was approximately 290 trillion yen in 2021, larger than the 250 trillion yen of the market capitalization of the top 30 Japanese stocks during the same period. In addition, the total trading value of the world's top 10 NFT  exchanges is 2.7 trillion yen, larger than the 2.5 trillion yen in total traded in Japan's digital B2C market (digital content such as videos and manga/comics).

DeFi insurance is another DeFi example. At the time of this writing, its definition ranges from "insurance that covers risks to assets on DeFi" in a narrow sense to "insurance with smart contract-based processes and governance" in a broader sense. Despite these various definitions, we believe that DeFi insurance differs from traditional insurance in three ways.

The first is a narrow definition of DeFi insurance in covered risk. Conventionally, insurance covers the monetary loss risk to physical things such as people and property. Instead, DeFi insurance mainly covers risks to digital assets (e.g., crypto assets traded on DeFi).

The second is from the perspective of business operations. For example, conventional insurance is managed by a single organization, such as a stock company or mutual company. On the other hand, DeFi insurance is often managed by a decentralized organization called DAO (Decentralized Autonomous Organization), built on a blockchain with a common purpose.

Generally, a stock company is organized based on a pyramid structure, where the management team at the top of the organization make decisions, and employees at the bottom follow the decisions.
In contrast, a DAO builds smart contracts based on rules set at its establishment. DAO participants own "governance tokens" as participation rights to vote on DAO decisions and the vote becomes effective when approved by the number of voters defined in smart contract. For example, some DeFi insurances make claims payment decisions based on the votes with the governance tokens.

The third is from the viewpoint of the claim payment process. In conventional insurance policies, claim forms are sent to insurance companies along with various medical certificates, and payment is determined by an examiner using the insurance company's core system. This payment decision process is not accessible to the user. In contrast, in some cases in DeFi, the payment decision is automated by a program that can be referred to by anyone using smart contracts, making the process highly transparent.

Attracting great public attention, web3 and DeFi present great opportunities and, at the same time, threats. Finally, we discuss what insurance companies should do to cope with web3 and DeFi movement.

Given the current state of various systems and laws, it is not easy for insurers to enter the "business to cover assets on DeFi." Therefore, we believe that insurance companies need to take the first step to "learn" about DeFi insurance from a medium-term perspective by researching advanced cases and protocols, as well as participating in DAOs.

In addition, we believe that from a short-term perspective, insurance companies can develop new services based on the web3 concept. For example, we refer to "STEPN^*7" from the Move to Earn project, a GameFi, one of the web3 use cases, related to health and longevity risks.

STEPN is a blockchain game in which users can earn crypto assets by buying NFT sneakers, putting them on the app, and running or walking. Ten minutes of exercise daily can make the equivalent of several hundred yen in crypto assets. As a result, the game has changed behavior among home workers who rarely go out or users who had not been in the habit of exercising.

The incentives that cause these behavioral changes have two design aspects: economic value and social contribution value. The former is economic value design based on Tokenomics (token economy)^*8with crypto assets. The latter is social value design by the game operator, which promises from the beginning of the service launch to allocate a portion of game revenues to purchase carbon credits for carbon neutrality.^*9

Finally, by utilizing the web3 mechanism and technology, we can increase customer contacts, urge people to change their behavior in ways that could not be achieved with the traditional insurance, and develop services to solve social issues.

ABeam Consulting is working to create business for well-being and social good expected in web3 era by leveraging deep insights on insurance from strategy to operation, insights on emerging technologies and trends, and know-how and talents for new business development. Stay tuned for our coming web3 related publications. Feel free to contact us when you have interests in this Insight.