The recent, dramatic, and sudden fall of cryptocurrency exchange, FTX, has set much of the crypto market and many of its investors on edge. For some, this meltdown has elevated general scepticism around the long term health of Web3 decentralized tech innovations, which can include DAOs – Decentralized Autonomous Organizations.
For insurers watching the web3 space, particularly the ways DeFi-enabled insurance and cryptocurrencies are reshaping the traditional insurance products and services landscape, it is perhaps too early to say definitively if DAOs will have a disruptive impact on insurance. Though improvements are surely necessary, the open-source software and decentralized protocols that form the backbone of Web3 are likely to be resilient.
Blockchain has several potential applications for insurance, including DAOs, which may be able to replicate some typical functions of an insurance provider (i.e. assembling a pool of capital; creating conditions for a payout). Because of that, we can have a fair amount of confidence that the underlying blockchain technology which powers DAOs will remain relevant, both for the insurance industry (especially as it relates to smart contracts) and beyond.
Let’s take a closer look at DAOs and their potential impact on insurance.
A Decentralized Autonomous Organization (DAO) is a new kind of legal entity and community decision-making tool operated without any central governing body or authority. Instead, A DAO’s members, or token holders, are compelled to act in good faith, making decisions and generally participating in the business interest of the entity through voting (with voting power distributed proportionally, transparently, and “on-chain,” according to the number of tokens held). Coded, blockchain-based rules determine how the DAO works and how its funds are allocated.
To give some examples, DAOs have supported charities, provided seed funding for startups, managed decentralized protocols, invested millions in treasuries and bonds, and even attempted to buy historically significant documents.
A smart contract is a digital contract that sets agreement terms between users in its code, executed automatically after its predefined conditions have been satisfied. Smart contracts are decentralized, distributed on blockchain networks, and can also hold assets like NFTs and cryptocurrencies. Decision-making within a DAO happens largely via smart contracts, triggered after a decision, event, or some other activity has occurred on a blockchain.
Operating on an open-source blockchain, means that every DAO-related transaction and vote becomes part of an unchangeable record, greatly reducing the likelihood of fraudulent transactions or other wrongful activities. It's this kind of trustworthiness and transparency that are seen as the primary advantage of smart contract-powered DAOs.
Smart contracts have particular relevance in insurance because of their use and potential in parametrics, which uses triggers or indexes rather than claims to payout after a specific event has occurred. DAO decisions are also triggered by outside or real-world events (for example, a weather event, interest rates, price of an NFT, or other market data). DAO smart contracts rely on blockchain middleware, also known as oracles, to connect their blockchains to off-chain, authenticated data and provide the mechanism for triggering their functions.
As global demand for transparent and automated insurance products continues, smart contract technology will remain an interesting proposition to insurers, particularly as it relates to parametrics. With very real challenges for Web3 ahead (especially around data protection, regulation, security and privacy), there’s still great potential for adoption, growth and scalability in the smart contract space. And that makes bottom-up entities like DAOs worth watching.