Blockchain and Catastrophe Bonds: How granulation can open up this new asset class.
The financial revolution has begun. Blueprints for decentralised institutions are being drawn up and certain securities are embracing the blockchain. In this article I want to talk about how Catastrophe Bonds will benefit from being placed on the blockchain. This article is part of a series on blockchain and finance that is potentially going to be sponsored by SmartCash. (More on SmartCash at the end of this article)
I’m going to start off with an explanation of what a Catastrophe Bond is. I’m then going to describe a blockchain feature called Granulation. I’ll conclude with how Granulation will make Catastrophe Bonds available to all investors and the benefits that this will bring to society.
A Catastrophe Bond is an instrument that transfers risk from one party to another. Insurance is also a risk transfer instrument and an easy way to think of a Catastrophe Bond is to think of it as insurance in reverse. Let me explain with an example.
Lets pretend I buy a beautiful new car. I’ve spent a lot of money on it and I’m worried that if I crash, I won’t be able to cover the cost to repair it. I don’t want this risk and I’m prepared to pay to transfer the risk to someone else.
With Traditional Insurance I pay a premium (say $100) to an insurance company. If I don’t crash my car, they keep my premium. If I do crash my car, they will pay me a benefit (say $2500) to repair my car. So I pay the premium upfront and get the benefit after the risk event (car crash) occurs.
With a Catastrophe Bond the opposite happens. I receive the benefit at the beginning and only pay it back along with a premium if I don’t crash. What is nice about this, is that I have the money to repair my car immediately and don’t have to wait for the claim process.
Catastrophe Bonds are only made available to parties with the highest level of trust as there is a risk that they may not be repaid. Parties that are considered very trustworthy are large cities like San Francisco and Tokyo. These cities can use Catastrophe Bonds to cover the damages of a natural disaster like an earthquake or tsunami. Let me explain with another example.
Investors will give San Francisco billions of dollars at the beginning of the year. If an earthquake occurs, San Fran can use this money to immediately pay for rescue services and repair damages. If an earthquake doesn’t occur by the end of the year, then San Fran will return the billions of dollars plus a premium. The premium is usually more than the fixed interest rate to accommodate the investor for the additional risk.
Now I’ve mentioned that risk transfer mechanisms require trust and most of us are aware that blockchains can help reduce the need for trust, but thats not what I want to talk about. Instead, I want to talk about a blockchain feature called Granulation. Granulation is the idea that each bitcoin can be fragmented into one million pieces, commonly known as satoshis. How does this apply to Catastrophe Bonds? Well Catastrophe Bonds are huge billion dollar instruments that can only be enjoyed by the largest of investors. I use the word “enjoy” because Catastrophe Bonds are less correlated to other assets classes and so they give a well balance portfolio even more diversification. This means that investors who hold Catastrophe Bonds have less risk in their overall holdings. This is a good thing.
Granulation allows a giant Catastrophe Bond to be fragmented into tiny pieces that your everyday investor can afford. Imagine buying LA Firecoins for $1 each. If by the end of the year no fire has occurred, LA will repurchase the coins at $1.20. These tokens can be traded like any other cryptocurrency and this allows them to enjoy the liquidity that classic Catastrophe Bonds lack.
Blockchain plus Catastrophe Bonds bring a heap of benefits to society. They allow cities to transfer catastrophe risk to investors all around the world. They give diversification benefits to your everyday investor’s portfolio. And most importantly, blockchain will make Catastrophe Bonds more popular, allowing every city to have access to immediate finance incase disaster strikes. This will allow cities to fund emergency plans and save thousands of lives.
The crypto-market is maturing from get-rich-quick schemes to initiative that add value to society. I’m proposing to partner with a crypto that shares this vision called SmartCash. My proposal is to ask SmartCash to sponsor posts like these by turning them into videos and spreading the word about how blockchain can revolutionize finance.
SmartCash has an interesting philosophy and they believe that miners of a coin shouldn’t be the only ones to get rewards. Who else should get the rewards though? That question is answered by their governance system where anyone can request rewards and then the community votes for it. 1 coin = 1 vote so those who have more coins have a bigger say. SmartVoting has been criticized for favoring the wealthier users but it is a great way to stimulate discussion where the community can financially steer the coin. They call this incentivized decentralised community the SmartHive.
If you would like to learn more about SmartCash please visit: https://smartcash.cc/
You may also be interested in my upcoming posts:
2. Blockchain and Foreign Markets: How international barriers have been broken down.
If you have any questions or comments please let me know down below.