The Lifecycle and Governance of Blockchain-based Investment Syndicates
Blockchain technology allows automating processes and trust to be placed in decentralized protocols instead of trusted third parties. Libertarian blockchain enthusiasts believe this to be the solution to revolutionizing whole industries from ground up. However, any enterprise solution will quickly run into the need to fit within existing regulatory requirements. Pragmatics believe the key to adoption is working within system to the extend necessary. For this reason any enterprise blockchain solution must consider on-chain and off-chain processes together and fit the whole system into legal and regulatory frameworks. In this article, we will use the Black Insurance model for investments into insurance protocols to demonstrate how this can be achieved in practise.
We recently discussed token economy models and the design considerations that are involved in creating such a model for enterprise blockchain solution. The Black Insurance dual token model is designed to separate utility functionality from security functionality. Instead of trying to force a utility token model onto a blatant investment opportunity it is often best to work within regulatory frameworks and embrace the security token model. This not only avoids legal complications but also reduces conflicts of interests between investors and users of a platform. Whereas users want price stability, investors generally prefer token to rise in value.
Recall that the Black Insurance platform uses a utility token, the Black Platform Token (BLCK), and a number of security tokens, called Black Syndicate Tokens (BST). BST represent investments in insurance syndicates and each syndicate has its own syndicate token. Let’s look at how syndicates are created, how they function and how they are governed.
In the Black Insurance system, syndicates are groups of investors that underwrite portfolios of insurance products. The purpose of this investment is to provide the reserve capital to cover the risk of insurances. Any insurance product will be covered by the insurance premiums, which should be calculated to be enough to yield a profit. The reserve capital is a backup for very unlikely worst case scenarios.
The above shows a simplified example to illustrate how insurance underwriting in Black Insurance Syndicates works. In the extremely unlikely worst case scenario, the claims are enough to cover premiums and the reserve. In the more likely second example the remainder of unused income from claims is returned to the investors as profit.
Shares in a syndicate are tokenized on the blockchain in the form of a Black Syndicate Token. The tokens an investor holds represent the value of the participation and a right to profit sharing. The token is basically an interest-bearing security.
Syndicates cover a certain spectrum of insurance products, aligned with the investment preferences of its investors. In the way Black Insurance organizes itself into syndicates, there is a similarity with the Lloyd’s of London insurance market.
Lifecycle and Governance
The above diagram shows different stages in a syndicate’s lifecycle and governance. Governance is a complicated matter and has two components: on-chain governance and off-chain governance.
On-chain governance is possible in a number of situations and certain decision points can be identified. At each of these decision points, syndicate members may enter the participate by staking a pre-defined number of BLK tokens. The staking process is necessary to prevent fraudulent behavior and encourage long-term commitment to the syndicate’s operations.
When a syndicate is started, a preparation phase is entered. Syndicate founders seek investors to populate the syndicate. At this stage, the partners negotiate the governance, token and profit-sharing models of their particular syndicate.
Should this early negotiation be successful they may proceed to the syndicate establishment phase and create the necessary structures on-chain and off-chain. On-chain, the process consists in deploying a number of smart contracts and a syndicate token. The token will eventually be emitted to the investors.
However, in the regulated insurance industry, it is not sufficient to rely on on-chain governance only. Anyone wishing to sell insurance products needs a license to do so, which requires off-chain processes. Therefore, in the Black Insurance model for the European market, a newly established syndicate constitutes a cell in a Maltese Protected Cell Company (PCC). This innovative company type allows protecting “ring-fenced” liabilities and assets in separate cells. This way all syndicates are part of the Black Insurance parent structure but have independent assets and liabilities. This aspect of how to back up a tokenized economy with real-world legal structures is often overlooked.
When the syndicate has been established, insurance product designers may propose new products to the syndicate, although any viable syndicate will already have considered an initial product range before creation.
Nevertheless, when a new product is considered, the syndicate members enter another critical governance decision point. Risk coverage needs to be designed and reinsurance may be sought.
The above diagram illustrates the type of decisions that have to be made at this stage. Without going into detail, it is clear that several governance decisions are necessary, most of which may be executed through smart contracts and on-chain governance, but always in compliance with off-chain regulatory processes.
Black Insurance operates an innovative technology solution in a regulated industry. This applies to both investment regulations and insurance industry-specific aspects. Blockchain solutions and smart contracts of any enterprise solution are likely to find themselves in similar situations. Any on-chain solution must consider off-chain processes and requirements. In this article, we have explained how Black Insurance deals with these issues in the lifecycle management of blockchain-based insurance syndicates.