InsurTech and the cutting edge of blockchains: Identity tokens and insurance

The emergence of "identity tokens"

The initial and, to date, most widely adopted use-cases for blockchains have been financial. Whether through the creation of decentralized currencies, like bitcoin and ether, or the development of DeFi protocols, like decentralized lending platforms or stablecoins, blockchains have been focused almost exclusively on money. Recently, however, on-chain assets have emerged that can be broadly classified as "identity tokens" – that is, tokens that denote a user's experiences, credentials, commitments, relationships, and other social identifiers. While the structure and the use of identity tokens is in its nascent stages, we suggest a few ways in which identity tokens may influence the insurance industry, both in its traditional form and as the industry may exist natively in an on-chain economy.

Identity tokens are issued on a blockchain just as any cryptocurrency coin or token would be. Unlike cryptocurrency tokens, however, identity tokens have either limited or no fungibility. Additionally, identity tokens may be either transferable, like cryptocurrency tokens, or non-transferable. For example, both proof-of-attendance-protocol (POAP) tokens and "soulbound" tokens (SBTs) are identity tokens, even though they have different properties. POAP tokens – which may be issued, for example, to attendees of a particular conference – have limited fungibility and are transferable from one user to another (even a user who did not attend the conference). In contrast, SBTs – which may evidence, for example, a user's completion of a university program or repayment of a particular debt – are non-transferable and non-fungible. Regardless of the form they take, identity tokens can denote users' credentials and potentially even users' reputation, credibility and social standing on-chain. As such, identity tokens may be used as a substitute for traditional, off-chain identity markers or as a way represent, and distinguish among, particular individuals on-chain.

Potential application of identity tokens to traditional insurance markets

The most likely near-term use case for identity tokens within the traditional insurance market is as a supplement to self-reported (i.e. policy-holder reported) underwriting information. For instance, rather than rely on the insured to simply state that she holds a bachelor’s degree from a certain college, the insured can sign a transaction to prove ownership of a wallet that has been issued a token issued by that college that attests to that degree. This method of credentialing may be particularly valuable for potential insureds that have a less traditional education or career path. A developer that bypassed a formal degree, for example, may hold tokens commemorating his contributions to a variety of projects and those tokens may serve as a substitute or a proxy for a formal degree under an insurer’s underwriting guidelines. Similarly, identity tokens may offer a more detailed or nuanced description of an insured's employment, creditworthiness, or a host of other attributes relevant to an insurer’s risk assessment.

Certain types of cyber risk may also be mitigated through the use of identity tokens. Insurers provide coverage against data breaches and are, of course, subject to those risks themselves. In an increasingly internet-native economy (both on and off-chain), certain identity tokens may serve to identify and authenticate a user while exposing less sensitive information (passwords or other personal data) to malicious actors. Because crypto assets are controlled by a private key held by the individual user and not, in contrast, maintained on a centralized server, the incidence of data hacks may decrease and, when they do occur, be less systemic.

As identity tokens become more commonplace, insurers may strive to obtain a more detailed assessment of insureds through the use of this technology. The insurer may be able to ascertain that, in addition to an insured being an accountant who graduated from college 10 years ago, the insured has repaid several uncollateralized loans issued by members of his local community, actively contributed to an online database over the past two years, and made charitable contributions. This additional information may be useful in underwriting an individual risk (perhaps individuals that extend credit within their neighborhood report a below-average number of homeowners claims, for instance) or in understanding correlations between individuals that may not otherwise be apparent (and, consequently, the diversification of the risk pool). Of course, many of the new identity features that reveal themselves could be irrelevant for underwriting purposes, but at least some likely will be useful, particularly as new kinds of risks are insured in crypto-native insurance markets, as discussed below.

Of course, it remains to be seen how governments and regulators will address the emergence of identity tokens and other new crypto assets in insurance. Our team will continue to monitor legal and regulatory developments as this technology rapidly evolves.

The potential impact of identity tokens on crypto-insurance markets

As the White House recently indicated in an Executive Order on the "Responsible Development of Digital Assets," digital assets recently surpassed US$3 trillion in market capitalization from US$14 billion about five years ago, and yet the emergent crypto-native, or web3, economy is full of hard-to-value risks. Wallets can be hacked, protocols have exploitable bugs, stablecoins become unstable. Insurance, whether from an institution, decentralized autonomous organization (DAO), protocol, or community, can mitigate these risks and may be necessary for onboarding of more and more users (and value) into the crypto-native economy. So far, the growth of that economy has far outpaced the growth of the insurance industry supporting it – a notable situation, given the ways in which insurance has historically been salutary to growth and innovation in other industries.

While crypto-insurance more generally is a topic beyond the scope of this article, we do wish to note that identity tokens may have an impact on "crypto-native insurance" that is issued to a wallet, smart contract, or public multi-signature address, rather than an individual. 

• With the emergence of identity tokens, an insurer could have greater confidence in the diversity of a risk pool composed solely of on-chain policyholders. Insurance programs, just like blockchains, need to be "sybil resistant," meaning that there must be strong assurances that individuals that appear to be distinct (whether they are policyholders in a risk pool or validators of a blockchain) actually are distinct. Without sybil resistance, an insurer cannot adequately diversify the risk that it is underwriting and a blockchain cannot be safe from manipulation by a controlling validator. Identity tokens offer insurers a way to ensure diversity without recourse to off-chain data. 
• Also, identity tokens may facilitate community-based insurance on-chain. Traditionally, local communities, whether bound by a shared religion, geography, trade, or otherwise, often provide certain types of insurance to their constituent members. If the flourishing of identity tokens promotes some kind of community growth on-chain, related insurance could follow. Members of a particular DAO, for example, may choose to insure themselves against a certain risk because of a sense of common purpose or identity among the members.

As always, Hogan Lovells remains on the cutting edge of InsurTech issues. Please visit the Hogan Lovells Blockchain Hub to see our global guide to developing regulatory requirements within the insurance industry sector and beyond.  

Authored by David Marley and Jordan Teti.