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Blockchain: From hype to reality

Are blockchains the revolutionary technology we have been waiting for, or just old wine in new bottles?

Two years ago, almost nobody besides IT experts and bitcoin fans had heard of blockchains. Today, the technology is being hyped throughout the financial sector. Blockchains are being hailed as the answer to many long-standing problems, such as outdated IT infrastructures and elaborate administrative processes. Are blockchains the revolutionary technology we have been waiting for, or just old wine in new bottles? The truth probably lies somewhere between the two.

Basically, a blockchain is nothing more than a digital storage medium, maintained decentrally by numerous participants, in which transactions bundled into blocks can be stored securely and free from tampering. In addition, blockchains can also store so-called smart contracts, which can be made to execute automatically. The main advantage of blockchain technology is, firstly, that the transactions do not need to be executed and confirmed by a reliable central body. Second, a special encryption mechanism ensures that the data cannot be manipulated after the fact.

Using blockchains can therefore add value particularly when two conditions are fulfilled: first, more than two parties need to be involved in the transaction, so that it becomes worthwhile to store the data decentrally. And second, the technology is only truly useful when no reliable intermediary exists. In such cases, it makes sense to use a secure transaction process. Some possible uses in the financial sector would be, for example, the international transfer of funds, or securities trading. Using blockchain technology can make payments and securities transactions significantly quicker and less expensive, and keep them safe from fraud. The technology also has the potential to become the new standard for the exchange of data between companies in the insurance industry. It is even theoretically possible, with the help of smart contracts, to process primary insurance and reinsurance contracts completely using a blockchain.

If use of the new technology becomes widespread, it should lead to significant increases in productivity in the financial sector, and presumably increase the latter's economic importance. Also, many processes would become more streamlined and transparent, and transactions between policyholders, primary insurers and reinsurers quicker. For consumers, this should result in shorter processing times, quicker settlement of claims, and lower premiums. Blockchain technology could also become the basis for the development of innovative products that meet customer needs even more closely.

However, regardless of the hype, we need to generate an awareness that blockchains can be used to solve certain kinds of problems – and not as the solution that we then need to invent problems for. We also cannot forget that a number of initial challenges still need to be overcome, both from a technical as well as a legal standpoint, before blockchains can actually be used.   The technology currently reaches its limits relatively quickly in terms of processing speed and the number of transactions that can be executed simultaneously. There is still a good deal of work to be done in this respect.

On the other hand, the idea that one day independent smart contracts will be executed using only blockchains, without any outside participation, remains a utopian vision. The valid terms and conditions of the contract necessarily have to be recorded outside the blockchain as well, for both technical and legal reasons. If the smart contract's program code is interpreted as its only binding wording, cases similar to the spectacular hack of the blockchain-based DAO investment fund may continue to occur in the future. Indeed, in June 2016 an investor succeeded in exploiting a weakness in the DAO's code, and was able to withdraw the equivalent of over €40m from the fund.

Nevertheless, most experts agree that blockchain technology offers great potential. Though it is essential that companies work together to create joint solutions. For this reason, Munich Re has now joined other primary insurers and reinsurers in launching the Blockchain Insurance Industry Initiative (B3I).

Munich Re Experts
Susanne Gäde
is an economist at Munich Re and is responsible for issues related to monetary policy, financial market regulation and capital markets.
Christina Wallner
is an economist in Munich Re’s Economic Research Department and works on topics such as digital trends.
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