Inclusive Finance — Machu Picchu Self-Help Protocol [1]

Photo by Redicul Pict on Unsplash

Executive Summary

How can proven technologies of the 21st century help the persons-in-need reproduce the ancestral community financial protection practices and improve their life? Our answer to this challenge uses the following technologies:

• Decentralised IPFS storage to maintain the profile of a person-in-need.
• Blockchain smart contract to do trustless transactions.
• Ethereum Account Abstraction (ERC-4337) associated with mobile messaging (SMS or USSD) to hide completely to the person-in-need the key management, blockchain signature and business logic.
• DeFi smart contract to handle risk-sharing among a community of persons-in-need.
• Neural Networks (“AI”) word embedding with vector databases to represent the “degree of neighbourhood” between persons-in-need, to do risk-sharing.
• Earth Observation and blockchain voting to assess the level of risk-sharing in case of climate catastrophe.

All these techniques have been individually proven in well-known applications and have all released open-source code. Machu-Picchu is simply composing them together for the purpose to reproduce the ancestral practices and let the persons in need take care of their own financial safety.

The pains

The main issues with conventional insurance, applied to the poor, are as follows:

• Insurance is defined as a risk-transfer between 2 economic agents. A risk-averse party may accept to pay another more risk-neutral agent to transfer a risk to this agent. When the risk happens and is attested by a third party, the second agent compensates the first agent for the loss. Risk transfer is forbidden by Muslim “shariah”.
• On the opposite, a risk-sharing situation happens when all members of a community agree to participate in a common loss compensation of any single member. The risk is shared among the community instead of being transferred to any party. Risk sharing is accepted by the Muslim law, the “shariah”.
• Because risk-sharing is decentralised, it has been notoriously difficult to enforce the commitment of each participant when a loss occurs. In contrast, risk-transfer presents a well identified responsible (the insurer) whose commitment is easier to enforce.
• But considering the considerable amount of money gathered in one hand, the temptation of imprudent financial behaviour and misuse to the benefit of the insurer are high. To guarantee that the commitments can be met, supervision authorities require considerable reporting and control, which adds to the operating expenses of insurance.
• The poor’s risk transfer amounts very often are too small as relative to the high costs of supervision reporting. This applies specially to crop insurance, where the risk is frequent while the loss coverage is relatively small. Health insurance is the opposite and is more profitably covered by insurance.

However, because of the difficulty to enforce risk-sharing commitments, insurance is today the only solution available on the market and recognized by authorities. Even the so-called “mutual aids” are legally considered as insurers.

The solution

Fortunately, a solution exists to enforce risk-sharing commitments inside a decentralised community. The commitments of each person are represented by one or several blockchain smart contracts. Enforcement of these smart contracts is obtained by construction and becomes effective as soon as these contracts are deployed on the blockchain. The following drawing shows how it can be done:

• In Traditional Finance, intermediaries with deep pockets are trusted by all parties to execute the finance protocol. These middlemen must comply with rules established by supervision authorities.
• In Decentralised Finance, each participant is represented by a blockchain smart contract that controls a personal liquidity pool. The commonly agreed DeFi protocol executes the flow of liquidity between the pools.

Difference between Risk-Transfer and Risk-Sharing

Existing blockchain-based insurance solutions

For legacy technical reasons, all existing blockchain risk-management solutions are currently based on risk transfer and, because of this, they act as insurers and are obliged to comply with insurance regulations.

In particular, it is required that insurers prove that they comply with strict actuarial and capital requirements (Solvency II Directive, https://chat.openai.com/share/13ba266b-c1e1-4a98-a185-97c7ee6ef8e0).

As a result, all existing blockchain insurance startups act only as frontend or backend to established insurers, to whom the risks are ultimately transferred. Examples of established insurers are Swiss Re, Munich Re, Allianz, Axa etc. Here is a non-exhaustive list of such “insurtech” startups.

Insurtech based on provision of insurance

• Nexus Mutual (https://nexusmutual.io/): Blockchain Insurance.
• Etherisc (https://etherisc.com/): Blockchain Insurance platform.
• Lemonade (https://www.lemonade.com/): Blockchain Insurance.

Insurtech based on provision of platform service to insurers

• IBM: Blockchain Insurance library to various functions of insurance.

• IBISA (https://ibisa.network/): Earth Observation-based actuarial tools to address drought risks.

Insurtech Type doing academic research and open source code

• Risk Transfer Protocol (https://wwz.unibas.ch/en/news/details-2598/defi-risk-transfer-towards-a-fully-decentralized-insurance-protocol-new-publication-by-felix-bekemeier-matthias-nadler-and-fabian-schaer-published-in-the-proceedings-of-ieee-icbc-23-nominated-for-best-paper-award/): Insurance Smart Contract source code.

Inclusive Self-Help: The Machu Picchu Risk-Sharing Protocol

See part 2 here (link).