1) moral hazard/information assymetry - If I insure you against fraud I have removed most of your financial incentive to protect yourself, so I need to have some other reason to think that you will. I also need protection against the fact that you have more information than I have about the risk of fraud (how do I know you won't collude with the fraudster, in effect defraud yourself and collect on the insurance?) In the normal world this category of concerns prevents lots of types of risks from being insurable, and we have criminal law to protect against collusion
2) Capital commitment - It's not sufficient to just get a promise from the vetters, the capital has to be committed (ie escrowed in some way) otherwise how do I (as an insured party) know they will make good on their payment when I need them to? As an insured party I have to be able to verify that you have done this. In the normal world, this is handled by regulatory capital guidelines for insurers and counterparty collateral posting in the world of OTC contracts.
3) Network effects - If I have capital in escrow, the contracts protecting that escrow would presumably themselves become extremely high-value targets for fraud. Can they be insured? How would you know that the capital is committed to pay out on these insurance contracts? Escrow again? This is a very significant bootstrapping problem - how do I as a participant somewhere in this chain know that in the last resort my insurance will be able to pay out so that if need by I can make good on my commitments. In the normal world this is handled by central counterparties demanding collateral posting against open contracts.
It's very tempting for engineering/technical people to assume that even though they don't really understand all the details, everything has an engineering/technical solution that would be so much better than what has been developed by their predecessors. This disruptor's hubris is necessary for progress to be made against very hard problems otherwise they would probably be to daunting to tackle.
Trust in the existing contract law system has grown organically over a very long period of time. Some of the smartest people going are lawyers and they've had a significant head start on these problems. It would be pretty difficult for trust to evolve organically given some of the poor decisions and scale of subsequent fraud that has already happened in the "smart" contract world.
These are valid and clearly articulated points. I do not disagree. I would simply point out the following:
You point out the non-trivial nature of building a system like we have today. I'd argue that Ethereum, with smart contracts and an immutable public blockchain is a useful innovation that I consider a useful building block for creating and improving the kinds of institutional relationships and interactions that you describe.
A system of insurance implemented on Ethereum would need to have the same sorts of moving parts that you describe. Ethereum would make some aspects of this harder and others far easier.
There would still be a need for collateral, escrow, etc. My comments are not meant to argue that these mechanisms become useless, they simply become more transparent and when viewed in terms of the rule of law, become significantly more resilient when markets become politicized and the rule of law is in danger of breaking down.
Things that would potentially be far easier in an Ethereum based system would be:
- assessing/auditing the books of an entity. Things like proof of solvency become much easier, and also looking at assets which are accounts receivable that depend on another entity's solvency. The modern financial system has very course-grained and inadequate ways of looking at this sort of systemic risk, which makes cascading firm failures truly devastating and nearly impossible to insure against, since any cascading firm failure will involve many ad-hoc regulatory interventions and rule changes that essentially nullify a large number of pre-existing contracts/hedges that might have existed.
- forcing precise regulations. One of the pre-2008 meatspace glitches was the too-little-too-late regulatory decision to force firms to mark certain types of assets to market even if their accounting approach determined that doing so inflated or deflated their balance sheets incorrectly. With a public ledger it would be possible to easily test a new accounting rule's impact on a firm's financial statements.
1) moral hazard/information assymetry - If I insure you against fraud I have removed most of your financial incentive to protect yourself, so I need to have some other reason to think that you will. I also need protection against the fact that you have more information than I have about the risk of fraud (how do I know you won't collude with the fraudster, in effect defraud yourself and collect on the insurance?) In the normal world this category of concerns prevents lots of types of risks from being insurable, and we have criminal law to protect against collusion 2) Capital commitment - It's not sufficient to just get a promise from the vetters, the capital has to be committed (ie escrowed in some way) otherwise how do I (as an insured party) know they will make good on their payment when I need them to? As an insured party I have to be able to verify that you have done this. In the normal world, this is handled by regulatory capital guidelines for insurers and counterparty collateral posting in the world of OTC contracts. 3) Network effects - If I have capital in escrow, the contracts protecting that escrow would presumably themselves become extremely high-value targets for fraud. Can they be insured? How would you know that the capital is committed to pay out on these insurance contracts? Escrow again? This is a very significant bootstrapping problem - how do I as a participant somewhere in this chain know that in the last resort my insurance will be able to pay out so that if need by I can make good on my commitments. In the normal world this is handled by central counterparties demanding collateral posting against open contracts.
It's very tempting for engineering/technical people to assume that even though they don't really understand all the details, everything has an engineering/technical solution that would be so much better than what has been developed by their predecessors. This disruptor's hubris is necessary for progress to be made against very hard problems otherwise they would probably be to daunting to tackle.
Trust in the existing contract law system has grown organically over a very long period of time. Some of the smartest people going are lawyers and they've had a significant head start on these problems. It would be pretty difficult for trust to evolve organically given some of the poor decisions and scale of subsequent fraud that has already happened in the "smart" contract world.