Why Start Crypto Policy DAO?
The backstory of Crypto Policy DAO starts with it's founder and the need for legal and financial clarity while creating a crypto insurance startup. As with most businesses, there are financial and legal obligations that need to be met, and within the traditional insurance market, those were yet to be defined for Web3 insurance. Even though there were no laws specified for cryptocurrency insurance at this time, there is still a financial framework from traditional insurance that can be applied for some guidance. They can be specific to countries like the NAIC1 in the United States, and now even an entire union of countries with the EIOPA2 in the European Union.
However, if we were to apply the current insurance regulatory frameworks to crypto insurance, by default, it would not be possible to start a crypto insurance company. This is because the framework for current traditional insurance companies apply a set of standards that doesnt correlate to the web3 space. The main two frameworks for traditional insurance is EIOPA from Europe and NAIC from the United States and they provide parameters on what financially constitutes an insurance company and clearly differentiates it from other companies, like a financial or investment company.
When creating an insurance company, the two main aspects to consider initially is the legal enforcement of insurance policies and the financial requirements established by the government. Essentially, half of your work is creating an insurance policy while considering its eventual interpretation by the courts, while the other half of your work is establishing internal financial mechanisms that abide by the current legal financial requirements. However, in web3, there is no statutory law or legal precedence established and the financial framework that exists only applies to the traditional insurance market.
Why is there a financial framework at all?
Companies may have cash on hand that they want to invest and try to earn some of their losses (claims that are paid) back. There is nothing wrong with this process as at all, as any company should have a right to invest on the businesses behalf. Though within the insurance industry, there are several different types of insurance mechanisms, or engines, powering these companies and that is where the financial framework requirement starts.
Without going into depth, a financial framework is not needed in order to define what an insurance company is, unless the profits of the company go back to the policyholders, or the customers. However, regardless of the reasons why this is, one of the by-products of the financial framework is the creators of it were not aware of Decentralized Finance (DeFi) when it was created, so it inhibits innovation within the crypto insurance space. Below are the main points of the financial framework provided by the National Association of Insurance Commissioners (NAIC) in their Insurance Regulatory Information System (IRIS) Ratio manual from 2023 for United States3.
NAIC Financial Framework / Ratios
| No. | Variable | Over | Under |
|---|---|---|---|
| 1 | Gross Premiums Written to Policyholders Surplus | 900% | |
| 2 | Net Premiums Written to Policyholders Surplus | 300% | |
| 3 | Change in Net Premiums Written | 33% | -33% |
| 4 | Surplus Aid to Policyholders Surplus | 15% | |
| 5 | Two-Year Overall Operating Ratio | 100% | |
| 6 | Investment Yield | 5.5% | 2% |
| 7 | Gross Change in Policyholders Surplus | 50% | -10% |
| 8 | Change in Adjusted Policyholders Surplus | 25% | -10% |
| 9 | Adjusted Liabilities to Liquid Assets | 100% | |
| 10 | Gross Agents Balances (in collection) to Policyholders Surplus | 40% | |
| 11 | One-Year Reserve Development to Policyholders Surplus | 20% | |
| 12 | Two-Year Reserve Development to Policyholders Surplus | 20% | |
| 13 | Estimated Current Reserve Deficiency to Policyholders Surplus | 25% |
Above is the most recent version of the NAIC ratios in the financial framework that illustrate the acceptable parameters for an insurance company. These ratios are flexible but if you earned 12% investment yield three years in a row as an insurance company, they were more likely to think that you were a bank or investment company instead of an insurance company. Albeit, that itself is a flaw, they are the current thresholds for definining an insurance company from a financial perspective.
According to the whitepaper for Bitcoin, one of it's main purposes was to decrease the reliance on banks for people around the globe. Since the blockchain is a decentralized intermediary when exchanging funds between two parties, it is now possible to purchase goods without the transaction fees going to the bank and can go back to some of the users instead. Not all DeFi scenarios are the same, but for the most part, the transaction fees that are generated are given back to the individuals that provided the liquidity for the transactions to be possible, much like the Treasury of the United States. Except, in the case of the United States, the US Treasury provides the funds while a US sovereign entity, the Federal Reserve, receives all of the transaction fees generated by the users. Which is also known as roughly 1/4 of the debt that the United States has. Thats right, not to digress, but roughly one quarter of the United States' debt is to the Federal Reserve, which is not part of the United States because it has "legislative sovereignty" from the US.
So, because the transaction fees are now going back to some of the users*, this means that it is not just possible for the investment yield to be above 5.5%, but it is expected to be much more, and sometimes daily. When some of the users are able to generate much more than 5.5% investment yield, then the parameters need to be updated in order to maintain a continuously sensible and pragmatic level of compliance.
Within the crypto industry, we are familiar with DeFi and the very real-world interest that can be earned from it, though we need to educate legislators about DeFi and the new opportunities and parameters it creates. This is why we have written about defining the new finanical parameters of what constitutes a crypto insurance company, when to reevaluate them in the future, to what thresholds can be considered, and what needs to be done in order to apply those new standards. That all may sound convoluted, but it's the start of risk management and public policy and it needs to be practiced in every aspect of our political spectrum.
Historically, laws were written in a reactionary manner in order to prevent a particular crime from being repeated. Whether it was white collar or blue collar, if a law cannot be clearly and succintly written to prevent it, then the courts would create a precedent for it and enforce the law that way. But what happens in crypto when the judges have never heard of metamask or opensea or the lawyers dont know the difference between a flash loan and an exploit (which can be the same exact thing at times)?
Applying new knowledge to an old process
Education is the best precursor to writing effective legislation. We are at a time when information is so fast and readily available that we should be able to create more relevant and impactful legislation in a sensible timeline. The blockchain provides immeasurable value that our govnerments are yet to even consider taking advantage of. And by all means, as valuable as a Bitcoin or Ethereum ETH is, it is not even 1/1000th of the value that the blockchain inherently provides of which is yet to be utilized.
In conclusion, Crypto Policy DAO was established to provide context, content, and guidance for the web3 legislative process and landscape. Legislation should be proactive and not wait to create a law until only after innocent consumers have been robbed of their finances. So, we have created the Blockchain Regulation Matrix (BRM) that provides a backbone for understanding where and how regulation needs to be addressed and considered. The BRM provides clear and distinct layers to the blockchain and all aspects of it from the users perspective, which creates a clear path forward to friendly web3 regulation. Our next blog post will dive deeper into the BRM and how it will be utilized.
Membership for Crypto Policy DAO will be limited to a select few in order to maintain efficiency, though if you are interested in joining, please reach out.
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