# Underwriting DAO

**We propose the use of cryptocurrencies as claims on future cash flows of an underwriting business operated by a Decentralized Autonomous Organization (DAO). The structure of incentives embedded in our DAO design has the potential to substantially lower capital requirements and the related need for capital regulation. Further, it allows for trustless collaboration (i) among DAO underwriters as well as (ii) between underwriters and consumers. In this decentralized, trustless system, the tokens essentially substitute for reputation. Financial distress or bankruptcy of an individual underwriter does not have to affect either consumers or the DAO as the insurance contracts are backed by encumbered tokens.**

## Risk Diversification

Centralized underwriting is subject to several shortcomings. In traditional centralized underwriting, a small group of elite and privileged individuals and institutions with significant funding collectively make the underwriting determination based on a centralized risk assessment. Centralized risk assessments are subject to significant information asymmetries and associated transaction costs. These limitations in centralized risk assessments can only be partially be overcome with big data analyses and artificial intelligence, among other technology solutions.

Semada’s Underwriting DAO provides unparalleled risk diversification for underwriting. Key for Semada’s risk diversification is decentralization of risk. In the Semada Underwriting DAO, risk is  decentralized because of two mutually reinforcing core factors:

a.)   Individually, each DAO member provides a unique risk assessment before staking reputation and accepting proportional liability for damages. The individual due diligence capitalizes on each individual’s unique insights, background and merit in the risk assessment.

b.)   Collectively, the DAO members only incur legal liability if and when the validation pool, e.g. the collective due diligence that combines all the DAO members skill sets and unique insights, decides in favor of underwriting the legal risk involved in the transaction. In other words, the outcome of the validation pool provides a collective due diligence analysis that removes information asymmetries and associated transaction cost otherwise afflicting centralized risk assessment solutions.

## Consumer Protection

Consumer protection for risk in various settings can be facilitated by existing centralized underwriting businesses. Yet, many communities cannot receive insurance and underwriting products for certain risks that either exceed the threshold centralized underwriters are willing to exceed or they are otherwise uninsurable because of extraneous factors such as location, among others.

Consumer protection is a core objective of the Semada Underwriting DAO. Consumers are in the best position to assess the risks. Consumers in markets that cannot get insurance and in markets that allow insurance coverage are ideally positioned to assess the insurance and underwriting risks. Consumers in such communities typically lack the financial means to underwrite their own risks collectively. Hence, centralized underwriting solutions fill the void. Underwriting the risks themselves is often not an option for such consumers because they often lack a properly incentivized decentralized mechanism that allows them to underwrite the collective risks for the greater good of the community.

The evolutionary structure of the Semada Underwriting DAOs allows for any programs underwritten by the risk pool to be subject to the approval of the Underwriting DAO community and is constantly evaluated for efficiency.  This evolutionary structure does not only create timely protocol and governance upgrades for the Underwriting DAO, it also prevents bloat and preserves efficiency.

A core benefit for consumer protection is the Semada Underwriting DAO’s liquidity pool. While each member of the Underwriting DAO may be willing to take on the proportional liability based on their reputation staking, it is unclear if the individual DAO member will have the financial ability to cover the financial risk if it should materialize. Consumer trust in the product necessitates a guarantee for payouts should the legal risk materialize. Liability guarantees for individual members of the Underwriting DAO can be accomplished via a smart contract encumbrance. This solution, however, would necessitate the freezing of assets with all the financial suboptimal effects. It would also assume that any Underwriting DAO member would be willing to freeze these portions of their assets in the smart contract encumbrance. Hence, the solution would create barriers to entry and increase cost. A liquidity pool, however, would accomplish instantaneous consumer trust and consumer protection. By providing a guarantee that any payouts in the case of underwriting liability are financially possible, the liquidity pool protects the public and the individual consumers. The founding group of underwriters agrees to allocate funds for a minimally viable liquidity pool guarantee (based on consumer sentiment/expectations) that is calculated in proportion to the total Net Asset Value at Risk (VAR) in the Underwriting DAO, e.g. the total assets underwritten at any point in time. VAR is reassessed monthly or more frequently. The reserve ratio is calculated as a proportion of risk premia paid to members of the Underwriting DAO, e.g. parts of the payouts for taking on the additional legal liability is allocated in proportion to the payouts by reputation of the respective Underwriting DAO member.

## Example: Digital Property Rights

Crypto Kitties are typically derided and ridiculed in the crypto press and in the blockchain community. Yet, crypto kitties exemplify a new class of digital and cryptographically secured assets. Crypto kitties exist in code on the Ethereum blockchain and each kitty has individual unique characteristics. They are immutable and valuable and can be traded and exchanged as digital assets.

In the real world, the creation of property rights was the foundation of freedom of contract. Without a definition of property rights, freedom of contract pertaining to assets would be pointless because the assets cannot be defined without any rights attached to them. Property rights can be defined as rights from freely concluded contracts, legal claims from tortious acts, private ownership of land, copyright, among others. Freedom of contract means freedom to contract or not, freedom to choose counterparty, freedom to determine contract content, and the freedom to choose the form of the contract, among others.

The creation of digital property rights over digital assets necessitates a decentralized  underwriting function.

### Standalone Digital Assets

In the case of standalone digital assets, the cryptographic guarantees of the blockchain alone may suffice to create property rights in digital assets. Digital assets as standalone assets can be created simply by using the cryptographic verification / hashing etc. procedures in existing blockchains. Once the asset exists on a blockchain it can be traded and used in commerce. The blockchain ensures that once the assets was created and is transferred, each property right associated with the digital assets is immutably stored and can be fully traced.

### Digital Assets with Underlying Real Assets

Digital assets that are connected to existing hard/real assets require additional verification and legal liability guarantees in order to create consumer confidence and legal certainty with the associated effects on distributed commerce. Unlike in the case of a standalone digital asset, where the blockchain ensures that once the assets was created and is transferred and each property right associated with the digital assets is immutably stored and can be fully traced, for digital assets that are associated ot hard assets, the consumer and market confidence in digital assets that are attached to hard assets require legal guarantees that the digital asset encapsulates an existing hard asset with clean title. Consumers will not trade such digital assets and the market will severely discount its price because of the underlying legal and economic uncertainty, unless some entity or person investigates the origin and rights attached to the underlying hard asset and guarantees its origin and existence of clean title, e.g. no rights are attached to the underlying assets other than the rights of the current asset holder.

The Semada Underwriting DAO can certify the existence of a digital asset with an underlying hard asset and create a record of clean title for such assets. By taking on the legal liability that protects an acquirer of such digital asset if the title to the asset should not be clean, the underwriting DAO creates the much needed legal certainty and consumer confidence that are the fundamental preconditions of decentralized commerce.

## Democratization of Finance

In existing centralized underwriting solutions, the consumers utilize risk diversification to improve personal and community outcomes.  Yet, consumers cannot directly participate in the value creation that is associated with the underwriting business.

Decentralized underwriting provides individuals who are otherwise excluded from participation in the underwriting business an opportunity to participate in the associated value creation. Decentralized underwriting in capital formation and insurance provides unparalleled opportunities for value creation in a fully democratized way.

## Markets

### Existing Underwriting Markets with Coverage

Decentralized underwriting has the potential to capture parts of the existing centralized underwriting markets. Market capture can be accomplished by lowering information asymmetries in the risk assessment process and eradicating the associated transaction cost. With a lower cost structure, the decentralized underwriting has a comparative cost and coverage advantage.

### Community Needs for Underwriting without Coverage

Communities that cannot get insurance in less mature markets will be able to use decentralized underwriting DAOs to obtain coverage. To optimize decentralized risk assessment, it may be advisable that insurance policy holders in such communities are not members of the Underwriting DAO that provides the coverage.

## Evolution of Decentralized Commerce

Decentralized commerce cannot fully evolve without decentralized underwriting. Consumers simply will not be willing to transact and expand into decentralized markets without decentralized risk insurance providing legacy system equivalence.

## Optimizing Semada’s Core Incentive Design

Semada’s core protocol enables an incentive design through reputation staking. In the core protocol, DAO members are incentivized to seek truth and investigate the information provided for the validation pool because they stake an intangible good, e.g. reputation in the DAO.

Semada’s DAO incentive design can be further optimized by adding legal liability in Semada’s Underwriting DAO. In the Semada Underwriting DAO, DAO members would not only stake their reputation for the participation in the validation pool but also accept legal liability on the outcome of the staked pool they participated in. Liability is allocated in proportion to the staked reputation. Acceptance of legal liability if an outcome of a validation pool vote should harm a consumer increases the truth seeking and investigation incentives for DAO members because DAO members not only need to consider losing a valuable, yet intangible good, i.e. their staked reputation, but also face a potential legal liability if their legal risk assessment was inaccurate and leads to legal liability in proportion to the respective DAO members’ staked reputation out of the total reputation staked in the validation pool. Only DAO members who stake their reputation and proportional legal liability in favor of underwriting the legal risk/proposition and win jointly are legally liable if a consumer was harmed. DAO members who voted against the proposal are generally not liable. DAO members who voted in favor of a proposal and lost are naturally also not liable.

The incentive design of the Underwriting DAO is further optimized by providing anonymous voting. The Underwriting DAO incentive optimization via anonymity helps overcome the possible free-rider problem. The free-rider problem in the existing protocol design is overcome via anonymous reputation staking. Similarly, in the Underwriting DAO, if DAO members do not know who is voting for or against a proposal before the vote, other DAO members are incentivized to continue their due diligence before the vote to ensure limitation of legal risk.\\
