Blockchain technology enables peer-to-peer transactions to occur openly and without the need for an intermediary such as a bank (as in the case of cryptocurrency) or a middleman in the agriculture sector. By removing the requirement for a central authority, technology alters the way trust is provided — rather than trusting an authority, confidence is placed in encryption and peer-to-peer technology. It, therefore, contributes to the restoration of confidence between producers and customers, which can lower transaction costs in the agri-food sector.
Blockchain technology provides a trustworthy method of tracing transactions between anonymous individuals. Thus, fraud and defects may be identified fast. Furthermore, by implementing smart contracts, issues may be notified in real-time.
Due to the complexity of the agri-food system, this helps to handle the difficulty of monitoring items in the vast supply chain. Thus, blockchain technology brings solutions to consumers, government, and other stakeholders’ concerns about food quality and safety.
Blockchain technology increases transparency among all parties involved and allows the acquisition of verifiable data. Blockchain can record every stage in a product’s value chain, from conception to death. Reliable data from the agricultural process is extremely important for establishing data-driven facilities and insurance solutions that will make farming smarter and less susceptible.
Importance of Blockchain in Agricultural Insurance
Weather extremes damage agricultural production, threatening food security. Crop and animal output are also affected, and climate change is projected to worsen weather extremes in the future.
Agricultural insurance programs are a well-known method for managing weather-related hazards. Farmers pay an insurance payment before the cropping cycle begins and receive a payout if they suffer a loss on their farm. As a result, the insurer assumes full responsibility for the insured risk, and farmers may limit their financial exposure to weather extremes, i.e., financial losses induced by weather extremes.
Furthermore, in the event of weather hazards that impact all covered farmers on a systemic level, the insurer can further hedge the systemic portion of the risk with a reinsurance business.
Agricultural insurance policies differ in terms of how losses are assessed and, as a result, how payouts are triggered. Indemnity-based insurances are those that compensate farmers based on a damage estimate done by an expert on the farm. Indemnity-based insurances can exactly pay losses, but they are vulnerable to difficulties caused by asymmetric knowledge In particular, information on the riskiness of agricultural output and production techniques is transferred asymmetrically between farmer and insurer.
Farmers with higher ex-ante risk exposure are more inclined to obtain insurance than farmers with lesser risk, indicated by adverse selection. When farmers are insured, they are more likely to engage in riskier agricultural techniques. If the insurer lacks sufficient knowledge of the two scenarios, these circumstances result in market failure of the insurance plan.
As a result, indemnity-based insurances are prone to costly damage assessment and must include safeguards such as deductibles to minimize difficulties
caused by asymmetric knowledge. Furthermore, products that cannot be quantified, such as grazed meadows, cannot be covered, although causing financial loss.
Motivated by the shortcomings of indemnity-based insurances, the concept of index-based insurances arose as an alternative or supplement to traditional products. In this case, the compensation is triggered by a quantifiable index, such as rainfall at a local weather station, rather than by the loss itself If this weather station has long enough historical weather data, both the farmer and the insurer will have identical knowledge on the insured value, and agricultural methods will have no effect on the insurance payout.
As a result, adverse selection and moral hazard are no longer factors, and the technical method for triggering a payout has been significantly simplified.
Furthermore, full insurance coverage with no deductibles is feasible, and payments may be sent on time and automatically immediately after a bad weather event is measured.
However, differences in payment and on-farm loss might arise, which is referred to as basis risk.
There are three potential sources of basis risk.
Geographical basis risk denotes any discrepancies in observed and on-farm weather, such as spatial distance.
Temporal basis risk suggests that an imprecise time window was used to calculate the index, such as whole-year rainfall vs. growth season rainfall All remaining causes, such as missing meteorological data or biased technological implementation, are summarized in the design foundation risk
To summarize, index insurance is becoming an increasingly significant risk management instrument for farmers, while basis risk reduction is of primary importance.
In two ways, blockchain can help to improve index insurance.
First, payments may be issued on time and automatically depending on meteorological data that triggers a smart contract payout.
Second, weather data and other data sources, such as plant growth data or data gathered by farm machinery, may be automatically incorporated via a smart oracle, reducing basis risk and enhancing the index calculation and payment process.
Smart contracts that employ smart oracles to integrate external data have previously proved beneficial in various crypto-economic applications.
The first smart index insurance contract prototypes are already in the works or have been released. Etherisc, a Swiss-based startup, for example, offers decentralized crop insurance based on blockchain technology, with payouts in DIP as local currency (DIP – Decentralized Insurance Protocol tokens).
Furthermore, WorldCover, a New York City-based insurance company that sells index insurance contracts to smallholder farmers in Ghana, simulated the use of an Ethereum blockchain-based smart contract. As a result, payouts would be made in the cryptocurrency Ether.
Arbol is yet another clever crop insurance supplier. A farmer can submit a contract with Arbol that comprises the premium payment, a payout, and a weather event that triggers the payout. Following that, an investor acting as a counterparty might consent to the proposed contract. Initial and final payments are made in Ether.
Aside from the benefits of decentralized insurances based on smart contracts that make automatic payouts, the applicability of cryptocurrency payouts to compensate farmers must be shown in the field.
Furthermore, farmers, particularly in underdeveloped countries, may lack access to the necessary infrastructure to participate in a decentralized blockchain-based insurance scheme. As a first option, Etherisc argues that third-party organizations “[…] can offer payment channels and interfaces that remove the end customer’s requirement to possess cryptocurrency.”