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When a State Has 80% Homeowners Lawsuits in the Country, How Can We Do Better in Risk Management?

The Takeaways:

  1. Risks are inevitable, losses don’t have to be — if we do risk management right.
  2. One-way attorney fees and assignment of benefits (AOB) are the two big legal loopholes pushing up insurance cost and lowering down private insurance affordability and availability in Florida.
  3. Four technological platforms or tools are very useful in risk management: ChatGPT, Smart Contract, Internet of Things (IoT) & Tango. Together they have the potential to revolutionize insurance business by significantly reducing insurance costs and increasing fare & efficient insurance coverage.
  4. ChatGPT will be trained to read and explain lengthy and complicated legal documents such that ordinary citizens can quickly understand the gist of a 200-page contract. This will significantly reduce the currently indispensable role of human attorneys (they may be needed to proof check the ChatGPT answer but that should not take very long.)
  5. Another ChatGPT development is customized, always on, mobile and industry- or even firm-specific ChatGPT. The program will be locally pre-trained by records of past risks and past losses, and then provide intelligent and insightful answers to inquiries of all employees in dealing with new but similar problems.
  6. Smart contract associated with blockchain will effectively reduce the problem of legal system abuse, over-crowed or jammed court rooms, long waiting lists of scheduled litigations — by drafting really smarter contracts that are filled with very detailed, context specific “what if” terms and conditions (ChatGPT can help draft and interpret the document), taking into account all relevant historical cases and eliminating extra spaces for misinterpretation and post hoc litigation, while keeping the feature of automatic execution of a predetermined agreement.
  7. Internet of Things (IoT) will establish a field monitoring network at critical junctions of business operation to record objective evidence admissible to the court of law, deterring frivolous lawsuits and prevent predatory practices of trial attorneys.
  8. Tango is the easiest and most intuitive training tool for employees by providing step by step guides with intuitive screenshots every step of the way that everyone can understand and easy to follow. In the future new employee orientations will be mostly done by watching Tango generated PDF files. Numerous risk management field guides can be developed with context specific Tango flowcharts to reduce the chances of misbehavior and mishandling.

This is a more detailed (and longer) version of my proposal for the “In2Risk23” Conference to be held on October 5-7 in Washington D.C. by the CPCU Society of the Insurance Information Institute or the Triple-I as it is called.  

Bad & Then Good News from Florida

Don’t get me wrong, I only have California state insurance (and financial) license so what happens in Florida does not really concern me. Yet insurance everywhere bears similarities, and it doesn’t hurt to learn from the mistakes in another big state like Florida.

The Insurance Information Institute (Triple I), one of my favorite sources of insurance related information, has recently issued a two page news brief on Florida Property /Casualty (P/C) Insurance crisis. It tells us the bad news first, and then some good news.

Perhaps the best way to start a story is by providing some quick statistics: “Florida accounts for nearly 80% of the nation’s homeowners’ insurance lawsuits, but only 9% of all U.S. homeowners’ insurance claims are filed.”

Wow, there are disproportionally way more insurance lawsuits than other states adding together! As a result of excessive or runaway lawsuits, it “costs every Florida household more than $5,000, and the state more than 173,000 jobs annually,” according to the American Tort Reform Foundation’s “Judicial Hellhole” report.

So what’s going on here?

“Legal system abuse and misuse of assignment of benefits ‘are creating a lose-lose, contributing enormously to the net underwriting losses for the few remaining insurers in the state,’ said the Triple-I CEO Sean Kevelighan.”

The CEO only talked about assignment of benefit or AOB problem in Florida, another is “One-way attorney fees” to be discussed later in more detail.

The good news is that, as the above briefing points out, “Reforms put in place in the closing weeks of 2022 and proposed in the first quarter of 2023 suggest Florida is now quite serious about fixing the fraud and legal system abuse that have contributed to the state’s insurance crisis.”

The Underwriting Losses in Florida

Let’s look at another shocking figure from Florida:

“Florida’s homeowners insurers cumulatively incurred net underwriting losses of more than $1 billion in both 2020 and 2021 and expect larger losses for 2022 when year-end results are tabulated.”

The figure of $1 billion loss in Florida has to be placed in the context of national figures to make more sense. According to this report, “In 2021, the insurance industry experienced a $3.8 billion net underwriting loss, after a $5.2 billion underwriting gain in 2020.” In other words, the entire country had a gain in 2020 when Florida had a loss, and of the national loss of $3.8 billion in 2021, Floridan contributed $1 billion, more than 25% of it.

One crucial term in the above news is “underwriting losses.” According to ChatGPT, “Underwriting loss is the financial loss incurred by an insurance company as a result of the claims paid out to policyholders being greater than the premiums collected from those policyholders. In other words, underwriting loss occurs when an insurance company pays out more in claims than it receives in premiums.”

Simply put, underwriting losses happen when insurance companies have to pay out more money for insurance claims than they received from policyholders’ premiums. You don’t have to be a genius to figure out that is not good.

To be sure, insurance companies make money in several ways, not just from premium. Therefore, underwriting losses are not the only factor to determine the company’s overall financial health. Investment income is another major source of revenue.

When an investment company receive policyholder’s premium payment, they won’t let the money sit there collecting dust. Instead, they invest the premiums to security market to generate additional income.

In addition, operating expenses such as salaries, rent, and marketing costs can also affect an insurer’s bottom line. If an insurer has high operating expenses, it may be more challenging to achieve profitability even if its underwriting results are strong.

Still, other things equal, having an underwriting loss is definitely not a good news.

Trouble with Assignment of Benefit AOB

Assignment of Benefits or AOB is common primarily in property & casualty insurance but also in others like healthcare insurance. it is a legal agreement that involves the transfer of insurance benefits from the policyholder to a third party, such as a contractor or healthcare provider.

It seems to be a harmless arrangement. For example, say you have some illness and your physician successfully treated you. If that illness is covered by healthcare insurance, you know you will be reimbursed. So instead of you paying the physician and then get reimbursed from your insurance, you can choose to assign your physician to get all the insurance payment because he did all the job and earned it, right?

The answer is not that simple. While AOBs can be useful in certain situations, they are generally not recommended because they can lead to a variety of problems for both the insured and especially the insurer (i.e., the insurance company).

A main problem is insurance fraud. In some cases, contractors or healthcare providers may exaggerate the cost of their services to get paid for work they never did. Or they can perform unnecessary work in order to increase their profits, sometimes charging the patients with free medicines they received from marketer, for example.

I know this happens a lot in China, where hospitals over-examine patients because those imported medical equipment (e.g., an MRI scanner) cost a lot of money and hospitals don’t want the machine sitting there collecting dust. Doctors ask most if not all patients to have a medical imaging done first, even though it is clearly not necessary for some, and the procedure sometimes costs enough to send a family back to poverty!

Another issue with AOBs is to make it difficult for insurance companies to manage their claims because there is a third party involved in the claims process. The insurance company have to verify the work that was done and to ensure that the costs are reasonable. Delays and higher costs become common.

The bad news is that ultimately it is the insured person will bear the extra cost due to AOB. If the third party performs work that is not covered by the insurance policy, the insured person may be responsible for the additional costs.

Problems with One-way Attorney Fee

Another major problem in Florida that reduces insurance affordability and availability is the so called “One-way Attorney Fees,” also called “fee shifting.” This determines who is responsible for the litigation cost and to pay the attorney(s) involved in the case.

One-way attorney fees are meant to shield policyholders from legal bills if they need to sue an insurer, but critics say attorneys and contractors exploit the law to file unnecessary suits with the goal of collecting attorney fees.

The Triple-I briefing has this to say: “Before the reform, state law required insurers to pay the fees of policyholders who successfully sued over claims, while shielding policyholders from paying insurers’ attorney fees when the policyholders lose.”

Here is how one way attorney fees work: Policyholder can sue their insurer at limited risk for legal fees. If they win the case, insurance company will pay for their attorney fees; but if they lose, they will only pay their own attorney fees and let insurance company pay their own.

Honestly, the name “One way attorney fees” may have created the impression that win or lose the policyholders won’t have to pay for any legal cost, and insurer will take care of that. That is not true. A better way is to call it “asymmetric attorney fees,” where the asymmetry exists in demanding for more financial responsibility from insurance company such that if they lose the case, they will have to pay for attorneys for both sides. But if they win, they cannot ask policyholder to do the same for their legal cost — although policyholder still must pay for their own lawyer(s).   

Such a legal arrangement is not out of line but rather reasonable. After all, insurance companies have a deeper pocket than an insured.

But perhaps this is one of the things where the rule looks fine on paper but not so in practice. The reality is that there are way too many lawsuits filed by policyholders against insurance companies. As a result, several private insurance companies either had closed down or packed up to leave Florida.   

What are the problems? There are several:

  • Increased Litigation against insurance companies, caused by the asymmetric (i.e., lower) financial responsibility for policyholders than for insurance companies. We have marginal or meritless legal dispute that people just hope to extract a favorable settlement from the insurance company.
  • Difficulty in estimating claims costs, a relatively minor problem: One-way attorney fees can make it difficult for insurance companies to estimate the total costs of a claim, as it is challenging to predict the outcome of a lawsuit, which determines whether the insurance company will have to pay the plaintiff’s attorney fees.
  • Higher Settlements: One-way attorney fees can push up settlement amounts for claims. This is because insurance companies may be more willing to settle claims, even if they have a good chance of winning in court, to avoid the possibility of having to pay the plaintiff’s attorney fees in the event of a loss. This means settlement is better than attorney fees.

Going from Florida to the Nation

Florida insurance crises are basically supply sided problems. I mean look at how many private insurance companies left or shut down there. But if we look around the entire country, you’ll find insurance losses across lines but especially in Property & Casualty.

Prove to yourself by entering the search phrase “News about insurance underwriter loss” and you will see many headline pieces. For example, “Private U.S. property/casualty insurers saw a $5.6 billion net underwriting loss in the first nine months of 2021,” according to this report on February 15, 2022.

State Farm provides another example, as its main auto unit generated $8.6 billion in underwriting losses through the first nine months of 2022.

One obvious solution is to raise insurance rates. This USA Today report tells us that auto insurance rate will go up this year. “Drivers nationally are spending an average of 2.93% of their income on car insurance this year, based on an average annual premium of $2,014 for full coverage insurance.” and “car insurance rates increased by nearly 14% between 2022 and 2023, compared with an overall rise in yearly inflation of 6.5% in December.”

What about California? “Progressive recently received approval for a 19% rate increase for those renewing their policies or buying new ones.”

Risk Transfer & Risk Management

In insurance business, there is a familiar saying that risk is inevitable, loss does not have to be — if we do risk management right.

Compared with raising price, risk management is a more efficient, sustainable and proactive way of lowering insurance cost and ensuring just and fair coverage for losses.

ChatGPT says the following: “Risk management and risk transfer are two different approaches to managing risks, and each has its own advantages and disadvantages. However, risk management is generally considered a better approach than risk transfer for several reasons:

  • Retaining Control: Risk management allows an organization to retain control over the risks it faces. By implementing risk management strategies, an organization can identify and assess potential risks and take steps to mitigate or avoid them. In contrast, risk transfer involves passing the risk to another party, which means giving up control over how the risk is managed.
  • Cost Effectiveness: While risk transfer can be a quick solution, it can be more costly in the long run. Risk transfer often involves paying premiums to an insurer, which can add up over time. Risk management, on the other hand, can involve implementing cost-effective measures to reduce the likelihood and impact of a risk.
  • Tailored Approach: Risk management allows an organization to tailor its risk management strategies to its specific needs and circumstances. This can result in more effective risk management than a one-size-fits-all approach, which is often the case with risk transfer.
  • Reputation: In some cases, risk transfer can damage an organization’s reputation, particularly if the transfer is seen as an attempt to avoid responsibility. In contrast, implementing effective risk management strategies can enhance an organization’s reputation by demonstrating a commitment to responsible and proactive management.”

The above answer provides a good overview of why risk management is better than risk transfer (i.e., insurance). However, the best approach is to do both risk management AND risk transfer. We cannot bet entirely on risk management because there are things out of our control. But we can do everything in our power of control to reduce and/or control risks. I propose the followings along that line:

  1. The key to risk management is to empower employees and/or clients to quickly and easily learn the right and crucial things to improve risk reduction. The term “risk management” sounds like only managers are the stakeholder but that’s not the case. The best risk management is to mobilize all employees and clients to get the job done. Reaching that goal requires first and foremost modern technological tools.
  2. ChatGPT, Smart contract, Internet of Things (IoT) & Tango are the four most important technologies for risk management with the potential to revolutionize insurance business by proactively and significantly reducing insurance cost and making insurance sustainable. Of the four, ChatGPT is likely to play the most important role because it is approachable by ordinary employees and clients. All we need to do is to expand its functionality to make it useful to professionals.
  3. ChatGPT will not just give everyday texts for fun but will be trained professionally to understand, and then to explain, complicated legal documents such that even ordinary citizens can comprehend the gist of a 200 page legal document. This will significantly reduce the currently indispensable role of human attorneys (they may be needed to proof check the ChatGPT answer but that should not take very long.) The key is to reduce our reliance on the middlemen like attorneys by empowering the end users.
  4. Another ChatGPT development is customized, always on, mobile and industry- or even firm-specific ChatGPT. The program will be locally pre-trained by records of past risks and past losses, and then provide intelligent and insightful answers to inquiries of all employees in dealing with new but similar problems. Localized and customized ChatGPT can do many things faster, better and cheaper.
  5. Smart contract associated with blockchain will effectively reduce the problem of legal system abuse, over-crowed or jammed court rooms, long waiting lists of scheduled litigations — by drafting nothing less than really “smarter” contracts that are filled with very detailed, context specific “what if” terms and conditions (ChatGPT can help draft and interpret the document), taking into account all relevant historical cases and eliminating extra spaces for misinterpretation and post hoc litigation, while keeping the feature of automatic execution of a predetermined agreement. The idea is to work with a better beginning to save time and energy toward the end.
  6. Internet of Things (IoT) will establish a field surveillance network at critical junctions of business operation to record objective evidence admissible to the court of law, deterring frivolous lawsuits and prevent predatory practices of trial attorneys. Even with caseload remaining the same as before, having historical field evidence will still speed up the litigation process.
  7. Tango is the easiest and most intuitive training tool for employees by providing step by step guides with intuitive screenshots every step of the way that everyone can understand and easy to follow. In the future new employee orientations will be mostly done by watching Tango generated PDF files. Numerous risk management field guides can be developed with context specific Tango flowcharts to reduce the chances of misbehavior and mishandling.
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Cryptocurrencies & NFTs Financial talks at dinner table

Talking About Stablecoins

The Kingstons have decided to switch the gear toward what is happening in real life instead of abstract knowledge points.

Lily: I feel we have been out of touch with reality by talking about blockchain, cryptography, hash and hashrate, nonce, and even proof of work and proof of stake. They are foundational of course but we need to look at the “livelier” developments.

Kimberly: I agree. We also have had a very positive tone about cryptocurrency or the blockchain. We rarely talked about whether the whole thing of cryptocurrencies is worth it. After all, if famous investment gurus like Warren Buffett have questions and reservations about investing in cryptocurrency, shouldn’t we think twice about that as well?

Lily: To give a good example, what about the recent crash of stablecoins? I’ve read a report on CNBC the other day, talking about whether this 30-year-old South Korean founder of a stablecoins project will face jail time or just civil penalties.

Emily: What happened to the project? What is a “stablecoin?”

Lily: The idea of stablecoins sounds very attractive. It addresses one of the biggest problems with cryptocurrency. You know, their prices jump up and down dramatically. Stablecoins were born to change that.

Emily: How do stablecoins do that?

Lily: It helps to keep in mind we have two currencies today: dollar and crypto. They are not isolated from each other. The value of all cryptocurrencies is always measured by dollar. Jason, could you find out the dollar prices for Bitcoin and Ethereum today, please?

Jason: Let me Google it: It says $30,041 for Bitcoin and $1,809.64 for Ethereum.

Lily: Thanks. If you think of it, those prices really are the exchange rates between the dollar and crypto. Remember last year we had a trip to France and at the airport we used our dollars to buy Euros?

Emily: Oh yeah. Euro was more expensive than dollars. We gave them $200 but only got about 190 Euros back.

Lily: If you think the Euro is expensive, wait to see the exchange rate of Bitcoin. You heard Jason just said: One Bitcoin is sold for more than $30,000 dollars.

Joy: Just so you know, on May 1st I invested $1,000 on Bitcoin and $500 on Ethereum. Want to guess the prices back then? I have them on my iPhone: Bitcoin (BTC) was $38,890.81 and Ethereum (Ether) was $2,856.45.

Emily: You’ve lost money on cryptocurrencies. No wonder investors all want stabilized crypto prices.

Lily: That’s not true. Many speculative investors actually prefer big movement in price because it’s easier to make money that way. They all try to buy low and sell high.

Greg: Lily said it right earlier: We have two currencies within the country. With two currencies, what’s gonna happen is there will be an exchange rate between currencies.

Kimberly: A quick question: Exchange rate is the rate at which one currency can buy another, right?

Greg: Right. Normally exchange rate keeps changing because things change. However, sometimes a country decides to have a fixed exchange rate with another currency. This is called “currency peg.” The Hong Kong dollar for example has been pegged to the U.S. dollar since 1983.

Kimberly: Why would they want to do that?

Greg: Currency peg is a national policy to promote international trade. Many businesses involved in international trade have a low profit margin. Even a little fluctuation in exchange rate could wipe out their profits. A currency peg means a fixed exchange rate and it’s a godsend because it eliminates foreign exchange risk.

Kimberly: I can see currency peg is useful for international trade but we are talking about stablecoins, why is currency peg relevant?

Greg: Because the same idea of currency peg drives stablecoins. You guys may not have been keeping up with the latest in the payment business. Both crypto platforms like Coinbase and legacy service providers like Visa and Mastercard are pushing for direct deposits or cryptocurrency wallets and accepting both dollars and crypto. In the first half of 2021, Visa reported that it had processed over $1 billion worth of cryptocurrency payments

Joy: Yeah, for a currency to be useful for payment people all prefer stable value. Price jumping around too much turns people off from using it. This is why so many people are interested in stablecoins, which keep the exchange rate fixed between currencies — or so promised.

Kimberly: I see a big reason for stablecoins. Nobody wants to use a currency that can buy 10 gallons of gas today but only 7 gallons next month.

Greg: Another reason stablecoin is needed is that certain institutional investors like pension plans would desire stablecoins. At retirement ages people just want to preserve their hard earned money, they have little taste for speculation. I read the news that Fidelity Investment now let companies offer their employees Bitcoin in their 401(k) plan for up to 20%.

Emily: What’s 401(k)?

Joy: That’s a retirement savings plan sponsored by employers for employees named after a section in the U.S. Internal Revenue Code. It’s the best deal because if an employee deposits $500 each month to the plan, many employers will match that and add another $500 to your savings account.

Lily: Another reason stablecoins are such a big news is that some platforms offer big incentives to investors. The LUNA project once promised almost 20% annual return on anyone’s deposit on the platform. That’s crazy when others were paying 1% or less.

Greg: If something sounds too good to be true, most likely it’s not true. Unfortunately some always find excuses to believe the unbelievable. This billionaire investor named Mike Novogratz even made a tattoo on his arm to memorialize his membership in this LUNA club. The project quickly gathered almost $60 billion but today is almost worthless. I found this article from Motley Fool published right before Luna’s crash in May very insightful.

Joy: I’ve read from online that stablecoins are valuable to migrant workers who need to sent remittance money home fast and inexpensively compared with other means of sending money internationally. It also preserves value of foreign aids.

Kimberly: Should we get back to Emily’s question of how stablecoin works?

Joy: Of course. From what I understand, there are different models of stablecoins. Some are safer and stabler than others. The key terminology is “algorithms stablecoins.” The LUNA project Lily was talking about is an example of that.

Emily: “Algorithm stablecoins?” It sounds complicated.

Greg: Let’s go back to the “currency peg” and it helps us understand algorithms stablecoins.

Emily: Please give an example of currency peg.

Greg: Let’s say Hong Kong dollar is pegged at 1:8 to US dollar, meaning one US dollar will always buy 8 HK dollars. Normally the exchange rate is not fixed but fluctuates, so bear in mind this is unusual.

Emily: Because a fixed exchange rate helps exporting goods, right?

Greg: Right. Say last year one US dollar could buy 8 Hong Kong dollar, but this year one US dollar can buy 8.5 Hong Kong dollars. We say American dollar is stronger and Hong Kong dollar weaker. A stronger dollar can buy more imported stuff from Hong Kong, or Hong Kong can export more stuff to the US. That’s what Hong Kong wants.

Emily: What if things change and the exchange rate shifts away from 1:8?

Greg: That is called “breaking the peg.” Let’s say for some reason capital starts to flow out of Hong Kong, like businesses are leaving and foreign investments are leaving. What would that mean to Hong Kong dollar?

Lily: I would say Hong Kong dollar will be weaker because Hong Kong economy is weaker.

Greg: Right. A weak currency does not always signal weak businesses, because sometimes a country would intentionally make its currency weak just to increase its trade competitiveness. However, other things equal, a weak economy usually means weak currency.

Emily: But Hong Kong wants to have a fixed exchange rate with US dollar, what can Hong Kong do to keep the peg?

Greg: A country’s central bank keeps watching the exchange rate closely and if there are signs of deviation from the pegged rate the central bank will respond to drive the exchange rate back to the pegged value.

Emily: Details please?

Greg: In order to keep the exchange rate going down from 1:8 to 1:8.5, Hong Kong Monetary Authority will buy Hong Kong dollars from local banks, which will cut down the amount of Hong Kong dollar in circulation. When money supply is reduced, what happens to interest rates?

Lily: We learned from school that the interest rate is the price of borrowing money. So if money is in short supply, just like everything else, its price — the interest rate — goes up.

Greg: Yes, now when Hong Kong interest rate is up, it will attract money back into the city. Say interest rate goes from 1% to 2%, the same $1,000,000 Hong Kong dollars deposited in a Hong Kong bank will get interest payment of $20,000 rather than just $10,000.

Lily: More money flowing back to Hong Kong will make Hong Kong dollar stronger, and that’s how the peg is maintained or restored.

Joy: Hong Kong is a special case because it’s a part of China and does not have central bank. If China wants to maintain a stable exchange rate of Yuan with US dollar, the Chinese central bank will rely on open market operations to keep the pegging.

Emily: So what will Chinese central bank do if the Yuan goes down in value relative to US dollar?

Joy: Ask yourself this question: If the prices for something is down, does it mean the demand for that something is up or down?

Emily: I would say down, otherwise the price would go up for something that’s popular, like housing in California, right?

Joy: You got it. The same idea applies to currency as well. If the value of a country’s currency goes down, it usually means there is insufficient demand for it. Chinese central bank will then sell some of the US Treasuries and use the money to buy its own Yuan. This way it creates artificial demand for Yuan to bring its value up.

Kimberly: If China’s Yuan goes up too much in value relative to US dollar, China’s central bank will buy more US securities to raise the demand — and the value — for US dollar, right?

Joy: Right. Because central bank’s deep pocket, anytime it buys a currency, its value will go up and when it sells a currency, its value will go down. This is called “open market operations.”

Kimberly: I wonder how many countries can afford the pegging. Not all countries have a deep pocket of US currency or treasuries like Hong Kong and China.

Greg: That’s exactly right. It’s never easy nor free to keep the currency peg.

Emily: So for stablecoins to keep a stable value with the dollar, they use the same open market operations to maintain the peg, right?

Greg: Yes and no. There is an article that summarizes four types of stablecoins. I’ll simply break them into two types of collateralized versus non-collateralized stablecoins. The former works just like currency peg and requires collateral asset, such as fiat currency, bonds, commercial paper or crypto tokens, while the latter only depends on algorithm and smart contract.

Emily: I remember Lily told me collaterals are backup asset, but what is a “smart contract?”

Joy: A smart contract is like other contracts with one exception: It does not require an intermediary or a third party because it can execute itself when certain specified conditions are met. Think of them as “If – Then” automatic contracts.

Kimberly: So if a stablecoin’s exchange rate moves away from 1:1, then the contract will automatically trigger open market operations to move it back to the pegged rate.

Joy: That’s the case for collateralized stablecoins. A few things to keep in mind. First of all, keeping a peg requires resources. If you are pegging to Euro, you need to have sufficient amount of Euro in reserve, ready for backing up to keep the peg.

Greg: The same is true for crypto-collateralized stablecoins. Say you want to have $1,000 worth of stablecoins, the smart contract will ask you to deposit $2,000 worth of Ethereum as the collateral. That amount will be locked up before the $1,000 stablecoin is created or “minted.”

Joy: The second condition in a stablecoin smart contract is that you can choose to peg a single currency or a basket of currencies like the Euro, Japanese Yen and the dollar. Pegging to several currencies is generally better than pegging to a single currency because more currencies mean less price movement. The idea is the same as investing in more stocks is safer than pouring all the money into one stock.

Greg: A country can also have a “soft peg,” which allows the exchange rate to stay in a limited range rather than an exact point.

Kimberly: So Hong Kong may choose a pegged rate not exactly one dollar buying 8 Hong Kong dollars, but perhaps one dollar buying between 7:85 and 8:15 Hong Kong dollars.

Joy: That’s right. Finally, pegging can be done not just to currencies but commodities like gold, precious metals, bonds, commercial papers or even real estates.

Emily: Is commercial paper some kind of newspaper?

Joy: No, it is a type of “I Owe You” note issued by a corporation to borrow money from investors and usually will be paid back within 270 days maximum.

Greg: I’ll add one more note regarding collateralized stablecoins: Cointelegraph.com reported last year that the Office of the Comptroller of the Currency, or OCC, allowed national banks to run independent nodes for distributed ledger networks like blockchain.

Joy: Yeah I remember that report as well. The OCC essentially says banks should treat blockchains the same as other legitimate global financial networks like SWIFT and ACH.

Greg: The government formally promised to have collateralized stablecoin backed up with its full faith and credit.

Emily: What about the non-collateralized stablecoins?

Greg: That’s a different story. Let’s talk about it next time.