DeFi Insurance Overview
DeFi seems to be the better alternative, but it’s not completely safe as we’ve seen with recent hacks. Let’s take a quick look at your protection options when it comes to DeFi Insurance
FTX has made us lose trust in CEXs in general. DeFi seems to be the better alternative, but it’s not completely safe as we’ve seen with recent hacks. Let’s take a quick look at your protection options when it comes to DeFi Insurance.
The possibility of hacks and exploits leading to the loss of assets locked in smart contracts on nascent protocols has emerged as a formidable concern for DeFi. We need a decentralized intervention system to bring DeFi closer to TradFi in terms of consumer protection.
How does DeFi insurance work?
Insurance in DeFi is essentially nothing different from regular insurance. It simply focuses on protecting yourself against losses due to unforeseen events.
In Essence: a group of liquidity providers contributes capital to a decentralized pool of funds that provides coverage to DeFi users in the event of losses. The underwriters or liquidity providers receive insurance premiums as a reward for their stake in the pool.
Through a DeFi insurance provider, users pay a specific amount to obtain coverage for the loss of their assets on a platform. The premium you pay depends on several factors, including the coverage type, provider, and duration.
Instead of purchasing coverage from one specific individual or company, you can buy coverage from a decentralized pool of insurance providers. Any individual or company can function as an insurance provider by locking up capital in the decentralized capital pool.
Liquidity providers, also called underwriters, serve as the primary agents in DeFi insurance protocols. They are incentivized to provide capital to these pools for a share of the premiums.
Governance token holders and claims assessors are those who take on the responsibility for voting on claims and modifications to the protocol. Then there are the claimants who purchase the insurance premiums. Who has the authority to determine the validity of a claim?
In most cases, the community does, through a DAO structure. Native token holders get governance rights in the insurance protocol and participate in voting for claims verification.
🔥 Pros and Cons of Decentralized Insurance
- Improved claims processing
- Smart Contracts
- Reduced insurance fraud
- Ambiguity regarding DeFi risks
- DeFi protocol exploits and smart contract bugs are costly
- Regulatory uncertainty
DeFi Insurance Protocols
- InsurAce - globally decentralized protocol that allows users to purchase mutual protection for their digital assets against losses from hacking, smart contract bugs, stablecoin de-peg, or other digital asset-related risks
- Nexus Mutual - members can buy cover to protect against material losses when transferring funds into a protocol’s smart contract or keeping funds with a custodian
DeFi insurance still needs to develop to cover technical and economic risks to users (technical = exploits and hacks, economic = impermanent loss, slippage in AMMs, lending liquidations, and stablecoins depegging).
If insurance protocols can develop to cover both of these, it’ll significantly widen coverage, and likely draw more people to DeFi. It’ll give users a way to mitigate risk when partaking in different protocols, especially new ones.
Here's a deep dive from Three Sigma on the DeFi insurance landscape with numerous projects evaluated in depth:
1/5 In the crypto industry, DeFi insurance represents a massive growth opportunity, accounting for less than 1% of DeFi’s TVL.
Our most recent research piece provides a comprehensive overview of the DeFi insurance landscape.
— Three Sigma (@threesigma_xyz)
Oct 31, 2022
🔥 In Conclusion
The growing complexity and variety of hacks and exploits in the DeFi space highlight the immediate need for decentralized insurance. DeFi insurance can also be a massive force in fields like property insurance, travel insurance, and title insurance.
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