In the last few years, the DeFi space has seen explosive growth. According to the latest data, the total value locked in DeFi protocols now stands at a whopping $197 billion — up from under $1 billion just two years ago.
This growth can be attributed to a number of factors, including the rise in popularity of Ethereum, the launch of dozens of additional layer-1 and layer-2 blockchains, the release of a huge number of popular DeFi protocols, and the influx of new users alongside an extraordinary bull market for the cryptocurrency sector.
By providing a huge range of new opportunities for cryptocurrency users, including increased access to financial services, improved transparency and security, reduced counterparty risk, and dozens of new ways to speculate and invest.
But this growth hasn’t been without its drawbacks. As DeFi has exploded in popularity among users, it has also become a hotspot for hackers, who have set their sights on the ballooning sums held in the coffers of DeFi protocols. Indeed, a whopping ~$7 billion was stolen from DeFi protocols in 2021 alone, and 2022 isn’t shaping up much better. And being decentralized, unregulated platforms, those affected by hacks typically have no legal recourse and almost no chance of getting their money back.
To help tackle this challenge and make DeFi more sustainable, attractive, and resilient, a range of blockchain-based insurance protocols are now available, and they’re seeing similar extraordinary growth.
What is DeFi Insurance?
DeFi insurance is a type of insurance that is designed to protect against losses that may occur due to the use of decentralized financial protocols and platforms. This insurance can be purchased by the users of these protocols and platforms and can help to cover the cost of losses that can occur due to hacks, attacks, or other unforeseen events.
DeFi insurance providers are similar to traditional insurance providers in that they offer a range of different coverage plans, allowing users to take out protection against one or more possible threats to their finances. This can range from coverage against hacks and exploits to stablecoin de-peg insurance, protection against rug-pulls and insider theft, economic risks like oracle attacks, governance attacks, and more.
Some platforms will also offer combined plans, which can protect against multiple risks in a single package — a good example being Unlashed’s Anchor + UST Peg coverage plan — which protects users’ funds saved using Anchor Protocol and against the possibility of the UST stablecoin losing its $1 peg. In many cases, combined insurance products like this are cheaper than buying individual coverage products separately.
How Does it Work?
Unlike traditional insurance providers, DeFi insurance platforms typically rely on user-contributed liquidity to fund their coverage plans. In this case, users contribute their funds to a pool and share the risk of any active coverage policies — earning a yield in return. Since most platforms use this system, there might not always be enough liquidity to provide coverage, in which case users will need to wait for space to open up or for the capacity to increase.
These platforms typically leverage a system of smart contracts to automatically track the amount of coverage capacity available, set the pricing for end-users, and both determine and distribute rewards to insurance risk underwriters. The pricing of each insurance product is usually set based on either supply and demand (e.g. the amount of coverage needed vs the amount supplied) and/or based on the perceived risk of the platform — typically taking into account its reputation, security, novelty, and history.
Depending on the platform, the insurance premium might be paid in the same asset that the user wishes to protect, or in a specific cryptocurrency — most commonly Ether (ETH).
Just like traditional insurance plans, DeFi coverage plans are almost always subject to a range of exclusions, clauses, and provisos which can either work for or (more often than not) against the user depending on the circumstances. Because of this, it’s important to carefully read the full cover policy before purchasing a plan — since some only provide coverage under extremely restrictive conditions.
When it comes to the claims procedure and review process, each platform has its own process. But most DeFi insurance platforms do not offer guaranteed payment even if a claim is valid since they usually leverage a crowdsourced review process to determine whether claims should be paid or not, given the policy details and the circumstances surrounding the loss. These platforms typically also include a process to ensure claims are judged fairly and may include a secondary review process or arbitration step if there are any disputes.
That said, the vast majority of DeFi insurance platforms tend to avoid the word “insurance” when it comes to describing how their coverage plans work. This may be due to regulatory baggage associated with the term, whereas most DeFi protocols are designed to avoid any kind of regulatory oversight.
To better understand how DeFi insurance works, let’s take a look at the typical process you are likely to go through when purchasing cover and then claiming on it.
- First, you’d need to find an insurance platform that offers the coverage you’re looking for, bearing in mind the premium cost, covered events, and exclusions.
- Once you’ve found a suitable protocol and coverage policy, you may need to sign up and create an account on the platform — this might entail completing KYC.
- You would then select the amount of coverage you need and then pay the insurance premium. This is usually paid as a lump sum, rather than monthly as with traditional insurance providers.
- The policy details will then detail whether the policy kicks in right away or if there is a waiting period. Once the policy is in effect you will then be covered under the terms of the policy and will have the opportunity to raise a claim if you have suffered a loss.
- If you need to make a claim, you then usually need to prove that they have been affected by an incident. You might do this by providing a transaction hash or a wallet address.
- Once you have provided proof, you will need to submit a claim to the platform. It will then be reviewed by either a dedicated claims team, a group of specialized assessors, or in some cases, by other stakeholders (such as the underwriters).
- If the claim is approved, you will receive your payout to a wallet of your choice.
Who Are the Major Players?
The DeFi insurance landscape has expanded considerably over the last few years, and there are now more than a dozen different platforms that offer coverage products for blockchain-based protocols and events.
Let’s take a quick look at some of the major players in the DeFi insurance space today:
- Nexus Mutual: One of the earliest movers in the DeFi coverage industry and widely considered to be one of its most prominent pioneers, Nexus Mutual has been providing coverage against smart contract failures and hacks since May 2019. Built on the Ethereum blockchain, Nexus Mutual allows anybody to become a member and provide assets to the mutual. It currently offers well over 100 different coverage products, with premiums as low as 2.6% per year.
- InsurAce: InsurAce currently offers protection for 140 different protocols across 20 different public chains, making it one of the most comprehensive DeFi insurance platforms around. The platform covers a variety of potential risk events, including smart contract vulnerabilities, IDO event risks, and stablecoin de-peg events, and allows users to underwrite insurance risks by providing their capital in return for I$INSUR token rewards.
- Bridge Mutual: Like most DeFi insurance platforms, Bridge Mutual allows anybody to hop on board as a risk underwriter by providing their capital to the protocol. Bridge Mutual is one of the simpler to use DeFi insurance platforms and features all the common features you’d expect from one of the most popular options — including a wide array of coverage plans and token staking features. It also includes a unique shield mining product that users and projects can use to boost their yields.
These can be broadly compared using the following base metrics:
As the DeFi insurance sector grows in scope and complexity, so too has competition grown between its participants. Indeed, it is now possible to take out coverage against essentially the same range of potential events from multiple different platforms, though each platform will vary in the premium cost and the exact terms of coverage.
This increased competition has also led to improvements in usability and most popular decentralized insurance platforms are relatively simple to use.
Moving the Needle
To help make navigating the expanding insurance landscape more efficient and minimize costs for coverage takers, the first wave of insurance aggregators is beginning to appear. Arguably leading the charge, Bright Union is currently the most popular option, and allows users to search and compare coverage products across a range of coverage providers, and offers access to a unique risk index product to help make earning as an insurer less daunting and potentially more profitable.
The DeFi insurance landscape is also starting to overlap with the traditional insurance space with the advent of platforms like Etherisc. Launched back in 2019, Etherisc immediately began to distinguish itself from other platforms by offering insurance plans for a range of traditional risk cases — such as flight delays, crop insurance, and crypto wallet insurance. Unlike other platforms, Etherisc’s products are fully licensed and compliant, but still remain sold by smart contract similar to competing platforms.
As the needs of users become increasingly complex and the line between traditional and decentralized finance blurs, it is likely that the DeFi insurance landscape will continue ballooning in scope — helping to make participating in DeFi safer for everyone. Nonetheless, as it stands, just 1% of DeFi TVL is currently covered by decentralized insurance plans, indicating the road ahead will likely be lengthy.
About Master Ventures
Master Ventures is a blockchain-focused venture studio helping to build the next generation of blockchain-based Web 3.0 system innovations within the crypto industry. Launched in 2018 by Founder and CEO Kyle Chassé, the company’s ethos can best be summarized in the acronym #BeBOLD: Benevolent, Open, Love, Decentralized.
Master Ventures co-creates with entrepreneurs and businesses worldwide to turn the best ideas into innovative and disruptive products. They do this by investing as strategic partners through offering advisory services to the projects they believe in. To date, Master Ventures has invested in over 40 crypto projects, including the likes of Kraken, Coinbase, Bitfinex, Reef, DAO Maker, Mantra DAO, Thorchain, and Elrond.
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