Nexus Mutual and Defensibility in Cryptonative Insurance
Risk sharing is a cornerstone of well-functioning economies. It improves the efficiency, scalability, and stability of financial markets, and grows economies by enabling new ventures to emerge.
Risk sharing is a massive market. The credit default swaps (CDS) market is at $2.6 trillion, making up 87% of the total credit derivatives market. With DeFi TVL at $70B and decentralised insurance TVL at $800M, there is ample room to grow. Insurance is the next primitive to unlock crypto’s broader retail and institutional adoption, and is an industry ripe for disruption by token networks.
Nexus Mutual is the world’s leading cryptonative insurance solution. Having launched with smart contract coverage in 2019, Nexus has expanded its product suite across DeFi protocols, custodial services, and cryptoassets. With the largest capital pool in the decentralized insurance sector, a scalable, risk-agnostic claims and risk assessment process, and unforkable track record, Nexus Mutual is on a trajectory to become the generalized risk protocol for crypto and beyond.
Mutuals have been a popular form of risk sharing since 1752 and currently serve over 900 million policyholders. Unlike insurance stock companies, mutuals are owned by policyholders (members) and distribute any profits from premiums and investments to members via dividends or a reduction in premiums.
Nexus Mutual is the world’s first cryptonative mutual. Cryptonative mutuals represent its membership rights through a token. The mutual underwrites risk using a shared capital pool, and tokens are redeemable for the pool’s assets. Like traditional mutuals, members (token holders) own the mutual and have sole discretion in its governance and claims decisions. In contrast to traditional mutuals, a crypto mutuals have fast access to capital, thanks to open markets on the public blockchain.
Tokenization gives insurance mutuals the best of both worlds: capital access without sacrificing policyholder interests.
A crypto mutual becomes highly defensible as it grows its capital pool and risk diversity. By having the largest capital pool and most diversified risk portfolio, Nexus Mutual can:
- Spread risk using a common capital pool that can be under-collateralized in relation to active cover amount. Under-collateralization is not possible for prediction markets- or derivatives-based insurance alternatives, where each market needs to be able to pay out by itself.
- Increase its leverage factor as it diversifies risk. As each new risk plugs into the existing capital pool, the mutual can diversify risk quicker than alternatives based on two-sided markets. Risk diversification is a key factor in the protocol’s defensibility, as higher leverage allows it to offer more competitive premiums.
- Serve as the primary risk carrier and capital coordination platform on which distributors can create tailored products for different market niches. Distributors can own risk and claims assessment for their respective products, allowing the mutual to scale risk-agnostically in contrast to solutions that automate claims assessments, where the types of risk that can be underwritten is limited by what scenarios can be captured in code.
- Scale the capital pool as needed and programmatically balance capital efficiency with carried risk. Nexus’ protocol token (NXM) captures value as the mutual underwrites more risk — giving policyholders, capital providers, stakers, and claims assessors vested interest in the mutual’s success.
As the first mover in cryptonative insurance, Nexus Mutual has established a moat through several factors.
First, its capital pool is by far the largest among decentralised insurance alternatives, making the platform most capable of accommodating growing demand for cover across DeFi protocols, assets, and custodian services. Nexus Mutual’s capital pool grew from $3M in May 2020 to over $600M in 2021 and outstanding covers grew from $3M to over $1B in the same time period. Note that liquidity scales the platform superlinearly. With more liquidity, not only does the platform grow its capacity and attract more distributors with underwriting authority (Managing General Agents), but also take on entirely new types of risk.
The mutual’s risk is currently spread across 70+ protocols, 10+ custody providers, and 5 yield assets. Diversified liabilities increase the mutual’s robustness against multiple “deep out of the money” events happening at once, allowing it to take on more leverage (using $1 of capital to underwrite >$1 of risk) [1]. The mutual can therefore offer more competitive premiums than new entrants with less diversified risk portfolios even if those entrants manage to attract liquidity.
Lastly, the mutual has established a promising track record of successful claims payouts against some of the industry’s highest-profile exploits, with members coming together to share their opinions and expertise around each event. Each time the platform demonstrates its ability to pay out, it strengthens a brand moat that, unlike code, cannot be forked.
These factors have set up a flywheel for organic growth and network value that is captured by the NXM token.
Protocol Overview
Nexus Mutual is designed to be maximally demand-responsive, risk-agnostic, and capital efficient.
Market-driven Risk Assessment
The mutual uses staking mechanics to price its cover products. When cover is sold for a protocol, its stakers earn a proportional share of the revenue. If a successful claim is made on a protocol, its stakers get proportionally slashed. The more NXM staked on a risk, the lower its premium, and the more policies Nexus can underwrite for that risk.
Staking creates a prediction market on protocol risk, incentivizing participants to only back the protocols they deem to be safe. Staking allows Nexus Mutual to enter new markets quickly, as market participants can act as assessors for any type of risk.
Community-driven Claims Assessment
Nexus Mutual employs stake-weighted voting on claims. If voting reaches a 70% quorum, the cover amount is paid to the claimant, else the claim escalates to a full member vote.
While some decentralised insurance alternatives have opted to automate claims assessment, this ultimately narrows the viable product set (i.e. what risks can be covered). There are nuances that cannot be fully programmatically captured even with smart contract risk alone, and thus the majority of claims will rely on manual interpretation. [2]
Stake-weighted voting allows the mutual to scale risk-agnostically, leaving claims decisions to the discretion of stakeholders intimately knowledgeable about the situation.
Capital Efficiency and Value Capture
NXM tokens represent membership rights in the mutual. Members use NXM to purchase cover, stake on risks, and vote on claims as well as other governance parameters. The mutual balances capital efficiency with carried risk using a Continuous Token Model. NXM price is a function of the MCR%: the ratio between total value of assets in the capital pool and the minimum amount of funds it needs to be confident it can pay all claims (Minimum Capital Requirement).
If capital enters the pool (via NXM purchase) without NXM being burned (via cover purchase), the token price goes up exponentially fast, discouraging unnecessary capital lockup that does not reflect true demand for cover. As the mutual writes more policies, the MCR increases to account for outstanding covers and dampens the increase in token price, attracting more capital to the pool while keeping the token price tied to actual demand [3].
Since NXM is tied to how much cover the mutual writes, its price is intrinsically driven by long term adoption.
And it’s working. Nexus Mutual has been profitable since mid-2020, with surpluses accruing to NXM holders through token burning from actual adoption (cover purchases) as opposed to short-term incentivized programs.
In addition to generating revenue from premiums, the mutual can also invest its assets in yield-generating opportunities. Returns on these investments will also accrue to the NXM token. In May 2021, members voted to deploy 15,000 ETH of the capital pool into ETH 2.0 staking on Lido Finance. This has already generated the mutual 158 stETH (~$394k) at the time of writing.
Products & The Distributor Ecosystem
For DeFi users, Nexus Mutual currently offers the most comprehensive suite of coverage products including:
- Protocol Cover: protects against smart contract exploits as well as oracle, economic, and governance failures
- Custody Cover: protects against the event that a custodian loses more than 10% of the value of their custodied funds, or if withdrawals from were halted for more than 90 days.
- Yield Token Cover: protects against the event that a yield bearing token de-pegs in value by more than 10%, allowing users to claim up to 90% of the loss by swapping the yield bearing token for a claim payment.
For brokers, Nexus Mutual serves as a risk capital coordination platform on which customised products, underwritten by Nexus, can be created and sold.
In traditional insurance, distributors with delegated authority to underwrite claims on the carrier’s behalf are known as managing general agents (MGAs). Carriers and MGAs form a synergistic relationship. The carrier provides the infrastructure and capacity that enable MGAs to sell more products. The MGA’s underwriting expertise creates products that better meet the market’s needs, expanding the carrier’s reach into profitable niche markets.
For Nexus Mutual, Armor is one such synergistic project. With Nexus Mutual as the primary risk carrier, Armor offers convenience features on policies such as pay-as-you-go coverage, flexible policy parameters, and automated tracking as funds move between protocols. Nexus Mutual receives the full cover payment streamed from Armor, while Armor takes a fee for the flexibility it provides.
Nexus can acquire significant market share by being the most attractive platform for MGA-like distributors as its underwriting capacity grows. Distributors translate to cover purchases, which grow the mutual’s capital pool (capacity) even further. The distributor ecosystem is therefore a crucial component of Nexus Mutual’s growth.
As the industry matures, we anticipate that distributors will own their respective products end to end from design, to cover pricing, to claims assessment. Nexus Mutual becomes a generalized capital coordination infrastructure and primary carrier whose portfolio is only limited by the imagination of entrepreneurs that come to build on top of it.
What’s next for Nexus Mutual
- Growing the Distribution Network. Ease of integration becomes crucial as increased capacity attracts more distributors. Strategic partnerships could place cover as close to the primary product interaction as possible. For example, a lending protocol that gives users the option of depositing into an insured vs. an uninsured vault. Thanks to composability, the insured vault can produce a natively covered, interest-bearing token that trades at a premium to its uninsured counterpart.
- Strengthening Staking Incentives to direct overall capacity toward the risks whose coverage is in highest demand.
- Shield Mining. Work with partners to reward users who stake on their protocol with the respective protocol token (in addition to NXM).
- Delegated staking. Allow users to delegate staking decisions to a more knowledgeable party (e.g. well-respected security researcher) or committee.
- Tokenized staking positions. Allow users to “exit” a stake before the lock-up period ends while retaining actual capital staked, increasing the average capital staked on a protocol.
The team behind Nexus Mutual
Nexus Mutual is led by Hugh Karp, an insurance professional with over 15 years in actuarial experience including 3 years as CFO at Munich RE in the UK. Roxana Danila, previously a Tech Lead at Facebook. Ricky Tan, founder of TokenData and a fintech professional with experience in both institutional finance and early-stage startups.
The protocol was conceptualised in 2017, built through the bear market, and launched its first smart contract products in 2019. Nexus Mutual is now a 8-person core team including 4 engineers. The mutual currently serves over 3,000 members.
Nexus Mutual is looking for technical writers, community ambassadors, and analytic dashboard builders. Head over to Discord to chat about getting cover, or building on Nexus Mutual!
[1] Nexus Mutual’s capital model borrows heavily from European Insurance and Occupational Pensions Authority (EIOPA) Solvency II methodology which is calibrated to withstand events in a year with a 99.5% probability, or, in other words, a 1-in-200 year event.
[2] For example, with the protocol’s first ever set of claims following the bZx flash loan event, initial claims were denied through member voting as cover wording explicitly excludes activity where smart contracts were used as intended. This decision was reversed in light of a postmortem from the bZx team, which revealed a safeguard had been bypassed in the code. Members were able to resubmit their claims, which were voted to pass.
[3] “Deep out of the money” events are those that have low probability, but severe consequences. Examples include natural disasters and DeFi protocol failures. For such events, capital costs become a severe limiting factor if full collateralisation is required as with options- or prediction market-based approaches.
