In search of a better DeFi Insurance Protocol
Few days ago, on 31 Aug 2021, Cream Finance was exploited for over 34 million USD, this once again reminds us of the risk in DeFi.
Risks are inevitable, in traditional finance, people purchase insurance products to cope with the uncertainties, and in crypto: DeFi insurance. Unlike traditional insurance, DeFi insurance does not rely on a central agency, a pool is commonly used in these protocols for users to deposit assets and play the insureds and insurers.
In this article, we would like to introduce several existing DeFi insurance protocols, their mechanism, features and weaknesses.
Nexus Mutual
Nexus Mutual is a peer-to-peer mutual built on Ethereum, the protocol is established as a limited company in UK and have been received approval by the Financial Conduct Authority. To become either an insurer or an insured, user have to first obtain a membership of the platform by paying membership fee of 0.002 ETH and passing the KYC (Know Your Customer) check, 17 countries are currently restricted from using the protocol, including China, Japan and South Korea.
Simply speaking, the structure of the protocol can be classified into three parts: insurer vaults (capital provision), insured vaults (cover products), and claims governance. The model of the protocol is built on top of its internal token, NXM. After becoming a member and swapping ETH for NXM, users can participate in the risk assessment and become a Risk Assessors (insurers), in which they can audit and stake NXM into the vault of the specific protocol / contract that they believe are well-coded and secure, stakers earn NXM as reward when the cover is purchased. For members who would like to purchase a cover, they could pick the product of the protocol their assets are on and pay for the cover in ETH or NXM, 90% of the NXM used in the purchase will be burnt and the remaining is locked and be used as deposit when submitting claims.
When a claim is submitted by an insured, a claims assessment is required to determine whether the claim is fully legitimate. The claim is based on a community model, users can stake an amount of NXM for a certain period and become a claims assessor and earn NXM when voting for the assessment, the voting power and rewards are proportional to the stake. A claim is approved when passing the consensus threshold of >70% consensus. Staked assets in the pool are used to pay for the approved claims. The advisory board has the power to burn an assessor’s stake when acting dishonestly.
While the mechanism seems ideal, some problems come with the design. First, to access the protocol, users have to pay for member fees and pass the KYC check, this lowers the degree of decentralization and increases the threshold of using the protocol. Apart from this, the business scope of the protocol is also limited when only focusing on security risk and ignoring other possible risk in DeFi. On top of this, the claims governance is based on a community voting model, which could be time consuming (~72 hours) and disputable. Another issue comes with the liquidity of the cover, these existing products are not transferable and lack of a secondary market. These could be possible concerns for developers of future DeFi insurance protocols.
Helmet
Helmet is a peer-to-peer insurance protocol built on BSC on the option trading logic. Unlike Nexus Mutual or other DeFi insurance products, Helmet is not providing covers for security such as hackers’ attack, instead, it tries to protect insureds against price fluctuations. To put it simply, hedging investment risk. In the following, we will use CAKE as the underlying asset and BNB as the denominated asset.
There are two types of policies on Helmet: Cover Miss Out and Cover 50% Off. The former is a policy that the policy price is double of current price on the underlying asset (CAKE) against denominated asset (BNB) and the latter has a policy price of half the current price, similar to the concept of call options and put options.
The structure of Helmet is fundamentally different from Nexus Mutual: instead of having a pool of a specific protocol for all insurers to deposit, insurers can supply their own cover product (insurance policy) for certain pair (CAKE/BNB), deciding the policy’s DPR (daily percentage rate) and max quantity they could supply. Insurers will then have to stake stated amount of denominated asset (CAKE when supplying CAKE/BNB Cover Miss Out and BNB when supplying CAKE/BNB Cover 50% Off, BNB in our example) to publish and receive SHORT token in return. For participants who would like to hedge price loss, they could simply buy a policy on the platform with HELMET and in return they would receive LONG token and become insureds. Insurers will receive the HELMET from insureds instantly when they purchase the policy.
The claiming operation of the is rather intuitive. Similar to American options, insured can activate the policy any time before the expiration when the condition is satisfied and send required amount of underlying asset (CAKE) to the contract, the underlying assets will directly send to the insurer and the respective amount of the insurer’s staked denominated asset (BNB) will be sent to the insured instantly. If the insured do not claim the policy before expiration, the insurer can withdraw the policy.
While Helmet provides a satisfactory solution for investors to hedge the investment risk, there are still quite a lot of rooms for improvements for the protocol. Same as Nexus Mutual, the business scope of Helmet is limited and focuses only on the investment risk, this limited the users’ choice. Another problem is that Helmet is providing an option-like insurance but there is no marketplace and enough liquidity for the product to trade on secondary market, which again limited the possibility of the project.
Yinsure.Finance
Yinsure.Finance is a kind of CDS(credit default swap) built on blockchain, it has similar structure with Nexus Mutual, which has insurer vaults, insured vaults and claim governance. The first insurer’s treasury is the yiUSDC library. Users deposit USDC and get yiUSDC. Deposit USDC in the treasury and become a registered insurer. What are the benefits of becoming a guarantor? It can cover the start-up costs and the weekly expenses paid by the insured. Similarly, the insured deposits the insured funds into the “Insured’s Treasury” to become an insured and obtain insurance services. For example, if the user wants to insure his CRV assets, then the user deposits it in the insured’s fund library, and generates yiCRV after depositing it. When depositing in the “Insured’s Funds”, a 0.1% start-up fee is required, and at the same time, 0.01% of the fee will be deducted every week.
If a claim event occurs, a claim governance is required. In the above example, the insured filed a claim by pledge yiCRV. Insurers use their yiUSDC to vote. During the 3-day voting period, 33% approved it and 25% rejected it. Assuming that the claim is approved, then yiCRV will be allocated to the insurer of yiUSDC, and USDC will be paid to the insured. The design of this mechanism is relatively flexible. It can insure various assets, which can be basic assets (DAI) or compound assets (yDAI) per month. Insurers can obtain insurance start-up costs and weekly costs, and they are also responsible for claims management. If the insurer refuses to make a valid claim, the insured will move its funds out. This means the insurer is not profitable. While there are two main differences, one is yinsure.finance removed KYC restriction, aimed to expand its market size, the other is where CDS comes. CDS is one of the most basic credit derivatives contract. The protection buyer pays a periodical fee or a premium to the protection seller who is willing to take risks within the contract period; the protection seller accepts the fee and promises During the contract period, when the corresponding default event occurs, protection buyer will be compensated for the loss of the default. Through credit default swaps, both parties in the transaction successfully realized the transfer, conversion and reorganization of credit risks. So in yinsure.finance, every insurance policy is minted as an NFT, which can be traded on secondary markets like Opensea and Rarible. Yinsure NFT has 1,400 items with 5,200 ETH trading volume on Opensea after launching one month.
Here comes several problems about insurance, one is on-chain asset insurance has a relatively small market, just like in traditional financial markets, the best way to protected your asset is hedging. In real world, insurance are mostly medical insurance, pension and other insurances with very complicated compensation standards. Another problem is with endless DeFi protocol emerging, the insurance cannot be updated quickly, which causes inactive insurance agreement interaction. Introducing real-world insurance categories, paying lower friction costs through blockchain, and judging the payment conditions through the governance mechanism is the future path of on-chain insurance.
