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AMA Highlights — Nexus Mutual

By Daniel Dal Bello, Director.
January 21, 2021–10 min read.

On Tuesday 19th January, we welcomed Hugh Karp from Nexus Mutual (‘Nexus’) into the Hillrise Group Telegram chat for an AMA. Hugh is the founder of Nexus and an insurance expert.

Nexus is one of the original pioneering names for smart contract cover supporting the growth of the DeFi ecosystem.

While we appreciate that the crypto-markets borrow many of the fundamental componentry and infrastructure of traditional financial markets, insurance is one product category that is undoubtedly greatly underserved.

Insurance is a fundamental building block of a healthy DeFi market and is now becoming a hot topic with many new names building in this arena.

In this post, we have compiled key questions and answers from the event.

Daniel Dal Bello
Hi Hugh, welcome and thanks for joining us today. We’ve been quite heavily involved in assessing the insurance vertical in the industry over the past several months. This all culminated for us in an investment in the insurance world.

Nexus Mutual is really one of the pioneers in the world of smart contract cover and we’re all looking forward to this one!

You have been an actuary and have a lot of experience in corporate insurance, what motivated you to pursue insurance in the blockchain industry?

Raymond Reijnders
Hi Hugh, thank you for joining us today. Looking forward to hearing more about the Nexus Mutual journey and road ahead!

Hugh Karp
I got interested in the tech quite a while ago and it just felt so natural to have a community-based insurance entity running on-chain. It’s where insurance started thousands of years ago.

I got a bit jaded by the big corporate roles and when I heard about Ethereum I decided to start putting it [on-chain insurance] together.

I guess the other aspect is that there is so much waste in the insurance value chain, lots of frictional costs, and a fully automated provider could strip a lot of that away, and pass the benefits back to members rather than shareholders.

Daniel Dal Bello
I can imagine. So many use cases for blockchain strip out that middleman componentry — makes sense to me.

Hugh Karp
Yeah, it’s a big aspect, and there is also the chance to better align interests using a mutual model rather than shareholder model.

Daniel Dal Bello
With growing ‘TVL’ and other metrics in the DeFi ecosystem now in 2021, what is your outlook for the future of the insurance market in blockchain?

It feels conservative to say that less than 5% of value in DeFi is insured.

To build on this, do you think there will be a time where one or few protocols dominate the insurance market in an oligopolistic-type scenario? Or is there room for many, all with different strengths and models?

Hugh Karp
Insurance models work best at scale, capital efficiency is key, so I suspect it will be mostly dominated by a few larger players but there will always be room for new approaches etc, that’s one of the fascinating aspects of DeFi, very quick experimentation.

Insurance models work best at scale, capital efficiency is key, so I suspect it will be mostly dominated by a few larger players but there will always be room for new approaches.

On the TVL, and percentage covered, TVL is growing massively and there is such a low percentage covered right now, so the opportunity just within DeFi is really quite large. I’m not sure where it’s going to end up, but we haven’t really started yet.

Raymond Reijnders
While NXM’s model requiring KYC has been criticized by many in DeFi for privacy reasons, it has enabled “CeDeFi” cover as well as the recent exchange cover models. It seems clear that NXM is geared well towards developing product-market fit among the influx of institutions in blockchain.

Do you think that they will resist using NXM for the time being, seeking to develop their own solutions to hedge custodial risk? How do you think it will eventually play out?

Hugh Karp
We don’t actually need KYC for providing cover against CEX and crypto-lenders like Celsius, BlockFi etc, we need it for other regulatory reasons.

Right now institutions don’t have many other options.

Cover from the traditional insurers is very thin on the ground and hard to access. You likely have to deal with Bermuda or Lloyds via specialist brokers.

So, we’re really addressing a market gap, and some institutions are actually more comfortable that KYC exists.

Raymond Reijnders
Are you able to talk more about the regulatory reasons behind this?

Hugh Karp
Nexus Mutual is actually a company in the UK, it’s like a DAO with a legal wrapper. We did this because it gave regulatory clarity as we are just following an existing mutual model that exists in the real world today (even though we’re automating everything with smart contracts).

Because it’s a company we need to know who the members are and we have to block certain jurisdictions, so we need to have KYC to enforce this.

There is the possibility of removing the legal wrapper and therefore KYC in the future if the members wish to do so.

Raymond Reijnders
I can imagine. Would also be very curious to know to what extent you feel blockchain-enabled insurance is applicable in areas outside the crypto-context. Where there are slow, bureaucratic and expensive traditional insurers making a lot from these inefficiencies you’ve mentioned.

Hugh Karp
I see a huge opportunity here and it’s what we are building for in the much longer term — in particular, underserved markets.

We’re unlikely to go into for example, US Auto, for a whole range of reasons, but underserved communities — earthquake cover in Mexico, hurricane in Puerto Rico, marijuana growers in Canada, that’s where a mutual model can really shine.

@RebelOfBabylon
Has any custodial wallet expressed interest in becoming a member of the mutual and backing themselves?

Or, alternatively offer some form of shield mining?

Daniel Dal Bello
To build on this, how successful have the Shield Mining programs been so far and how do you foresee them evolving in the future in a multi-year time frame?

What are your thoughts on insurance aggregators such as ArmorFi?

Hugh Karp
We’re having discussions with various providers on these topics, but it’s fair to say we’ve just started as custody cover was only launched recently.

Shield mining has been working really well, especially with bootstrapping new cover markets, and it’s been very sticky in terms of capacity still available after the program ends. I’m sure the programs will evolve slightly but the general approach has been working really well, and feedback from the communities has been very positive.

On Armor.fi and aggregators, I see this as a natural evolution of the market, and it’s what we expected. We actually want 90%+ of covers to be purchased outside the Nexus Mutual app, that’s where things will work best.

Insurance is a whole range of different functions, underwriting/pricing, claims assessment, capital management, investment management, as well as distribution and sales. Nexus will work best focusing on the capital coordination and core insurance functions and enable distribution/sales to be built easily on top by experts in a particular niche.

Nexus will work best focusing on the capital coordination and core insurance functions and enable distribution/sales to be built easily on top by experts in a particular niche.

Raymond Reijnders
With the exponential growth in interest in this space and competition employing a variety of cover models, how is the NXM team expanding to meet these new challenges?

Furthermore, we all know how important the community is given the need for governance proposals and votes on these proposals. How has the community grown and what trends do you see? E.g. the growing number of small players participating or only large players making suggestions/proposals.

Hugh Karp
We’ve been growing the core team over the past 4–5 months, but also, over the holidays the mutual agreed to set-up a community fund, which will be used for a variety of things, but including grants, potentially employing more people, additional rewards, a whole range of things. The general focus will be on providing ownership to the community and pay them for doing actual work. So, lots to look forward to on this front.

I think our participation rates in governance are doing quite well. Participation can always be higher, but we have a range of large and smaller contributors that are continually getting involved. I also really like our Discord group as the conversation is generally very productive and less focused on “numba go up”.

Daniel Dal Bello
My broad understanding of the traditional insurance industry is that underwriters utilize large historical financial and event data sets to build their statistical risk models. Given that exchanges do not disclose financials and how rarely they get hacked, there is little data for the market to work with.

Do you think that the premiums for exchange cover reflect the actual custodial risk behind these exchanges?

Hugh Karp
One of the big theories we’re testing here is that a wisdom of the crowds approach to pricing can give us a good enough result. We won’t know the answer for several years but intuitively most of the rates feel reasonable to me.

I also know they are comparative to existing TradFi insurance rates, so that’s a good external data point.

Also, there is nothing preventing a larger staker using a big statistical model and using that to inform their staking decisions on chain. That’s how we see things evolving once we get to scale.

Daniel Dal Bello
Do you think that we are approaching a point where insurance becomes sophisticated and robust enough to enable more far-reaching institutional confidence in the blockchain industry?

Reducing risk sufficiently that larger TradFi entities start taking on more exposure?

Hugh Karp
Institutions have a checklist of compliance and risk items that need to be met before they can enter the space, and insurance is often on that list. So, one of our goals is to help them cross that item off and get close to entering.

Institutions manage other peoples money and therefore are more risk aware as well as having fiduciary responsibilities, so insurance is a natural topic for them to deal with. There is a big opportunity if we get this right

@Benlongstafff
With the reduction of the Nexus Mutual unstaking time from 90 days down to 30 days, has the distribution of cover fees to stakers also changed to ensure there is sufficient reason for stakers to remain staked after they receive the fees from large policies?

Hugh Karp
Nothing else has changed. Lots of the covers are relatively short term, 30 days, so we don’t see that as a massive issue. This is also a temporary situation until we get to staking 3.0 which will be a lot more fluid with respect to lock-ups.

Daniel Dal Bello
As a more established player in the insurance ‘vertical’ we’re curious to know what you think about upcoming insurance protocols? Especially on Polkadot, as there are several that have been coming to the surface over the past 3 months.

Are there any names in particular you like?

Hugh Karp
I haven’t had much of a chance to dive into details, there are quite a few that are looking at it.

I think a key aspect is getting the shared capital pool correct, as that’s fundamental to core insurance economics.

A lot of projects don’t seem to have that right in my opinion.

Raymond Reijnders
Where the Nexus mutual model is relatively static, some of the newer protocols are working on Balancer pool concepts where users have more flexibility when it comes to risk tolerance (as they can potentially choose from several pools with different risk/reward ratios).

Is this something that you have also considered, any pros/cons?

Hugh Karp
I see the benefits, I just don’t think that approach makes sense at scale.

It probably also depends what risks you’re going after in the long run, if you want to cover tail risks (low probably events) then in my opinion you can only do that efficiently with a shared capital pool. If you want to stay niche with higher probability events then it might work.

Raymond Reijnders
I can imagine it also being too complicated for the end-user who isn’t always as educated. That’s where a simpler model does shine in terms of user experience.

Hugh Karp
Agree, also nobody really understand the risks right now, so to then imply that you can tranche them seems very spurious to me.

Daniel Dal Bello
From September 2020, the MCR% fell towards 100% where it sits today and the token’s price followed due to the way the bonding curve works.

Could you explain in simple terms the factors involved? E.g. 90 day lockup for stakers, negative feedback loop.

Further, could you also explain how it might be different moving forward? E.g. due to 30 day lockups, stacked risk cover, ArmorFi.

Hugh Karp
We had massive growth over DeFi summer, a large chunk was temporarily driven by SAFE mining where people were buying cover for mining rewards not for actual use.

So, once that temp demand subsided it lead to people selling NXM into the bonding curve. I guess sentiment moves in cycles.

I don’t know where it will go from here, but we are fully focused on fundamental traction. More cover purchases + enabling investment earnings on the pool will start pushing the MCR% higher, that’s mechanically how the bonding curve works.

Raymond Reijnders
That also brings us to the topic of education, is there anything in particular that Nexus Mutual is doing to reach the ‘less avid’ DeFi user, regular users on Binance etc.?

Hugh Karp
We haven’t done much here so far as we’ve catering to the core DeFi crowd mainly, but with CEX cover and custody cover that’s changing so we’re expanding our footprint and marketing focus.

Daniel Dal Bello
Decentralized claims assessment has a fundamental human element. Whenever something is up for debate It is rare in almost any scenario that there is a unanimous decision.

Staking tokens as a bond against fraud is a sound deterrent at the surface, but how do you balance consequences for fraudulent voting on claim assessment against genuine differences of opinion?

Hugh Karp
That’s where the Advisory Board comes in. The board has the power to burn claims assessor bonds in the case of fraudulent activity (but not decide on claims outcomes).

We’ve done a lot of modelling work here, including attacking the system with AI-trained agents that could bribe each other, and the model held up really well. Of course reality is always more complicated so we need to battle-test this aspect more over time.

Hillrise Group supports ambitious Web3 startups with early-stage venture capital and fundamental research.

Nexus Mutual is a people-powered alternative to smart contract cover.

Connect with Hillrise Group
https://hillrise.group
https://hillrisegroup.medium.com
https://twitter.com/hillrisegroup

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Fundamental research arm of Hillrise Group. We bring simplicity to complex technology.

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Hillrise Group

Hillrise Group

Hillrise Group is a blockchain-native venture capital and consulting firm supporting emerging Web3 startups.

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