DeFi and the Future of Insurance

Decentralized finance (DeFi) is gaining momentum. As we have seen in previous blogs, Defi 2.0 is a reality and it’s bringing great applications built upon the first generation of the protocols. New protocols are making possible adding liquidity into the infrastructure layer, which makes the development of the industry healthy and sustainable. Governance and policy rights frameworks are changing as well, empowering more the members of the organization. And we can’t forget to mention that this new technology advancement has increased capital efficiency significantly.

The landscape looks bullish, but we are in crypto, and we can never forget that risk will always be an important factor to consider.

The DeFi community has rarely mentioned insurance in the past, however it’s an industry that has a significant opportunity to provide investors with confidence and protect their assets. Specially, with cases of DeFi hacks becoming increasingly more common recently, investors are realizing the importance of protecting themselves from these potential threats. According to The Block, exploits totaled $680 million in 2021 ($1.44 billion were initially stolen but $760 million have been returned).

Source: The Block Crypto Data

Due to this reality, while it may seem like a boring topic to many DeFi users, the insurance industry and coverage policies can play a fundamental role in its consolidation and future development of DeFi. Insurance is a financial industry that needs methods and strategies to protect companies and investors from risk. Let’s take a closer look at DeFi insurances.

What’s DeFi insurance?

As DeFi users, we are participating in one of the most exciting but riskiest areas of crypto. Yield farming strategies, lending, derivatives and futures have gained much appreciation in the space, however, we need to remind ourselves that the nature of smart contracts and decentralized protocols makes them subject to exploits and hacks (rug pulls, flash loan exploits, and smart contract bugs), occasionally leading to significant losses for investors. Let’s remember, there’s a big human component in audits to detect bugs in the protocols, and of course, they are not always flawless.

No matter how cliche it sounds, “expect the unexpected” can be one of the best pieces of advice for crypto investors, and having said this, decentralized insurance can protect us from the unexpected.

DeFi insurance refers to insuring yourself, or ‘buying coverage’, against losses caused by events in the DeFi industry.

How does DeFi insurance work?

As the name already indicates, the production of Defi insurance is generated in a decentralized infrastructure. While a traditional insurance policy might be issued and underwritten by a multinational, a DeFi insurance policy relies instead on its community of users to dictate premiums and payouts. To get into the mechanics, let’s explore the 4 main components of the ecosystem:

• Coverage Buyers: Either if you’re an individual or a company, if you have capital locked in a protocol and you want to insure yourself against the potential risks, you can pay an amount (premium) to a DeFi insurance provider to get covered based on a specific, predetermined event. As you might expect, the riskier the protocol, the more you have to pay for the safety.

The premium will also depend on different conditions like cover type, duration and provider. As mentioned above, it’s fundamental to understand the type of events that get you covered, they need to be very clear and specific. For example, on Nexus, it costs 0.17 ETH to insure 10 ETH on Curve Finance for 180 days. Ceteris paribus, on Pool Together would cost 2.9 ETH.

Source: Nexus Mutual

• Coverage Suppliers or Underwriters: Anyone can be a coverage provider. They provide and lock capital to provide capital to the pools for each individual protocol covered in the DeFi insurance platform (like becoming a liquidity provider).

As a coverage supplier, you are exposed to risk as your capital can be used to repay the coverage buyers in case a certain condition on the smart contract is triggered (i.e. a hack). As a coverage provider, you choose for which events or protocols you want to provide coverage for. That’s why in order for you to get rewards (share of the premiums or staking) you should be staking on projects you think are secure.

Source: BlockData

• Claims Assessors: How can the protocol decide if a claim is valid? Most DeFi insurance protocols are programmed as DAO (Decentralized Autonomous Organization) structures. So it’s the community that validates the claims. Holding the token associated with the insurance protocol gives you governance rights (meaning you can participate in voting to accept or deny claims)

It’s important to note that claims can be also automatically verified, instead of via community voting. In this case, the smart contract does the operation with the support of oracles.

In summary: instead of “buying coverage” from a single person or company in TradFi, you “buy coverage” from a decentralized pool of coverage providers.

The current decentralized insurance ecosystem

Currently, only 2% of all DeFi value (TVL) is being insured, therefore, there’s a massive gap to be filled and we are certain that more players will enter this industry soon. Let’s check some of DeFi insurance projects with unique value propositions:

• Nexus Mutual: a decentralized insurance platform built on Ethereum. It is considered a pioneer in the field of smart contract insurance. It is run entirely by its members. Having said this, only members can decide which claims are valid. Nexus Mutual currently provides a Yield Token Cover (against yield-bearing token de-pegging), a Protocol Cover (against hacks on a protocol), and a Custody Cover (against halted withdrawals on centralized exchanges. Currently, to become a member, you will need to perform KYC.

Have a look at their tracker to see in real time how covers and claims unfold over time.

• Etherisc: Compared to Nexus, Etherisc isn’t a decentralized insurance company. Rather, it’s a protocol to collectively build insurance products. Common infrastructure, product templates and insurance license-as-a-service makes this platform unique, allowing anyone to create their own insurance products. There’s already a flight delay protection product!
• InsurAce: InsurAce.io is a decentralized multi-chain insurance protocol, to empower the risk protection infrastructure for the DeFi community. InsurAce.io offers portfolio-based insurance products with optimized pricing models to substantially lower the cost; launches insurance investment functions with flexible underwriting mining programs to create sustainable returns for the participants; and provides coverage for cross-chain DeFi projects to benefit the whole ecosystem.

At the time of writing, InsurAce.io has provided coverage to 87+ protocols, safeguarding over $170M DeFi assets on 12+ public chains.

Benefits of smart contracts in today’s insurance industry (TradFi)

Yes, it’s exciting to see the evolution of the DeFi protocols. However, let’s go back for a moment to address the elephant in the room, traditional finance.

Despite the value (multi-trillion dollars globally), the insurance industry has plenty of problems nowadays including inefficiency, fraud, human error and misuse, cyberattacks, information asymmetry, etc. Although we could continue with this list, we can summarize this by detecting the root problem: an overreliance on trust.

In general, there’s evidently a lack of transparency between policyholders and providers that causes doubt in the pricing and value of insurance policies and thus, incentivizes policyholders to game the system, which creates even more bureaucracy and slowdown of the entire workflow.

Blockchain presents a series of characteristics inherent to this type of process: transparency, immutability, traceability, integrity, security, simplicity and quick access to information. Having said this, blockchain can potentially be implanted in areas such as claims, fraud detection, identity recognition, pricing & auto transactions/payments via smart contracts. The tech wouldn’t only solve the problem of transparency and enhance the efficiency of the process, it can also make insurance globally accessible to the underserved people thus enabling financial inclusion on scale.

Blockchain is a disruptive technology that has the ability to increase the efficiency, security, privacy and transparency of the workflows of any industry, but we are certain that the insurance industry has a large space for growth. Just to mention an example, Lemonade combines already distributed ledger technology with artificial intelligence to offer insurance for renters & homeowners at the most competitive prices in the market.

Verso and insurance products

At Verso we are aware of the challenges mentioned above for the whole distribution model of financial services. We believe that scalability and efficiency can be achieved by eliminating intermediaries and the necessity for various counterparty agreements. We are leveraging the power of blockchain and smart contracts to change the rules of the game.

Our marketplace will fill the role as a market layer that connects licensed financial institutions that offer regulated financial products (CeFi) and decentralized finance protocols (DeFi) to consumers, e-wallets, banks & platforms looking to upsell. Our primary focus will be microfinance, and insurance is already shaping to be one of the great pillars of our solution. Having said this, Verso will be ready to facilitate the arrival of new insurance solutions in DeFi and TradFi to a wide range of audiences.

If you would like to see us in action, we just released our Yearly Recap + Product Demo where our product team conducted a beta product demonstration on microinsurance for a flight delay.