The insurance industry is a sector that no one really enjoys interacting with, but is necessary when dealing with areas of considerable risk. Despite security audits in the DeFi sphere becoming more commonplace, there are still high-profile hacks occurring. Just recently, US$600 million worth of cryptocurrency was stolen from the PolyNetwork, a protocol that allows users to swap cryptocurrencies across multiple blockchains. Decentralized insurance for crypto and DeFi products is a way to give users peace of mind when interacting with innovative new applications.
- What does a decentralized insurance protocol cover?
- What are the benefits and challenges?
- Which are the leading companies and how do they insure the DeFi and crypto space?
These are all great questions, and we will attempt to comprehensively answer them in our blog post — so read on!
Decentralized insurance – managing all types of risks
Although insurance for the crypto world will be our focus here, decentralised insurance is providing an alternative to insurable events that have been until recently exclusively managed by traditional, centralized institutions. Etherisc, who formed in 2016, wanted to use blockchain to make insurance for real-world activities more accessible.
In Etherisc’s whitepaper from 2017, they claim that:
The insurance world has devolved into an inefficient, expensive, and ultimately frustrating industry. When customers most need help, they can end up fighting in vain for reimbursement from companies whose profits too often depend on avoiding paying out.
Like other financial mechanisms, insurance is just one area where banks and companies have increasingly stacked the deck, making it harder for certain types of customers to access, while extracting greater profits from the customers who are allowed to participate, often at the expense of their comfort. Any financial industry that can be opaque, slow, and frustrating is ripe for reform through the utilization of blockchain technologies.
Decentralized insurance meets decentralized finance
As DeFi has quickly become a prominent part of the crypto landscape, who better to build robust insurance policies for the sector than people who work with blockchain and are passionate advocates for the industry. As highlighted by Oliver Xie, CEO of InsurAce, a decentralized insurance company can work with smart contract auditing companies to bolster their offerings, benefiting everyone from users to new and established DeFi projects.
Benefits of decentralized insurance
While this is not an exhaustive list, some of the main benefits of decentralized insurance include:
- Easy and more democratized access – Like taking out a loan in a traditional bank, insurance often sees prohibitively higher premiums for some, and that is if they are deemed eligible in the first place. Decentralized insurance does not discriminate, with fair terms for everyone who wants to participate. Some crypto insurance companies such as Cover need no KYC, so your personal data is not tied up in some database to be mined by third parties.
- Automated payouts – As terms and conditions encoded into smart contracts, payouts can be made instantly, based on criteria for an insurable event being met in real-time.
- Broader cover – As discussed above, decentralized insurance can provide cover traditionally offered by centralized institutions (flight delay, medical, natural disasters), as well as insurance for cryptocurrency across centralized and decentralized protocols. This doesn’t just cover hacks and technical risks, but you can get insurance that protects against things such as crypto volatility and flash crashes.
- More innovation – New protocols can launch on the mainnet with greater confidence by purchasing insurance for their product’s smart contract and user funds.
- More growth – Established protocols are still susceptible to attacks, as demonstrated by yearn.finance and SushiSwap. Increasing user confidence by helping to protect their funds is beneficial for the DeFi products themselves, as well as their users.
Challenges of decentralized insurance
Of course, as with any new endeavor in a fast-moving industry, there are inevitable challenges that arise:
- Diverse risks – Covering all the different types of hacks that a DeFi protocol can face is no easy task, and the types of threats are constantly evolving — reentrancy attacks, price oracle manipulations, front-running attacks, and exploits of miscellaneous smart contract vulnerabilities is just a sample of what we are currently seeing.
- Multiple blockchains – DeFi and crypto insurance needs to cover multiple blockchains, as more diverse user offerings become mainstream. DeFi users are interacting with multiple blockchains; Ethereum, Binance Smart Chain, Harmony, Polygon, Solana, Near, and more!
- Greater complexity in the sector – Responding to the increasing complexity of financial products and the interlinking between them is paramount. We recently covered a relatively new DeFi trend called GameFi. With rapid innovation that can seemingly create new sectors overnight, decentralized insurance needs to adapt quickly to be able to provide proper protection.
Decentralized insurance use-cases
Just as in the medical insurance sector, where cover is based on your needs, it is the same with blockchain insurance. Here are some of the main areas that people request coverage for when engaging with decentralized cryptocurrency insurance companies working in DeFi.
#1: Protection against smart contract manipulation
We’ve all seen the headlines. Just one smart contract code vulnerability can result in millions of dollars worth of cryptocurrencies stolen in seconds. Smart contract cover protects a user’s funds in the event that they are misappropriated.
#2: Crypto wallet insurance
Crypto wallets come with much better security than they used to, with at least two-factor authentication now the norm. Despite this, thefts still occur, necessitating the need for comprehensive coverage of a user’s funds through an insured crypto wallet.
#3: Collateral protection on DeFi protocols
DeFi loans offered by the likes of Maker and Aave require over-collateralization, as an insurance policy that a loan will be repaid. If collateral is stolen then the loss of funds and help with repaying the loan can be taken over by an insurance policy.
Decentralized insurance platforms
Some platforms are more established, others have come about relatively recently; here are some of the decentralized insurance protocols that are catching people’s attention.
Etherisc stresses that it is not a decentralized insurance company, but a protocol that allows the collective building of insurance products. Through a common infrastructure and insurance license-as-a-service, anyone can create their own insurance products across any vertical. While only flight delay insurance is available at the moment, the company has received support and grants from the Ethereum and Chainlink foundations, partnering with the latter to deliver crop insurance to Kenya, a project that is in the prototype phase but promises to deliver quick payments to those who need it based on events reported by government agencies.
Geared more towards the DeFi space, Nexus Mutual offers coverage for decentralized exchanges, crypto wallets, smart contracts, and more. It is run by and for its members, giving it a greater sense of community than traditional insurance projects. With a total value locked rising ten-fold in one year, from $50 million to over $500 million, Nexus creates a pool of funds used to settle claims. Risk assessors, policymakers, and claim assessors work as participants within the ecosystem, staking NXM to gain voting rights on the legitimacy of claims. NXM is also used to purchase cover, the price of which can vary depending on how much NXM is staked.
Cover Protocol, a peer-to-peer insurance market, only launched in November 2020. It protects against different bugs and hacks for those trading on Aave, Year, Bancor, Curve, Compound, Balancer, and Uniswap.
There are two native tokens, CLAIM tokens, which are redeemable if an exploit occurs, and NOCLAIM, which are redeemable if no exploit occurs. Insurance policies are highly customizable and can be terminated at any time.
Decentralized insurance is the way forward
Recent hacks have demonstrated that security measures on the creator’s side are not able to cover all the potential risks that occur in the DeFi space. As we show in one of our recent blogs, hackers are using more technical ways to manipulate smart contracts. While there is no 100% guarantee of keeping funds, decentralized insurance acts as a safeguard; were the worst to happen, you have some recourse to your cryptocurrencies in a sector that is still patchily regulated.
DeFi insurance is a key tool encouraging sector growth, as more cautious users can feel greater confidence in the security of their funds, taking advantage of customized agreements, security of personal data and automated payments. Even centralized institutions such as Lloyd’s see the potential of cryptocurrency insurance, partnering with Coincover to offer services fit for 21st century finance.
If you’re looking to create a DeFi solution, benefit from blockchain consulting expertise, hire a dedicated CTO for project, or conduct a smart contract audit, don’t hesitate to contact INC4. We have the specialists and proven track record needed to create a worthwhile blockchain solution that distinguishes itself from competitors.