Decentralised finance, or DeFi, promises a better financial system without intermediaries, giving the user an increased level of control over their own money. It has given rise to various services in the DeFi ecosystem like crypto lending, crypto derivatives, and commodity future trading. Still, one of the lesser talked about services is DeFi Insurance.
While the industry is growing rapidly, it is a relatively new industry and is exposed to various risks like hacking and protocol exploits. As per elliptic, nearly $10 billion was lost in 2021 alone due to hacking and scams. A capital loss is a major risk that prevents the enterprise-wise adoption of DeFi protocols.
What is DeFi Insurance?
In any industry, risk management is an important activity, and DeFi insurance is emerging as a risk management tool in decentralised finance. The terms DeFi insurance and decentralised insurance are often used interchangeably. When we talk of DeFi insurance, it may refer to the protection of the players in the DeFi space, while decentralised insurance apps can virtually provide any insurance.
How Does DeFi Insurance Work?
Like the other applications, DeFi insurance is also decentralised, you do not buy insurance from a single company or person, but the players in DeFi insure themselves against each other. DeFi Insurance refers to insuring yourself against the losses or buying coverage against the losses in the DeFi events like hacking or a private key compromise. It is suitable for you if you are a participant in the DeFi platform and have capital locked somewhere on the platform. There is a chance that you may lose your capital if the platform is hacked.
To protect yourself against this risk, you may go to a DeFi insurance provider and buy the coverage for the capital loss in case of a specific predetermined event.
Instead of buying insurance from a single company, in DeFi, you buy insurance from a decentralised pool of coverage providers. The premium you pay to buy will depend on the events you want to cover, coverage type, and duration. The insurance buyers need to understand what kind of events you would like to cover, just like in the case of normal insurance. Examples of risk-causing events include DeFi Exchange Hacks, smart contract failures, attacks on DeFi protocols, or crashes in the price of stable coins.
On the other side of the table, there are coverage providers. Anyone, individual, or company can become a coverage provider in DeFi insurance by providing capital to the capital pool that, in turn, is locked up. As a coverage provider, you get to choose the events or DeFi protocols for which you will provide coverage. For example, if you believe that a particular exchange’s chance of getting hacked is minimal, you may decide to provide coverage and deposit the amount in the capital pool. As a coverage provider, you will be exposed to risk and hence get the interest on the amount put in the capital pool.
In the event of a particular exchange getting hacked, the funds in the capital pool will be used to provide relief to aggrieved parties.
The claims are also approved on a decentralised basis by the community itself. DeFi insurance products are mostly set up using a Decentralised Autonomous Organisation (DAO) Structure. In such a structure, holding the DeFi insurance-related tokens give you governance rights, and you can vote on denying or accepting the claims.
Sometimes claims are automatically accepted/rejected through inbuilt mechanisms instead of community voting. These mechanisms that can verify the external data are known as oracles. They can be programmed to accurately capture the outcome of a certain event and distribute the information on the internet. This is an important component of DeFi insurance protocols, as it is universally accepted and reduces the chances of a dispute.
The Road Ahead
The DeFi insurance industry is nascent, with only 2% of the total DeFi assets being covered. However, with the increasing number of transactions in decentralised finance, this is slated to grow soon at a rapid pace.
As the industry grows, the processes, systems, and protocols will evolve and mature, new protocols will come into play, more coverage options being available, and more DeFi value will be insured.
DeFi Insurance Options
Currently, DeFi insurance is available as crypto wallet insurance, smart contract cover, crypto cover, mutuals to replace insurance, and collateral protection for crypto-backed loans.
DeFi insurance providers
Some companies providing the DeFi insurance are listed below in the current scenario. However, as the industry grows, many more companies are expected to join
- Insure DeFi
- Nexus Mutual
The list is not exhaustive. You can do your research and select the providers that suit your requirement.
As the industry matures and more people rely on DeFi for their business and transactions, DeFi insurance is an effective tool to manage the platform’s risk.