The Decentralized Finance (DeFi) space, though largely nascent, is witnessing exponential growth. DeFi has made laudable achievements in eliminating centralization, increasing financial inclusion, and optimizing operational efficiency.
Despite its impressive growth and numerous advantages, DeFi, like many other ecosystems in the blockchain industry, is constantly battling hackers and system breaches. Users are constantly on the lookout for advanced strategies to safeguard their cryptocurrency assets. DeFi companies are also at the heart of the quest for solutions to mitigate the risks associated with the operations of their smart contracts.
The factors mentioned above prompted the need for decentralized insurance, as an insurance system that hedges the risks of losing assets to hackers is essential for crypto users and platforms.
This article comprehensively examines the concept of decentralized insurance, arming you with the extensive knowledge required to navigate the sector.
What is DeFi Insurance?
The growing demand for Staking, Lending, Automated Market Makers, and other DeFi services consequently increased the need for DeFi protocols. Hackers typically hunt for loopholes in the smart contracts of DeFi protocols, which they ultimately exploit to cart away substantial assets. DeFi protocols are actively exploring ways to hedge their risks, and DeFi Insurance is a product of this endeavor.
DeFi insurance is the process of obtaining insurance coverage against losses in the decentralized finance space for oneself or a DeFi protocol.
Users whose assets are locked on a DeFi protocol, such as an Automated Market Maker, may lose their crypto holdings if the platform is compromised. Individuals can choose to insure their funds against hacking-related losses, or the DeFi protocol can subscribe to the coverage, shielding its users from the risks associated with cyberattacks.
Typically, the coverage dictates the risks that it covers. It could be a smart contract attack, exchange hacks, stablecoin price decline, and so on.
If the predefined event occurs, the insurance is triggered, and the user or DeFi protocol is compensated.
The premiums charged by decentralized insurance companies vary depending on the type of coverage and its duration.
Types of Decentralized Insurance
Different DeFi insurance platforms provide their users with a variety of use cases. Some allow crypto enthusiasts to obtain insurance to protect their assets, while others may limit their services to DeFi protocols only. Before selecting any package, it is advisable to read the fine print to comprehend the terms and conditions.
Typically, the fine print states when the insurance will be triggered, the claim process, and actions that may void the insurance coverage.
As previously stated, there are various forms of coverage that a crypto enthusiast or DeFi protocol can obtain, and these will be described further below.
Crypto Wallet Insurance
Hackers are constantly looking for new ways to get unauthorized access to people’s cryptocurrency wallets. They devise various phishing strategies that operate via emails or social media, attempting to persuade victims to reveal their log-in information or seed words. Some decentralized insurance companies provide insurance coverage that focuses on mitigating the risks associated with the theft of crypto assets in a wallet. Etherisc is a good example.
Many decentralized insurance platforms do not provide this particular insurance package for reasons best known to them. Most of them focus on DeFi protocols rather than the average crypto enthusiast.
Smart Contract Cover
This is one of the common insurance coverages available in the DeFi space. Many decentralized insurance platforms such as Nexus Mutual offer this type of coverage. Nexus Mutual, for example, markets itself as an insurance alternative scheme rather than a standard insurance platform. Using this protocol does not confer the contract of insurance on Nexus Mutual.
Smart contract cover indicates that if the exploitation of a platform is linked to an issue with their smart contract address, the insurance platform may be required to cover the losses to a certain extent based on the terms and conditions.
A smart contract attack is one of the ways that people lose funds, and in some cases, it can be permanent. One of the risks that crypto users have to face when they use a DeFi protocol is the risk that the smart contract will be exploited by hackers.
When a DeFi protocol has smart contract coverage, it encourages more investors to use its services as they are reassured that they can access their funds even when an attack occurs.
Crypto lending is an important aspect of the DeFi space. Lenders typically offer their spare crypto holdings to the protocol to earn returns for a set period. Borrowers are given these funds for a set period with the obligation to pay interest. They must first deposit collateral before they can access the crypto loans.
The collateral may be taken or liquidated due to various reasons, including the volatility of the cryptocurrency market.
Benefits of Decentralized Insurance
With the risks associated with the crypto ecosystem, such as volatility and hacks, users and DeFi protocols can benefit from decentralized insurance. The following are some advantages of decentralized insurance.
• Crypto volatility protection
Purchasing crypto-insurance could help mitigate the risks associated with cryptocurrency volatility. With the level of volatility in the crypto market, it is crucial to protect one’s investments against extreme price swings.
• Hack protection
When users subscribe to an insurance policy that provides hack protection, they may be reimbursed if a hack occurs on that platform. The reimbursement is subject to the terms and conditions of the policy.
DeFi protocols that also benefit from the hack protection coverage receive aid from the decentralized insurance protocol when their architecture is compromised and they lose funds in the process.
• Claim payout
Depending on the type of decentralized insurance coverage employed, the claim payout may be instant, meaning that the person or protocol is paid out immediately after an attack occurs. If it is a parametric insurance platform, it pays out instantly once the conditions, as specified by the oracles feeding the smart contract, are met.
In other circumstances, such as Nexus Mutual, community members must evaluate filed claims and decide whether or not to issue a payment. Nexus Mutual is a community-centric insurance alternative platform that allows community members to choose whether or not to pay.
• Crypto wallet hacks
One advantage of decentralized insurance is that it adds an extra layer of security to users’ crypto wallets. They can rest assured that if a hack occurs and they lose their crypto holdings, they will be compensated to some extent.
What is the Claims Verification Process?
The verification process commences once claims are submitted. Typically, the community approves of the verification via a Decentralized Autonomous Organization (DAO) structure.
Following the submission of the claim conditions to the community, holders of the decentralized insurance platform’s native token begin the voting process. They can choose to accept or reject the claims. Voting may be incentivized for participants.
In some circumstances, the claims are verified by an automated system that interacts with oracles that feed it with data.
Some DeFi Insurance Providers
Some popular DeFi insurance protocols include:
- Decentralized insurance originated as a result of the need to hedge risks in the DeFi space.
- Some of these DeFi coverages are designed for individual users or DeFi protocols.
- Smart contract coverage, crypto wallet protection, and collateralized loan protection are all common DeFi insurance packages.
- When choosing a DeFi insurance protocol, it is important to study the terms and circumstances, especially the fine print.