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DeFi Insurance and How It Works?

In the wake of the $600 million crypto hack in 2021, decentralized finance (DeFi) came under increased scrutiny. The burgeoning industry offers several advantages over traditional finance, but security has remained a significant concern since the hack.

As a result, more decentralized insurance platforms flood the market. They all promise to protect crypto users from smart contract hacks, losses resulting from centralized exchange failures, and other common ways that users can be victimized (excluding scams or user error).

However, “[insurance] is not perceived as super sexy, but it’s the bedrock upon which everything else rests. Insurance is the lifeblood of any finance business, whether it be banking, international commerce, or anything else in the financial world.

So this article will explore DeFi insurance, and it works? Will it become a mainstay in the industry, or is it simply a Band-Aid for a much larger problem?”

What is DeFi Insurance?

A DeFi Insurance policy protects crypto assets and covers risks according to the coverage agreement. The policy covers investors who lose their funds or crypto-assets due to hacking, cyber-attacks, and other DeFi-related exploits.

Insurance may be obligated to play an even more critical role in the decentralized finance market (DeFi). Investors from the fiat-based financial system are accustomed to insurance. This means that DeFi must also provide a sense of security to gain widespread acceptance.

The DeFi insurance product consists of Crypto Wallet Insurance, Smart Contract Insurance, Cryptocurrency Insurance, Mutual Insurance that replaces auto insurance, and Collateral Protection for Crypto backed loans.

If you have keenly followed the market from 2017 until now, you have seen many examples of exchanges being hacked, like Binance, Okex, Mtgox, or even Kucoin just recently. Hackers can also attack Dapps, as with the DAO hack in 2017 that shook the Ethereum community and led to the hard fork in 2017.

These hacks show that no DeFi entity is safe, and this is where DeFi insurance comes in to provide the safety net that crypto needs. The DeFi Insurance allows insurers to compensate customers for losses caused by hacker attacks while at the same time ensuring sustainable earning potentials for insurers and customers.

How Does DeFi Insurance Work?

The objectives of DeFi insurance are similar to those of traditional insurance. The system protects people and institutions from financial losses caused by fraud, theft, and unanticipated problems with the infrastructure.

However, there are three critical components to any decentralized insurance product, regardless of its implementation.

  • Insurance buyers– They are individuals who want to protect themselves from the risks of participating in crypto or DeFi-related activities. In this instance, they buy the relevant insurance, and should something go wrong; they get compensated according to the contract in the smart contract.
  • Insurers– DeFi insurers believe in the products or systems related to DeFi and are willing to take on the risks should something go wrong. They receive premiums from customers, which they use to cover claims in the event of an incident.
  • Insurance protocol– The party evaluates and issues insurance contracts encoded in smart contracts. Most of these systems are DeFi applications in the insurance field, such as 3F mutual, Nexus mutual, etc.

In the event of a hack, the user files a claim with the insurance provider. The insurance company will then investigate the claim and determine its validity. If it is, the user gets compensation for their losses.

The key to making this work is to have a large pool of users who pay premiums into the system. This way, when there is a claim, there is enough money to cover it.

Is Decentralized Insurance Similar to Decentralized Finance?

Decentralized insurance apps and DeFi insurance are often used interchangeably. Though DeFi insurance explicitly protects financial transactions, investors, and DeFi providers, decentralized insurance apps can offer just about any insurance. People can create their insurance products using the blockchain in a decentralized insurance app.

Etherisc community members, for example, have already used the platform to create hurricane and flight delay insurance products. It is also possible to develop DeFi insurance products using a platform like Etherisc, and several users have done so.

Smart contracts establish the relationship between the insurer and the customer in a decentralized insurance app, whether it covers financial issues, flight delays, or anything else. Smart contracts contain the typical insurance details, such as the coverage and the number of assets the user has put into protection.

The smart contract infrastructure makes a lot more possible as well. A user’s account or wallet can also be credited by automating the payment process. A smart contract could often save an insurance company time, human resources, and money by bypassing much of the claims process.

The Main Decentralized Insurance Providers

Decentralized Insurance products offer complete protection of DeFi deposits, hedge risk against crypto volatility and flash crash, and provide security against the risk of theft and attack on crypto wallets. Investors feel safer because they are protected from all possible DeFi risks, technical and financial risks, thus building trust. So, some of the well known DeFi insurance providers include;

  • Nexus Mutual

Launched in 2019, Nexus Mutual allows its users to insure their smart contract positions with its native token, NXM. It functions by drafting risk-sharing pools. As a result of these pools, Nexus Mutual customers can invest capital in the pool or cover smart contact positions, therefore generating passive income.

Nexus mutual represents the first crypto-insurance provider. Within DeFi’s ecosystem, the company offers ways of protecting a user’s activity. Nexus Mutual avoids the term “insurance” despite utilizing it for practical purposes. Why? For legal reasons and each of the services that Nexus provides differs fundamentally.

The traditional insurance industry gets driven by the desire to generate revenue. These traditional insurance companies will go out of business if they don’t regularly rake in money. In other words, the desire to make profits outweighs the needs of individual policyholders.

Nexus Mutual, however, operates on a different model. They depend on blockchain technology to change the focus from profit to service. Goal? For the betterment of consumers, we must shift away from the for-profit model.

Nexus Mutual has, of course, some improvements to make as a forerunner in this area. Moreover, it has a lot of ground to cover before it can be considered a potent disruptor of the insurance market.

  • Etherisc

Etherisc develops protocols for decentralized insurance applications to make insurance transactions more efficient, reduce operational costs, and provide greater transparency. Etherisc does not plan to offer its services directly; instead, it plans to partner with existing or upcoming insurance companies.

Etherisc is split into two prominent “folds” of business. One is a non-profit foundation devoted to insurance-related products and services. The other is a for-profit commercial entity spread across several jurisdictions and combined into Etherisc Holding AG.

The commercial entities take on the risk and demonstrate the value of decentralized products to other companies to encourage them to adopt them. This proves the concept and serves as a revenue generator for Etherisc’s products and services.

The platform is underpinned by the protocols it develops, consisting of a barrage of rules, primarily in smart contracts to ensure smooth operation. Basically, the platform is a marketplace for insurance products and services, where protocols bind all parties.

  • CDX

The CDX protocol is a revolutionary smart contract framework that enables the issuance, trading, and resolution of credit swaps on the Ethereum blockchain. Through Tokenized credit default swaps, CDX solves the problem of hedging credit risk.

CDX protects crypto assets and covers investors against scams and hacks. The method eliminates credit risks, allowing investors to store digital assets on exchanges to ensure that their vital liquidity will be well-preserved. Additionally, investors can trade with greater confidence because they are fully aware of the actual credit risk.

  • Aigang

Aigang is a fully automated insurance network with a platform for insurance innovation. Using AIX tokens and prediction markets to crowd-source community intelligence, the network combines IoT devices, data, and autonomous insurance. As a result, a new set of insurance products may be developed and the insurance DAO protocol powered.

Members of the Aigang Network stake their predictions on specific insurance pools or commodities using smart contracts. As a proof of stake (POS) and proof of reputation (POR) algorithm based on token ownership, Aigang assesses reputation scores based on AIX token ownership.

The Aigang network enables the crowd to forecast insurance that can be profitably applied to new or existing insurance products, thereby rewarding AIX token holders to increase their symbolic value.

Benefits of Decentralized Insurance

There are many benefits of decentralized insurance, the most important being complete protection from hacks. Other benefits include;

  • Deposit protection for DeFi
  • Protection from cryptocurrency volatility and flash crashes
  • Immediate redemption of tokenized cryptocurrency
  • Protection against the risk of crypto wallet theft and attack
  • Security of funds from exchange platform hacks
  • Protects against technical and financial risks
  •  Immediate payment of claims
  • Honest risk evaluation

Conclusion

Decentralized insurance is still in its early days, with many kinks yet to be ironed out. However, the industry is growing exponentially, with new projects and solutions in development daily. With the recent hack of a major cryptocurrency exchange, it is clear that there is a need for such services.