Cryptocurrency has delivered incredible returns for numerous investors in recent years, however, it is not without risks. While technological advancements are making increasingly rare the types of hacks and exploits that colored the early days of crypto trading (Mount Gox’s still unrecovered $45 billion loss a case in point) these incidents do still happen.
The explosion of decentralized finance (DeFi) has also given rise to a plethora of new risks in the cryptocurrency space. The highest-profile among these are flash loan hacks, as the advent of multi-million dollar, virtually permissionless loans have combined with early-stage and vulnerable decentralized protocols to create a perfect environment for nimble hackers.
In addition to the risks specific to a cryptocurrency or smart-contract-based platform, there are also the common risks faced by any organization: financial failure, bankruptcy, and fraud, among others. Unlike traditional enterprises, however, cryptocurrency companies have little or no access to the type of traditional insurance products that ordinarily provide the cover needed to protect businesses and their customers.
DeFi insurance, as it stands
This is not to say that insurance does not exist for cryptocurrency, and DeFi in particular. As we have covered in a previous post, there exists a promising and fast-growing market for DeFi insurance. DeFi insurance protocols such as Nexus Mutual, Etherisc and Nsure are striving to solve some of the toughest challenges faced by platforms and their users — challenges that, until solved, will hinder DeFi’s growth.
The typical existing DeFi insurance model involves an interplay between underwriters, which in this case are users that provide capital for the insurance pools and who are rewarded with a share of premiums; users that hold governance tokens and who are frequently required to help assess claims (often also capital providers); and the users that buy cover.
Nexus Mutual, by far the largest DeFi insurance provider with a market cap of just over $560 million, allows users to buy cover against failures and issues at a vast array of protocols: from Compound and Aave to MolochDAO. Policies cost anything between 2.6% and 45% per year, depending on how risky the platform is perceived to be.
The same can be said for Nsure, while Cover — from Yearn Finance — allows users to buy and sell insurance in a tokenized format. Other DeFi insurance protocols such as Etherisc and the as-yet-to-be launched Union Finance offer higher levels of customization, as well as slightly different tokenomics and governance models.
Too many cooks, not enough liquidity
All of these innovative models are helping to support DeFi users as the ecosystem continues to grow at its current exponential rate. Despite these best efforts, however, none go nearly far enough.
Many are extremely limited in their coverage, only protecting against specific issues within or related to smart contracts, while liquidity is often an issue. While the more established platforms may attract significant capital to deliver adequate coverage for a representative number of users, smaller protocols struggle to attract the same depth of liquidity for broad insurance coverage.
Moreover, the sector’s largest player — Nexus Mutual — is highly centralized, with the validity of claims decided by “Claims Assessors” that provide capital to the platform. As well as being a highly centralized approach applied to a decentralized marketplace, these assessors directly profit from claims not being paid, creating a strong conflict of interest. In order to purchase cover, users also need to provide KYC, or “Know Your Customer,” information — again considered at odds with the premise of DeFi.
For cryptocurrency companies, the insurance conundrum is perhaps even more complex. While insurance companies are becoming increasingly interested in DeFi (including the world’s second-largest, Aon) it remains difficult to insure anything beyond the storage of hard cryptocurrency.
Even centralized exchange Coinbase, now listed in the New York Stock Exchange, only has 2% of the coins on its platform insured by a consortium including Aon and a Lloyds of London syndicate.
A call for insurance innovation
The lack of a fit-for-purpose, innovative insurance solution in the cryptocurrency space is a problem. Without adequate or familiar risk protections, the industry will continue to be overlooked by conservative mainstream investors.
This is a particular pain-point for DeFi which, at its core, is designed to appeal to and serve the mainstream. Savers that have for too long been stuck in near 0% interest rate accounts would be well served by the type of wealth creation opportunities now available in DeFi.
Robust insurance solutions that can provide the protections normally associated with financial risk are a crucial next step in driving mainstream adoption of cryptocurrency and DeFi. This includes an assurance that claims are met rather than declined for personal or commercial interests.
DeFi and its custodians now have a unique chance to channel the same determination and innovation that has grown the market to deliver an insurance product that fully meets its needs.
At YIELD App, protecting our users and enhancing the overall safety of the DeFi ecosystem has and will remain a primary objective: risks remain in DeFi, and being able to provide a safety net against them is essential to ensuring the continued growth of this nascent area.
We are not sitting on the sidelines when it comes to innovation or solutions and we will continue to work actively with our partners and advisors towards a safer DeFi future.
