DeFi Insurance – Useful Or Not?

defi insurance

Insurance plays an essential role in our lives. It can be for healthcare, auto insurance, home insurance, or life insurance. They all protect families in the event of an unexpected loss. 

Similar to traditional insurance products, there are products built to insure losses in crypto. Such products can protect you from hackers who could breach your hardware wallets like a Ledger or a Trezor. Other products protect you from hackers who steal crypto. It concerns cryptocurrency exchanges like Binance, Coinbase, Kraken etc. 

Additionally, there are more lucrative insurance products that protect investors from DeFi hacks and exploits. From stablecoins losing their peg with the USD to even some policies protecting from reward slashing for staking validator nodes. 

DeFi Insurance  

An insurance platform that offers all of the above protections is Unslashed Finance. Their smart contract integrity insurance protects the insured from DeFi protocol hacks and exploits. 

Here is an example. Say there is a bug in the contract. Therefore, a bad actor is allowed to take a loan without putting collateral on compound. In that case, insured investors can file a claim. They can be reimbursed on losses the insurance policy covers. 

For Compound, Unslashed charges 0.2% per year priced in Ethereum tokens. Other platforms like Nexus Mutual, Insurace, and Risk Harbor allow investors to pay in USDC, DAI or their own native tokens. 

For example, Nexus Mutual allows investors to pay premiums in NXM tokens for a discount. The quantity of insurance (amount covered) is customizable to suit your deposit amount needs. Furthermore, policy cycles typically lasting 30 days. A policy is attached for more information on each insurance product. Using the same example above, investors can lend USDT tokens on Compound for 2.2% APY. Then spend 0.2% per year on smart contract insurance. And last enjoy a risk free yield of 2% APY in USDT.

In case of a depeg

However, what if USDT loses its peg with the US dollar? Unslashed offers an insurance product for this as well. This type of insurance covers investors in the event that USDT trades below $0.95 USD on multiple reputable exchanges for more than a 2 week span. 

The current rate for USDT peg insurance on Unslashed is 1.45% per year but changes depending on demand and supply dynamics. By buying smart contract insurance, and USDT peg insurance, investors can still guarantee a 0.55% APY on USD deposits which is still 5.5 times better than a traditional savings account at Bank of America.

How DeFi insurances work

Most traditional insurance companies work in a manner of allocating a large pool of capital for different insurance products. This diversifies the risk to protect the pool of capital from significant losses. The pool of capital can be allocated to a combination of healthcare, auto, home and life insurance policies. This large pool of capital typically comes from big investment banks, companies, pension and retirement funds etc. 

Using large amounts of historical data, underwriters can determine the probability of an event occurring. For example, the probability that a 45 year old who exercises twice a week lives past 65 years old. This probability can translate to the amount of premium paid monthly for life insurance. Since the probability is fairly high, the insurance premiums would be low but enough to give investors a return on their capital over a long period. 

From the investors point of view, over the long term, they would win because the risk they are taking is low relative to the premiums earned. In other words, similar to the risk/reward relationship with traditional investments, the reward of earning insurance premiums every month which can then be invested, outweighs the risk of insurance payouts.

How DeFi insurances make profit

Similar to how traditional insurance companies make money, crypto insurance companies make money in a similar fashion. However, in this case regular investors like you and me can take the opportunity of investing in capital pools that get a return from insurance premiums. 

Unslashed Finance allows investors to supply capital in ‘Capital Buckets’ which are pools of capital that are allocated to a diversified set of insurance products. Currently, investors can get an 11% return on their capital by investing in Unslashed’s Spartan Bucket. Since premiums are paid in Ethereum tokens, the return is also in Ethereum tokens. 

The equivalent of this return would be lending Ethereum tokens on centralized exchanges or DeFi protocols like Compound. The return comes from 3 streams of revenue which are as follows: premiums paid by the insured, USF token rewards (Unslashed’s native governance tokens), and return on invested capital through Asset Management Strategies. 

Return on capital

The USF token is a governance token used to create and vote on proposals within the Unslashed DAOs. Proposals can vary from introducing new insurance products, to reducing fee structures and premiums on current insurance products. Unslashed partnered with Enzyme Asset Management to get a safe but low return on funds invested in the Capital Bucket. 

This allows a return on capital that would otherwise be idle. The Spartan Bucket stakes Ethereum tokens in an ETH 2.0 validator node to get yield on idle Ethereum tokens. This is similar to traditional insurance companies that may buy US treasuries or invest in low risk short term corporate bonds while capital is idle. In both cases, when an insurance claim is to be paid out Enzyme would return the specified amount of capital to pay out the insured.

Similar to other DeFi insurance platforms, when a claim is filed it is assessed by a third party but in some cases can be disputed by the respected DAO. For example, Unslashed has integrated with Kleros which handles independent claims on Unslashed. After being assessed by Kleros, the insurance is either paid out or denied. If there is still dispute, the Unslashed DAO could vote to re-assess the claims. 

Only starting

As the industry matures, DeFi insurance will allow various opportunities for yield that were not possible before due to barriers of entry like investor accreditation. Insurance platforms for DeFi are still in their infancy, only being around for about 2 years. However, I believe insurance for DeFi is very useful for DeFi power users and is vital for the industry to mature.