{"id":184543,"date":"2021-03-18T05:02:41","date_gmt":"2021-03-18T05:02:41","guid":{"rendered":"https:\/\/cryptoslate.com\/?p=184543"},"modified":"2021-03-18T05:02:41","modified_gmt":"2021-03-18T05:02:41","slug":"why-insurance-is-needed-for-defi-and-what-it-looks-like","status":"publish","type":"post","link":"https:\/\/cryptoslate.com\/why-insurance-is-needed-for-defi-and-what-it-looks-like\/","title":{"rendered":"Why insurance is needed for DeFi, and what it looks like"},"content":{"rendered":"

NFTs busted the door to decentralized finance wide open. CGI artist Beeple (Mike Winkelmann) had already captured the headlines by selling his collections for over $6 million worth of ETH. But on March 11, Beeple broke another two ceilings – getting his NFT listed on traditional auction house Christie\u2019s and selling it for an astronomically high price of $69.3 million<\/a>. This too is comparable to exorbitant traditional artwork pricing.<\/p>\n

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Source: Google Trends for \u201cNFT\u201d<\/figcaption><\/figure>\n

Effectively, this means we can expect a new wave of people joining DeFi, a new class of users represented by digital artists and their hordes of fans. After all, the first thing one associates with NFTs is the programmable Ethereum blockchain with its native ETH token, the second-largest cryptocurrency<\/a> by market cap (and popularity in general). Almost all NFTs are listed in ETH and all NFT marketplaces are a click away from DeFi dApps.<\/p>\n

However, there is something missing to greet the new DeFi explorers: Peace of mind, in the form of insurance. Let\u2019s find out how insurance would be implemented in the blockchain space.<\/p>\n

Why DeFi Insurance Is Needed<\/h2>\n

Just as crypto exchanges have become the favorite target of cybercriminals, reflecting Bitcoin\u2019s popularity growth, so too have DeFi protocols. Last year, when the DeFi space ramped up in activity, CipherTrace reported<\/a> a $2.7 billion loss in hacks and fraud. Although this is still lower than the $4.5 billion worth of damages in 2019, it still represents a cause for concern.<\/p>\n

The year 2021 didn\u2019t start any better. On February 5th, one of the most popular DeFi platforms \u2013 Yearn Finance \u2013 suffered a loss worth $11 million. Without going further into detail<\/a>, it was a so-called flash loan attack, falling into the category of exploits. Just like in the video gaming industry, it is a form of hack, but one that pinpoints and exploits an existing flaw in a given system.<\/p>\n

If this sounds familiar, it\u2019s because Yearn Finance was the same DeFi platform that had reportedly fixed an attack vector<\/a> for a flash loan exploit last November. The unfortunate protocol that suffered the attack then was Harvest Finance, with users losing $30 million worth of tokens from their accounts. These events point to a sobering reality \u2013 not even preparation in the wake of similar exploits in the past is sufficient to erect an impervious barrier against them.<\/p>\n

Like with crops and the unpredictability of weather, the only course of action is to institute insurance as a stabilizing force. Andre Cronje, the founder of Yearn Finance, informed the affected investors<\/a> who were insured that all of them will be reimbursed.<\/p>\n

One could read this as a signal to all DeFi participants to get insurance. Although Yearn Finance\u2019s native YFI token has recovered since, it suffered a 12% value drop in the immediate aftermath of the flash loan exploit.<\/p>\n

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Source: TradingView, YFI\u2019s price plunge after the flash loan exploit.<\/figcaption><\/figure>\n

Outside of malicious attacks, it is worth noting that funds can sometimes be lost due to glitches. After all, we are dealing with the digital space in which nothing is 100% bug-free 100% of the time. For these reasons, any serious DeFi stakeholders should consider taking an insurance policy ASAP.<\/p>\n

The Novelty of DeFi Insurance<\/h2>\n

The current market size of the traditional global insurance market is valued at about $6 trillion. This alone tells you that institutional investors prefer insurance whenever possible. More importantly, this is mandated by the government. For instance, the UK\u2019s top apps for stock trading<\/a> offer insurance as required by the Financial Conduct Authority (FCA).<\/p>\n

Although such insurance doesn\u2019t protect against losses incurred as a result of stock trading choices, it will protect against funds or assets that go missing. In the US, Congress created the Securities Investor Protection Corporation (SIPC) which protects investments from brokerages going bankrupt. Further, the SEC and FINRA assist investors with fraud-related matters.<\/p>\n

The point here is that traditional finance features significantly more protection and security (and also regulation) compared to the DeFi space.<\/p>\n

Keeping in mind that DeFi exploits are rare, they do remind us that Ethereum is a programmable blockchain. And that which offers flexibility inevitably comes with vulnerability. Just because governments will likely never mandate insurance for DeFi protocols, that doesn\u2019t mean we shouldn\u2019t take advantage of the concept. If the DeFi space is to overtake traditional finance as its most ardent proponents advocate, here are starting options in this newly emerging insurance market.<\/p>\n

Nexus Mutual and Nsure.Network<\/h2>\n

As intimated by Cronje in his tweet post-exploit attack, Nexus Mutual is becoming the go-to choice for DeFi insurance. Governed via its NXM token, it\u2019s a decentralized, Ethereum-based insurance utilizing risk-sharing pools. Mutual covers any smart contract loss on Ethereum, as long as it is public.<\/p>\n

Be sure to read their detailed claims page, covering what is excluded from coverage<\/a>. To judge if it is worthwhile, as of March, you could cover 10 ETH for about 0.1281 Ether (ETH) on Curve Finance for 180 days, representing a ~1.3% insurance premium. If you are already using MetaMask, you can easily connect to it and claim your insurance. Unfortunately, those who see DeFi as primarily anonymous will be disappointed, as Nexus Mutual requires KYC (know-your-customer) identity verification.<\/p>\n

However, if you want to preserve the original spirit of cryptocurrency, Nsure.Network<\/a> offers permissionless insurance. Departing from Mutual\u2019s staking in risk-sharing pools, this alternative is based on capital mining. Meaning, the price of insurance is predicated by the real-time supply of capital and demand for insurance coverage of that particular DeFi platform. They style themselves as the DeFi version of Lloyd\u2019s London\u2019s dynamic price model. Coverage is met by purchasing NSURE tokens that are automatically awarded on every block.<\/p>\n

As you can see, both Nexus Mutual<\/a> and Nsure.Network<\/a> are open-source projects, utilizing a number of popular open-source tools<\/a>. Github is just one \u2014 but projects can also facilitate contributions from the public through a number of different programming languages, such as Rust, Solidity, Javascript, Vue and TypeScript.<\/p>\n

Etherisc, CDx and Cook Protocol<\/h2>\n

Etherisc<\/a> is a framework for building insurance products and offering templates based on a license-as-a-service model. Utilizing risk pools like Nexus Mutual, it currently has 6 products in various stages of insurance pipeline completion:<\/p>\n