Parameters For Developing Insurance models for DeFi

Financial assets such as stocks, bonds, commodities, and the likes are usually known to possess a certain level of value. The owners of these assets need protection from disasters as well as unforeseen circumstances. These events may lead to partial damage or complete loss of their resources. The security of such valuables comes in the form of insurance.

Insurance is a risky endeavor that needs precise methods and strategies to guard against risks and uncertainties. This industry already plays a critical role in traditional finance by providing safety for investors. However, despite cryptocurrency’s recognition as a financial asset, there has been a slow adoption of proper risk management strategies so far. This pace stems from adapting traditional insurance methods to new technologies due to how expensive conventional ones are.

The Uncertainties in DeFi

Cryptocurrency and especially Decentralized finance (DeFi) has seen fast-paced growth in recent times. Huge sums of money running into billions of dollars have been pumped into this space as investor interests continue to increase. As reflected in the total value locked (TVL), this increase has made it a hotbed for scammers and hackers. These miscreants continuously look for ways to exploit the system and make away with invested funds.

Within the first two quarters of 2021 alone, Crypto analytics unit CipherTrace discovered that the DeFi industry has lost over $240 million. Of the $420 million lost to hacks, theft, and fraud within the cryptocurrency ecosystem, 60% were Defi related.

Frauds in DeFi occur in the form of exit scams, commonly known as rugpulls. Meanwhile, hacks refer to the exploitation of weaknesses found in any aspect of a protocol. These activities appear through flash loan attacks, oracle manipulation, and utilizing vulnerabilities in smart contracts.

Source: CipherTrace

From the above, we can draw a clear correlation. The explosive growth witnessed in DeFi has made it appealing not just for investors alone. Thieves, hackers, and miscreants have become increasingly active as well. This situation limits investors’ confidence and risk appetite and may not reflect market conditions correctly. This uncertainty has led to an increased need for insurers to become active participants within this ecosystem.

While the cumulative loss from DeFi hacks and frauds continues to decline, the ratio tilts in favor of the former. The chart below shows that this flip fully kicked off within the first four months of 2021. A sum of $156 million lost to DeFi hacks already surpasses the total amount lost in 2020, $129 million. For DeFi fraud, the $84 million shows a more than 200% increase from the values also recorded in 2020.

Source: CipherTrace

This change happens due to several reasons. One of which is the fact that a large portion of cryptocurrency trading occurs on centralized platforms. Strict security measures are usually enforced and adopted by them, thus pushing criminals to exploit the DeFi space. Also, in the event of a hack, more parties (investor and project) suffer. This endangers the industry more because it is easier to mitigate fraud.

Challenges of Defi-Insurance

Despite the increasing appeal of DeFi cover, creating indemnity poses a few challenges in itself. From the complexities of decentralized trading, sourcing for liquidity, to the actual development of insurance products and packages.

  • Sourcing Liquidity– When it comes to cryptocurrency, liquidity is king. In Open finance, it isn’t just king; it is the life force of the entire system. For Defi-insurance, liquidity sourcing is a challenge because someone has to underwrite insurance policies or the price insurance premiums. This issue may be challenging, considering the difficulty in assessing risks found within the ecosystem. Also, the benefits of investing directly in the Decentralised Finance protocols that exist may outweigh those gotten from taking underwritings in the insurance market. Finally, most of the revenue generated by traditional insurance markets comes from re-investing collateral into safe profit-making products. This may not be applicable in DeFi insurance as placing the liquidity back in Defi-protocols exposes them to the risks they should cover.
  • Developing Insurance Packages- Creating a one-size-fits-all approach is very difficult and almost impossible. Conversely, developing tailor-made services for the diverse platforms found in DeFi would also be expensive and cumbersome. This dilemma is the reason DeFi surety products are not common. There is a great need for insurance markets to be capital efficient. $1 placed in an insurance pool should underwrite more than $1 in multiple policies across various protocols. When markets are not able to provide leverage for pooled collateral, they become capital inefficient. Premiums become very expensive in this situation. Finally, entire marketplaces can go bankrupt in a moment if payouts are not limited to actual losses and left include unbounded losses.

Parameters needed to create insurance models

Certain variables need to be determined to develop a working model for DeFi-insurance. These models answer the fundamental questions about the insurance prototype.

  • Policy type used– This points to the choice of either an open market system or a closed system (Discrete policy). The former allows for the trading of the predicted future value of that token or cryptocurrency. The latter offers cover for a specified amount of time with clearly defined terms and conditions.
  • Claim resolution– Here, how claims are handled, how and who determines the validity of claims, and the payment method. The decision on whether it’s manual or automatic can be determined.
  • Insurance platform– Will the insurance platform be native to DeFi. This will subject it to some of the risks found there (on-chain). Or if it is deployed through the traditional insurance while they serve as underwriters providing rigid policies (Off-chain).
  • Capital efficiency– Will the insurance package be able to scale beyond the collateral committed into it? Or will there be natural limits to the amount and prices of the available coverage if scaling is not possible?

To develop a vibrant and robust Defi-insurance package, each one of these parameters has to be carefully considered and implemented appropriately.

The InsurAce Insurance model.

InsureAce is a new robust DeFi-insurance protocol that aims to empower the risk infrastructure within the DeFi space. This is achieved by implementing a portfolio-based insurance model within a user-defined period. It possesses multi-chain access as well as cross-chain capabilities. Also, it protects against loss from smart contracts and smart contract system failures.

Our platform offers optimized pricing models, which significantly lowers its cost. The insurance investment also functions with SCR mining programs that can create sustainable returns for the users. Finally, it provides coverage for cross-chain DeFi projects to benefit the whole ecosystem. InsurAce was deployed initially on the Ethereum and Binance Smart chain. It has expanded to provide coverage to other networks, including Solana, Polygon, Fantom, and Heco.

This interoperability allows for seamless access and interaction across different ecosystems in a fast-paced space like DeFi. This idea is essential because we have seen various platforms become obsolete simply because of the inability to evolve and adapt.

Claim resolution on the platform is handled by the InsurAce Advisory board together with the community claim assessor. This is done through a quantitative investigative process and community voting. Upon the completion of the claim assessment process, after claims are made, payment is done automatically. This negates the need to accept or reject results of claim assessments from other platforms.

The InsurAce DeFi-insurance model provides its users with low premiums, cross-chain coverage, multi-chain access, and sustainable investment returns. All of this makes it a robust and adequate package for users to secure their investment against risks.

Closing thoughts

Developing a DeFi-insurance protocol is inherently tricky to pull off. However, InsurAce, since its launch, has built a product that can fill the wide gap of insurance within DeFi. By drawing inspiration from the pioneers within the Defi- insurance space and their product designs, it has innovated along the way. Via this platform, it Is able to blaze a trail other protocols can follow.

The increased use of insurance in cryptocurrency will allow for increased growth in the DeFi space. Developers would be confident in designing platforms that provide solutions to real-world issues. Investors would also be willing to put more funds into open finance.

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