How TradFi Insurance and DeFi Insurance Can Work Together?

There has never been a greater need in Web3 for insurance.  

In these troubling times in Web3, the crypto space is having to learn some traditional finance lessons very fast. Whether this is about trusting anonymous teams or doing their own research before investing.  

Not too long ago, this was tested with the collapse of Terra and the De-Peg of $UST. More recently, the collapse of FTX has been a stark reminder of the dangers of working within not just crypto and Web3 but also finance as a whole. FTX collapsing was a symptom of what happens when financial institutions lend out their users funds, almost like what banks do on a daily basis.  

These hard learned lessons have some solutions in traditional finance that can be applied to Web3. Arguably the most important of these is insurance.  

So far, Traditional Insurance has been unable to access the crypto market. This is for the following reasons: 

  1. Unable to hold crypto 

Paying crypto users in crypto when they cannot hold crypto on their books is a barrier to entry.  

  1. Needs to KYC users 

Due to regulations in most nations, insurance companies are required to KYC users to know where funds are paid to in the event of a payout. This is to avoid money laundering.  

  1. Unable to develop the software themselves 

Whilst they could invest in web3 developers to build a solution in house, this would be costly and time consuming, whereas finding partners might be a better solution to test the waters.  

  1. They need to deal with regulated and/or licensed entities 

Any partnerships have to be regulated. This can be difficult when dealing with most web3 users and protocols. The issue here is that any regulated and licensed entity may be limited to one territory to sell their cover. 

On the other hand, the issues facing DeFi insurance are numerous also.  

  1. DeFi insurance is limited by the capacity it can offer to users 
  1. The industry is a risky industry, and the technology is new 
  1. Products are limited to objective on-chain risks like de-pegs and smart contract risks 
  1. Vast majority of de-fi users are degens and don’t think to buy cover 

How can Traditional Insurance and DeFi Insurance overcome these issues? 

The Web3 industry has a market cap of $800bn at the time of writing, within that, $40bn is the current TVL of DeFi, whilst these are down from highs of $3tn and $300bn respectively, they are still not small numbers to be dismissed.  

Less than 1% of all web3 is insured, mostly because of the above issues stopping Web3 and Traditional Insurance entities from working together.  

But there are solutions on the horizon. Entities are being set up on behalf of web3 companies in regulated territories, which will enable parnterships between tradfi and defi entities. Beyond this, on-ramp and off-ramp solutions are becoming more stable and trusted across the industry, even if some of the centralised exchanges are currently under intense scrutiny.  

KYC solutions exist but may not be currently good enough to satisfy both sides. Traditional insurance would be happy with current KYC, but most Web3 users would not. There are some new ZK (Zero Knowledge) Identity projects that are being developed that may provide a solution to this barrier also.  

Regulation around the world is beginning to emerge. A shining beacon of both insurance regulation and digital asset licensing is Bermuda. But others are following their example.  

Bridging this gap will allow for these traditional insurance institutions to enter the web3 market and provide much needed capacity for DeFi insurance, earning both sides of the partnerships premiums from access to the wider market.  

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