The ailing crypto markets may finally give up DeFi Insurance is an opportunity to thrive, but only if you can weather some headwinds.
Currently, less than 1% of all assets in the $47 billion DeFi ecosystem are covered by a policy to help replace them after a hack or code failure. This was also true last June, in the wake of the Terra Luna algorithm stablecoin, TerraUSD, loses touch, wiping out $40 billion in the process. For the rest of the year, and perhaps even now, the effects of the black swan event rippled through the industry, devastating other companies.
In the aftermath, tens of millions of dollars in DeFi insurance claims were filed as users tried to recoup their losses. About 68% of claims filed since June have been paid. Now that companies selling DeFi protection, the industry’s preferred term for this type of insurance, have escaped a baptism of fire, they are bullish about maintaining momentum.
“DeFi protection” is an umbrella term for insurance policies covering blockchain-related activity. It uses the same basic principles as traditional insurance: policyholders pay a premium and receive compensation if and when they file a claim for a covered event. These events are where products really differ from traditional insurance: stablecoins lose their peg, crypto assets crash on a platform, hacks or code errors cause smart contracts to behave erratically.
How and how quickly payments happen can vary.
For something like a stablecoin that loses its peg, for example when a coin designed to hold $1 in value suddenly drops below that mark, these tools can send payments to the policyholder as soon as they detect that the stablecoin has fallen 5% or more below its value. target asset value. In other cases, such as customer funds being stuck on the company’s platform, there is usually a 90-day waiting period before claims can be submitted. For them, people tend to share the judgment of which one is valid.
Despite all the similarities, DeFi protection must deal with the fact that the insurance industry has been highly regulated in the United States since the 1940s. So while DeFi protection sounds like it works a lot like what most people would call insurance, there are companies that sell it – including all of these Decrypt I spoke to — prefer the term “DeFi protection”.
Since June, more than 17,000 covers have been sold, according to OpenCover. The site was launched in December by Jeremiah Smith to collect data from the growing DeFi blockchain industry across the Ethereum, Polygon, Arbitrum, Optimism, BNB Smart Chain and Avalanche networks. As of Tuesday, there was a total of $284 million in value locked up in DeFi protection providers such as Nexus Mutual and InsurAce.
This means that less than 1% of the $47 billion worth of assets held in DeFi protocols, such as Aave and Lido, are covered. When OpenCover began tracking aggregate value booked at coverage providers in June, $394 million was locked in the cap against nearly $80 billion of assets in the DeFi ecosystem — higher totals, but roughly the same rate of coverage.
Of the 525 claims made since then — against everything from the Axie Infinity sidechain and Binance bridge hacks, the Mango Market attack on flash loans, or the demise of crypto companies like Celsius and FTX — roughly 68% have resulted in a payout.
It stands to reason that it would take falling prices, bankruptcies, and hacking to highlight the lure of DeFi protection for the dough community.
Degens, a short-lived cryptocurrency term, thrives on high-stakes trading and cryptocurrency obsession. And even if they don’t sign up for DeFi insurance right away, they can still find themselves with backing the next time they patch.
it’s becauseDAOsSmith said that DeFi projects and other crypto companies are now buying insurance themselves Decrypt.
“As a user, you don’t need to buy your own insurance. As a protocol, you can be sure that all users are protected.” “Just organizing it that way is so much easier.”
By doing this, teams launching new DeFi applications can ensure that at least part of their users’ lost funds can be recovered.
It also means that there is scope for highly focused coverage providers such as Sherlock Protocol, which covers smart contracts exclusively. Smart contracts are pieces of code that execute a set of instructions in response to a specific input, such as buying or selling a token if it reaches a certain price. To date, Sherlock has sold coverage of protocols including cryptocurrency lender Euler, staking platform LiquiFi, and DeFi options exchange Lyra.
“We only cover smart contract exploit risks,” said Jack Sanford, co-founder of Sherlock. Decrypt At the end of November. “We have been lucky because we are very focused and therefore we have not been exposed to anything. We have not had any claims since incorporation 14 months ago.”
There are still no claims of the 15 protocols covered by Sherlock, but there has been some exposure to FTX bankruptcy long tail infection.
In December, DeFi lending platform Maple Finance announced that Orthogonal Trading had defaulted on $31 million worth of loans issued by a lending aggregator managed by M11 Credit. Sherlock revealed in a blog post that they had deposited $5 million worth of coins (USDC) into the pool in August.
After FTX declared bankruptcy on November 11, Sherlock wanted to withdraw his funds but could not because of the mandatory 90-day lock-up period. By the time Sherlock had access to his USDC, it was too late and the company had lost $4 million.
“Sherlock is still figuring out his own identity when it comes to his place in the ecosystem, but it is becoming increasingly clear that Sherlock must have as little exposure to centralized entities as possible and that Sherlock must delegate capital allocation elsewhere, possibly back to the actors themselves. ,” the company wrote in its blog on Dec. 5.
Since the beginning of the year, the company has covered five more protocols and launched one Review competition for optimism On January 20th. Sanford said he found smart contract audits turning into open competitions between blockchain security analysts for rewards to be more comprehensive than hiring internal teams, but not ideal.
“You can never be 100% sure there is no bug in it. I don’t care what contract you’re looking for. If this is Uniswap’s first contract, there’s always a chance there’s a bug that no one has found yet and everything is stolen from it, So you have this paradox of people needing 100% certainty to put their money into not being able to get to 100% certainty because of how this code works. And so the only way, in my opinion, we’re going to be able to bridge it is with insurance.
Meanwhile, InsurAce has become the third largest DeFi protection provider after Nexus Mutual and Unslashed Finance, with a total value of $12 million locked in coverage for 150 protocols across 20 different chains.
Of the 219 claims the company has received, 182 are for the TerraUSD algorithm which lost its single peg to the US dollar in May 2022, according to its claims history. Of those, 141 received payments totaling more than $10 million.
Dan Thompson, director of marketing at InsurAce, said that payments help build a sense of trust and reliability with potential customers. But InsurAce is now at an inflection point where they want to start providing coverage to much larger customers.
“We’re thinking of anchoring ourselves in Bermuda so we can allow reinsurance. There are reinsurance companies in the market that have been chasing us for about a year now to get into space,” he says. Decrypt. “And that’s good because this will allow us to deal with some of the largest clients and customers who are looking for big coverage numbers.”
Thompson said there have been weekly inquiries coming in from institutional funds and high-net-worth individuals looking for coverage of up to $20 million that the policy will not be able to service, until the company relocates to Bermuda. Bermuda’s regulations on insurance would allow them to start working with a reinsurer, which acts as a guarantor for insurance companies and allows them to take on more risk than they could handle otherwise.
When InsurAce makes this move, it won’t be alone. One of its competitors, smart contract coverage provider Chainproof, moved there in July, according to a press release.
It is a relatively new development that traditional insurance players are looking to take advantage of when it comes to covering blockchain activity. Until recently, many of them didn’t understand the industry well enough to come up with a viable DeFi strategy, said Paul Ricard, partner in the insurance business with advisory firm Oliver Wyman. Decrypt.
He said they are now going through a process similar to what happened in the 1990s when the first electronic insurance policies covered corporate liability for errors in data processing. It has since evolved to cover data breaches and ransomware attacks.
“Traditional insurers have been very good at using historical data to predict how things will happen, but as you know, Web3 is an emerging risk that is always evolving,” Rickard said. “So having the right partnerships with companies that provide security audits for some of these Web3 companies, for example, is critical for players to continue developing coverage products.”
He believes, just like what happened with cyber liability insurance, that DeFi insurance from traditional players will cover a very narrow set of risks as they try to expand their industry knowledge through an ecosystem of local Web3 partners.
This task is made more difficult by the fact that the insurance industry first got excited about blockchain five years ago, only for the hype to explode.
“There was a lot of proof of concept,” Rickard said. “But at the time there were solutions mostly in search of a problem.”
Now Web3 has grown into an unprecedented source of risk. And despite the turmoil caused by the cryptocurrency contagion in the past year, it has also generated plenty of publicly available data to help DeFi protection and insurance providers better understand these risks.
“That’s the whole point, for everything on the chain to be transparent and auditable and self-preserving. There are many risks that DeFi solves by design,” says OpenCover founder Smith. “But then we also have to recognize that there are new risks that it creates, and we have to identify local solutions to these risks. That is why we are betting that this industry will be huge.”
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