Crypto adoption, as well as the evolution of decentralized finance (DeFi) as part of our everyday lives, continues to grow tremendously. DeFi promises to revolutionize our financial system with profound improvements such as limited dependency on centralized parties (decentralization), improved efficiency, transparency, and more. However, the possibility of hacks and exploits leading to the loss of assets locked in smart contracts in nascent protocols has emerged as a formidable concern for this developing sector.
DeFi offers freedom from centralized intervention in finance alongside improved transparency and flexibility in accessing financial services.
Insurance in DeFi is essentially nothing different from regular insurance. It simply focuses on protecting yourself against losses due to unforeseen events.
Through a DeFi insurance provider, you would pay a specific amount to obtain coverage if you lose your capital and assets on a platform. The premium you pay depends on several factors, including the cover type, provider, and duration.
Instead of purchasing insurance coverage from one specific individual or company, you can purchase coverage from a decentralized pool of insurance providers. Any individual or company can function as an insurance provider by locking up capital in the decentralized capital pool. The individual or company providing capital to the pool is known as a liquidity provider.
Liquidity providers, also called underwriters, serve as the main agents in DeFi insurance protocols. They are incentivized to provide capital to these pools for a share of the premiums.
Governance token holders and claims assessors are those who take on the responsibility for voting on claims and modifications to the protocol.
Then there are the claimants, who purchase the insurance premiums.
Who has the authority to determine the validity of a claim? In most cases, the community through a DAO structure. This decentralized aspect is a hallmark of cryptocurrencies. As a result, native token holders can get governance rights in the insurance protocol and participate in voting for claims verification.
- Improved claims processing
- Smart Contracts
- Reduced insurance fraud
- Ambiguity regarding DeFi risks
- DeFi protocol exploits, hacks, and smart contract bugs can be highly costly
- Regulatory uncertainty
DeFi insurance is suitable for protecting against losses from exploit attacks on DeFi protocols, stablecoin price depeg events, exchange hacks, smart contract failures, and more.
DeFi insurance can potentially be a massive force in the DeFi landscape over the coming years in the fields like property insurance, travel insurance, and title insurance. Many companies are currently trying to break into this emerging sector, albeit with formidable apprehensions regarding the risks involved. On the contrary, the growing complexity and variety of hacks and exploits in the DeFi space highlight the immediate need for decentralized insurance.
For now, decentralized insurance has a long way to go and many challenges to overcome.
How does DeFi Insurance work?
At the time of writing, there is a staggering $60.34B of capital locked up in DeFi smart contracts. That's a LOT of risk. DeFi protocols have offered early users the opportunity to make incredible gains, through yield farming, staking, borrowing, lending and even betting.