What is DeFi Insurance

DeFi risks and hacks have prompted many platforms in that ecosystem to turn to DeFi insurance protocols.

DeFi is mostly a self-regulating financial space that uses computer software called smart contracts to conduct its operations. The DeFi space was designed to mirror services offered by traditional financial institutions. As a result, DeFi protocols allow investors to borrow, lend, trade, and earn interest on a wide range of digital assets.

Decentralized finance protocols offer their users faster and cheaper transactions. Additionally, they eliminate the need for intermediaries or third parties in the financial process.

As a subset of the crypto and blockchain industries, decentralized finance protocols are designed to function globally. Due to this feature, users can engage in peer-to-peer transactions all over the world.

Due to its potential, the decentralized finance space has experienced rapid growth over the past few years. You can get a clear idea of this growth by looking at the value of crypto assets locked in several DeFi protocols over the last three years.

At the start of 2020, the total value of digital assets locked in various decentralized finance protocols was up to US $630 million. However, by the end of 2021, the DeFi space will have an estimated value of over US $241 billion. Despite this enormous development, experts believe that DeFi and crypto will experience more adoption and growth in the future.

Risks Associated With Decentralized Finance Rapid Expansion

Despite its potential, decentralized finance has faced several obstacles. A common problem associated with the DeFi space is scalability and high gas fees on Ethereum-based DeFi applications.

More importantly, many DeFi protocols are prone to scams, hacks, and infrastructural mishaps. Indeed, the DeFi space has become a prime sector for hacking and other illegal activities.

In 2020, hackers compromised a total of 15 DeFi protocols. Cumulatively, these hacks resulted in the theft of over US $120 million.

ImmuneFi, a platform that provides security and bug bounty services, reported a 137% rise in the number of hacks experienced within the DeFi space in 2020. ImmuneFi estimated $10B in DeFi hacks and scams during 2021.

DeFi risks and hacks have prompted many platforms in that ecosystem to turn to DeFi insurance protocols. You may be wondering what DeFi Insurance is if you're new to the space. Look no further as this article will explain what DeFi insurance is all about.

What is DeFi Insurance?

DeFi insurance was established to protect crypto investors and traders against threats and hacks in the DeFi ecosystem. In principle, traditional insurance companies and decentralized insurance protocols perform the same functions. Both platforms protect their users from technical and financial risks.

Despite their similarities, there are several differences. For example, the traditional insurance market is regulated by government institutions. Unlike the traditional finance industry, the DeFi insurance space is self-regulated, for now.

In terms of its services, most DeFi insurance protocols offer products like Smart Contract Cover, Collateral Protection Insurance, Crypto Wallet Insurance, and Cryptocurrency Cover.

How does DeFi insurance work?

Since the DeFi insurance space is self-regulated, the services offered by providers vary. However, two key components remain constant in the operation of any decentralized insurance platform.

Insurance Buyers

These are investors who purchase insurance policies to protect their digital assets from risk exposures and hacks. In cases where there is theft or a hack, insurance buyers can leverage their insurance policy and make claims.

DeFi insurance protocols

Generally, decentralized finance insurance protocols use a Decentralized Autonomous Organization or DAO. This system allows for a decentralized pool of providers rather than relying on a single individual or traditional insurer to provide insurance coverage.

Under this arrangement, insurance providers are added to insurance pools, where they act as capital providers for the insurance protocol. Simply put, these insurers serve as liquidity providers in an insurance pool.

Generally, coverage providers can select protocols or events they want to insure with their crypto assets. As a reward for their activities, insurers earn interest on the premiums paid by the insurance buyers. However, they are also exposed to risks in cases of hacks or breaches.

Although coverage providers are members of a DAO, they must hold their insurance protocol token to vote. Only members who have full membership rights are eligible to vote on insurance claims made by an insured party.

In some cases, insurance claims are automatically processed using oracles. When this situation arises, the smart contract relies on an oracle for information. The oracle is responsible for verifying and supplying information to the smart contract.

Popular Decentralized Insurance Platforms

The DeFi insurance industry is a relatively new sector. As a result, the number of insurance protocols in the DeFi space is limited. This section discusses some of the most popular decentralized insurance platforms in the crypto space today.

Nexus Mutual

Nexus Mutual is a crypto insurance platform built on the Ethereum network. The platform's main insurance product is called the Nexus Mutual Smart Contract Cover.

Users who buy this insurance product will receive compensation on their digital assets when there are hacks or breaches to the smart contract code. They are also eligible for compensation in cases of smart contract failure, parity multi-sig wallet issues, or DAO hacks. However, the insurance policy does not apply to the loss of funds due to an exchange hack.

As a Decentralized Autonomous Organization (DAO), coverage providers on this platform act as liquidity providers for its insurance pools. The NXM token is the native governance token on the Nexus Mutual protocol.

Etherisc

Etherisc is another popular insurance protocol in the DeFi ecosystem. This DeFi insurance protocol is developing a wide range of insurance products for the crypto lending industry. Some of which include collateral protection for crypto-backed loans and crypto wallet insurance.

This platform has developed and launched insurance products for other DeFi applications. These include crop protection insurance, flight delay insurance, and hurricane protection insurance. Currently, Etherisc does not have a smart contract cover policy.

Advantages of decentralized insurance

The development of the DeFi insurance sector has numerous benefits for investors and traders. Due to its launch, crypto investors can now enjoy complete coverage on their DeFi deposits. Also, users of these platforms will receive compensation in the event of smart contract bugs, crypto wallet hacks, and DAO attacks.

There are also insurance policies that help to protect the value of collateral for crypto-backed loans. These policies protect users when there is a crash in the value of crypto assets due to price fluctuations.

Key Takeaways

The DeFi insurance sector is still in its early days compared with CeFi, which offers many more options in regards to platforms with insurance. As a result, there is still room for improvement and growth. At present, only a few products are available, but this will certainly change with an increase in the adoption and use of DeFi applications.

If you plan to invest in the DeFi space, consider using an insurance protocol to safeguard your crypto investments. There are a handful of transparent and reliable insurance protocols that will ensure the safety of your investments.

We expect to see more growth in the decentralized finance space over the coming years. Therefore, expect more developments in the DeFi insurance industry.