Decentralized Insurances: should traditional insurance companies worry?

Gepubliceerd op 2 juli 2023 om 09:15

Crypto trading is incredibly volatile and risky. The fact that you can lose your money is inherent in crypto trading. This can happen because of the price of crypto dropping, but also because of scams. One new world that recently gained attention is DeFi insurance. These types of DeFi insurances are becoming increasingly popular. Nexus Mutual, NSure Network and Ease are some of such insurances.

The risks of DeFi
When you as a user choose to use Decentralized Finance (DeFi), there are a number of risks that you need to keep an eye on. At the heart of DeFi is smart contracts. Smart contracts, in short, are scripts that have preset conditions. If these conditions are met, the smart contract will automatically execute the output (if Y then X).

A lot can go wrong with a smart contract. It remains code created by a human. If something happens to the smart contract, there is actually no way to modify it. The smart contract works completely autonomously and transactions are recorded on the blockchain. Transactions can no longer be modified so mistakes can also no longer be reversed.

If you choose to invest in a DeFi project, you should be well aware that you can lose your deposit due to errors in the smart contract. That would be very unpleasant. After all, there is nothing you can do about this yourself, except to stop using the platform.

Nowadays there are solutions to this kind of risks. Several companies have come up with a special insurance that can cover you against such losses.

What is DeFi insurance?
DeFi insurance is insurance that covers you against the risks of DeFi. It is also not very surprising that these type of projects emerge. After all, DeFi is incredibly risky and not without danger. There is always a chance that something could go wrong, causing you to lose your money.

DeFi insurances themselves run as a Decentralized App on the blockchain (a Dapp is nothing more than an app built on the blockchain through smart contracts). This way, it is possible to detect hacks or errors on the blockchain. Some DeFi insurances have a built-in tool that can monitor hacks and errors.

Such DeFi insurances run on the blockchain. There is no central party that receives the claims, verifies and then pays out the claims.

Nexus Mutual (NXM).
NXM is an app that runs on the Ehereum blockchain. NXM can be compared to an insurance company running decentrally. Unlike central insurance companies, NXM has no profit motive. It is a mutual, which means the company is owned by the policyholders/users. All profits will be divided among them.

If you lose money during a token swap due to an error by UniSwap, Nexus Mutual will compensate you for the loss.

How does Nexus Mutual work?
At NXM, you can specify what kind of insurance you want. This can be done through their website. You then specify which DeFi application you want insurance for. You can choose from a large number of DeFi applications, such as Aave, Balancer or UniSwap. You then pay for the insurance and provide collateral. All payments from policyholders are kept in a pool.

Then, if you suffer damage on a DeFi application, you can file a claim with NXM. NXM's network will then vote on the validity of your claim. Fraud is impossible. The claim is reviewed and analyzed by the entire network. The claimant should also state why, what, how and what. Users who try to fraud will be punished harshly: the collateral will be taken away.

Frauding is also impossible. Why? Because all events are stored on the blockchain and everyone can see what happened in the past. After all, you can't modify the blockchain. That's theoretically possible, but practically unfeasible because you have to control 51% of the network. That is certainly impossible with the larger blockchains. It could be different with new blockchains or blockchains that are not well secured.

If you made a claim and the network agrees, the protocol will pay out your claim. The claim is paid from the pool in which policyholders pay their premiums. Therefore, the payout will be in NXM and not in Bitcoin, Dollars, Euros, etc. However, you can then convert your NXM into fiat money or another crypto.

The insurance can be cancelled at any time. You are not stuck with insurance policies of hundreds of pages that a normal person does not understand. You are not kidnapped, so to speak, by the insurance company. So the decentralized insurance world works simply, transparently and without lengthy contracts. When you cancel your insurance, you get your collateral back on the specified wallet.

NSure Network
NSure is a marketplace where insurance risks can be resold.

In such a marketplace, insurance issuers can resell policyholders' policies. If you think that the risk of a claim is very low, you can buy this insurance. You will then receive the premium paid by the policyholder, but will also have to pay the potential costs.

Insurance trading can be lucrative, but it is also very risky. In fact, it could cost you a lot of money should someone make a claim for their insurance. You are legally obligated to cover the claimed amount when you are the buyer of the policy.

How does NSure Network work?
NSure enables anyone to obtain insurance or cover certain risks for policyholders. As a capital provider/policyholder, you can see on the platform what kind of insurance users like. You can then decide to stake NSURE tokens on an insurance application you find attractive. Such an application may be attractive when you expect the risk to be small. You will receive daily rewards in the form of NSURE tokens when you cover someone's risk. Super cool right!

Before you do this, though, you have to provide collateral. That way the protocol knows for sure that you could bear a possible loss. Because should something go wrong, you will have to pay for the cost. So in effect, the risk is shifted from the user to the new lender who bought the insurance from another policyholder who should pay out the claims. But this person only wants to buy the insurance from another person if the risk of a claim is small.  This person can make a nice return on the risk being covered, though.

The cost you have to pay as a policyholder is determined by supply and demand. When a large number of people want to cover policyholders' risk, the policyholders pay a lower price. This also means that the lenders will receive a lower reward.

Users can protect themselves against hacks, scams and rug pulls through Ease. According to Ease, it can do so in a way that is simpler, safer and more effective than many other insurance protocols do.

With other insurance protocols, you have to provide collateral. This collateral must be equal to the value of the crypto you are insuring against. The moment the collateral decreases in value, or the covered tokens increase in value, you will have to take out a new insurance plan.

This ensures that this type of application can be used by only a small portion of crypto traders. After all, you have to own a lot of money before you can insure yourself against the risks.

Covering DeFi damage is what Ease does with Uninsurance. All assets/crypto covered by Uninsurance immediately serve as collateral. As a result, participants do not need to put up additional collateral, and everyone can participate in Ease's protocol.

With Uninsurance, there will always be enough collateral. This is because the value of the assets covered is equal to the value of the total collateral. In this way, Ease aims to be an insurance protocol that is user-friendly for its users.

You can participate in Uninsurance without having to pay. This is because the assets of all participants directly serve as collateral, so there is no need to pay any fees. You can cancel your insurance with Uninsurance by removing your assets. Super cool! This lowers the barrier to entry.

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