After much deliberation and careful thought Neptune Mutual decided to close the cover marketplaces.
After much deliberation and careful thought Neptune Mutual decided to close the cover marketplaces. Below the reasons for the decision as well as what it means for the community.
The marketplaces will be closed using an emergency withdrawal process whereby the liquidity provided to cover pools by LPs will be returned to the wallet addresses from which the liquidity was supplied. In addition to protecting cover pool LPs, there will also be refunds to all cover policy purchasers with an existing and valid policy who have paid over 10 USD in policy fees in one transaction.
For veNPM holders, please fill out this form to receive a refund for your veNPM to NPM conversion penalty.
From the end of June there will no longer be NPM emission incentives for LPs i.e. Epoch 3 of the liquidity gauge emissions will be canceled.
Unused funds raised from financial backers will be returned to those backers; this includes DEX liquidity that has now been removed from SushiSwap and Uniswap. A small amount of liquidity on SushiSwap Arbitrum has been left to enable a minimum amount of NPM trading.
The protocol will be open sourced, and become a true public good. Enabling the community to fork the code developed by the Neptune Mutual team such that others might use the existing resources to further our mission to make the blockchain space better protected against smart contracts and other risks.
There are numerous factors that have led to this difficult decision, some of which are external factors which are uncontrollable or unforeseeable. A few factors summarized below:
“Given Neptune Mutual’s Tier 1 backers, why have you not listed on a top CEX?”
This is perhaps one of the most frequently asked questions. In short, the answer is that for a variety of reasons Neptune Mutual was not able to achieve the diverse set of performance metrics (community size and engagement, marketplace user activity, DEX 24 hour trading volume, TVL growth etc.) required to list on top tier CEX. The CEXs that are prepared to list NPM token do not have the depth of liquidity or breadth of user-base to offer good prospects for NPM tokenholders.
“Why has Neptune Mutual not achieved strong growth?”
It is tempting to take a shortcut to answer this question by pointing a finger at one specific factor, but the reality is that there are many contributing factors. A few summarized below:
Since the outset of engaging with the community we have endeavored to highlight the need for DeFiInsurance; Neptune Mutual built a comprehensive dataset of on-chain hacks available, anywhere, and each week we highlight the many millions of dollars that are stolen as a result of smart contract hacks. Despite this, we have consistently been confronted by projects unwilling to spin up cover pools in our marketplace because of the sentiment that audits of their code are sufficient to persuade their community that their protocol is safe. Less than 0.3% of all digital assets are protected with some form of DeFiInsurance, and yet despite all the media reports of hacks, the conference discussions about the importance of governance or CEX proof-of-reserves, it continues to be the case that it is extremely difficult to get media attention to focus on the need for a fast and efficient means of mitigating smart contract risk.
A variety of approaches have been taken by different DeFiInsurance protocols to address this, from attending multiple conferences throughout the year and significant marketing spend, to the leaner approach that Neptune Mutual took (in part as a result of the bear market in 2023). What can be said is that no DeFiInsurance protocol has managed to achieve significant growth over the last 18 months, sadly the overall TVL of the sector has shrunk a lot.
For all the reasons above, at this moment the best course of action is no longer to double-down on investing in growth, but rather to refund unused capital and close the marketplaces.
The consequences are very tough for the Neptune Mutual team who have spent the past 3 years of their time on the mission to facilitate safer environments within DeFi. The team has delivered products according to the roadmap and the fact that the protocol was never hacked, despite attempts being made on the darkweb, is testament to the expertise, passion and absolute focus on security. The team survived the FTX and UST crisis unscathed, and believed that the continued growth in hacks would lead to growth in the demand for a good solution to mitigate these risks, but sadly, as can be seen right across the DeFiInsurance category, this is not yet in sight. So we would like to thank the team for all the dedication, skill and passion invested into the Neptune Mutual project since the outset.
The team will open source the protocol, including blockchain indexing protocol (subgraph alternative), frontend, middleware, database, and backend code, to make it a true public good. This will allow anyone to fork the code and create covers by defining parameters and premium ranges, potentially leading to innovative covers and organic usage.
The Discord channel will be closed to reduce the risk of phishing and other types of cyber attack, any questions / queries will be responded to in the Telegram channel.
We want to take this final opportunity to thank you all for your support.
Neptune Mutual will contact only its financial backers, with whom a signed agreement exists, in relation to next steps (i.e. holding NPM tokens does not qualify you for any form of refund). Contact will be made only from a neptunemutual.com domain email address so please check the source of any email you may receive very carefully. Please ignore any messages from any other email or social media accounts in relation to token/cash refunds.
Why capital requirement matters: What happens when more capital is required than there is capital?
Let’s start at the end with why capital requirement matters: What happens when more capital is required than there is capital?
Avid Neptune Mutual blog readers will have read one of our recent articles, Don’t Be a Salmon in a Bear Market, and recall a line that reminds us that “the stability of any stablecoin largely depends on what the collateral backing it up may be.” It goes on to describe how some stablecoins have zero collateral in terms of real-world assets, and others, such as BUSD, are 100% collateralised with real-world assets. This matters when, for one reason or another, a larger than expected call is made by depositors to withdraw their funds. As holders of the 2022 UST crash found out a couple of weeks ago, collateral, or capital requirement, really does matter — a lot.
Capital requirement matters greatly for entities that are either receiving deposits and making loans, or entities that are receiving underwriting capital and selling insurance, cover policies, or products that hedge other types of risk.
As any parent will know, it is difficult to share your hard-learnt life lessons with your children in a way that will help them avoid making the same mistakes. Some may recall the financial instrument that caused the 2008 financial meltdown and the bankruptcy of Lehman Brothers: CDOs or collateralized debt obligations that were used to refinance mortgage-backed securities; or even more toxic, synthetic CDOs. The keyword here being collateralized.
A more recent event, in 2021, albeit very different in nature, was the short squeeze inflicted upon a large American hedge fund, Melvin Capital, by an option trader community in the r/wallstreetbets subreddit. In an unexpected scenario, Melvin Capital ran into difficulties regarding insufficient capital to meet its much-maligned short trading bet against the infamous video game retailer, GameStop.
Without a doubt, capital requirement does indeed matter.
So, let’s dive into the two different approaches to balancing the need for sufficient capital versus the need to use capital efficiently so that it may be put to work and generate revenue:
Fractionalised reserve systems are financial systems that maintain only a portion of their customers’ funds in their reserves.
The concept was first introduced in the banking industry. As the name suggests, fractional reserve systems only have a fraction of their bank deposits available for withdrawal by customers because the remainder of the deposits is used to lend out to other customers. Put another way, a 100% reserve bank retains all deposits from its customers (as the name suggests) and so is able to guarantee that in the event that every customer wants to withdraw their respective deposits at the same time, they can do so. This approach means that a 100% reserve bank does not have sufficient capital from depositor funds alone to be able to make any loans. In turn, this means that whilst being very safe, it will not be able to generate revenue from loans to pay depositors an interest rate on their deposits.
In a fractionalised reserve system where, for example, a bank has a reserve requirement ratio of 10% (i.e. is only required to keep 10% of customer deposits in reserve). If someone deposits $100 to this bank, the bank can lend out $90. If the borrower of that $90 deposits that back to the bank again, the bank can now lend out another 90% or $81. Whilst this scenario is unlikely in the traditional banking system because lending rates are higher than deposit rates, this mechanism is definitely something that you’ll find in the DeFi sector. Looping is a mechanism that quite a number of yield aggregators use to achieve high levels of leverage to generate high yields from a variety of borrowing and lending protocols and stablecoin currencies.
The Minimum Capital Ratio or MCR dictates the very lowest level of reserves required by financial regulators.
The insurance industry also adopted fractionalised reserve systems as it enables more efficient use of capital.
As with banking and traditional finance, the insurance industry is regulated and requirements vary depending on geography, market sector, and the corresponding regulatory requirements. In Europe, EU insurance companies need to comply with the Solvency II Directive which provides codes and regulations in respect of capital requirements including MCR and SCR which we’ll talk more about later on.
Based on current regulatory standards, an insurance company needs to calculate its capital on hand against its total underwriting liabilities. They need to meet a minimum level of required capital on their balance sheet based on the forecasted payout of liabilities that may arise over the next foreseeable future, say one year. This means regulation could require an insurer with an underwriting liability of $100 million to hold 10M$ on its balance sheet.
Like banks, different insurance companies use different models.
The leverage effect of a fractionalised reserve approach is attractive because it makes use of the capital in a more efficient way to generate returns for underwriters than a non-fractionalised system. In order to mitigate the risk of using 1 dollar to underwrite several dollars of risk, it is important for insurance companies to ensure that those risks are diverse in nature in order to reduce the likelihood of them arising at the same time.
The extent to which entities leverage their fractionalised reserve system in combination with their ability to manage and diversify the risks that are underwritten combine to form the entity’s exposure to insolvency.
Pros of Fractionalised Reserve Systems
Capital efficient
Contributes to economic expansion
Cons of Fractionalised Reserve Systems
Less capital security
Policyholders payouts are not guaranteed
Insolvency; risk of bank runs, defaults, or entity liquidity.
A non-fractionalised reserve system can be used when the need for capital security and less, or no financial leverage outweighs the benefits of more capital efficiency.
For insurers, this means that underwriting capital is always equal to or greater than the total amount of underwriting liability. This ensures that there is always sufficient underwriting capital to pay all of the risks underwritten for policyholders, even if they all claim at the same time.
Minimum capital ratio, or MCR, is one of a number of metrics used to help answer the question, how do you measure capital requirement?
To start with, it’s important to understand the concept of solvency. According to Investopedia, solvency is a measure of capacity used in fractionalised reserve systems to find out whether a business can meet its debts, liabilities, and financial obligations in the long run. It is a reflection of business financial health.
Through the use of requirement ratios, investors can assess the solvency of a business and its capability to sustain operations. Requirement ratios help businesses to maintain a financial position that is safe and solvent. One of these requirement ratios includes MCR.
MCR is a term used in fractionalised reserve systems to determine the minimum required value of assets that a business must hold. MCR is regarded as a business’s capital requirement ‘hard’ floor in regulation. Once a business falls below the required Solvency Capital Requirement, or SCR (the other ‘soft’ floor requirement ratio), regulation intervenes to ensure that businesses don’t go below the MCR; failure to comply may incur regulatory actions to stop the entity from getting further out of line with its compliance requirements.
So, What Reserve System Does Neptune Mutual Run On?#
For traditional insurance models that use fractionalised reserve systems, MCR is a standard metric. In DeFi, several cover protocols adopt MCR as a metric.
Considering that the global DeFi ecosystem is relatively young there is not yet sufficient historical data to simulate the probability of loss reliably, and therefore it is not possible to calculate (with sufficient statistical significance) a reliable price point for this risk.
When considering what type of capital requirement modelNeptune Mutual has adopted, it is important to note that Neptune Mutual uses a parametric cover policy approach which is quite different from a basket of risks underwritten by a common set of underwriters using a discretionary model. As the parametric approach to financial protection has a different risk profile to traditional insurance pools, MCR is not well suited for parametric protocols like Neptune Mutual.
So, Neptune Mutual Protocol V1 follows a full reserve system (or a non-fractionalised one) that maintains 100% of the capital in stablecoins against the total amount covered for cover policyholders by any specific cover pools in the platform.
If you purchase a cover from the Neptune Mutual platform and become a policyholder, you’re guaranteed that any and all claims you make get a payout instantly once the incidents covered by your cover pool are resolved.
It is integral to the purpose and mission of Neptune Mutual that our cover protocol puts you, our users, and cover purchasers’ interests first above all else and ensures that we can make a payout immediately when needed. Discover how our platform makes this possible through protocol parametric protection. You can also learn how to purchase a cover on Neptune Mutual.
