DeFi Insurance: Managing Risks of Digital Assets
Understanding DeFi insurance and its importance in mitigating DeFi risks and threats.
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In this blog, you will learn about how to stay focused and prepared during the bear market.
With prices dropping double-digits every day, the crypto market is not an easy place to be right now; particularly if you are swimming with the crowd in the mainstream crypto space. The risk of being bitten by the bear is real, and the consequence is unpleasant, as social media posts confirm every day.
Smart investors manage risk and look for opportunities to take advantage of bearish conditions. Should you be investing in negative beta stocks? What type of projects do well in a bear market? What are their characteristics?
Despite recent events, managing your exposure to crypto price volatility by investing a proportion of your portfolio in stablecoin projects still makes sense; as always, understanding the fundamentals is crucial, because not all stablecoins are the same breed of animal. In fact, quite the opposite, as many have recently discovered. Keeping things simple, there are two important points to understand about any particular stablecoin: what is the risk of de-peg, and how are the returns being generated?
The stability of any stablecoin largely depends on what the collateral backing it up may be. For instance, UST’s value was not at risk because of its lack-thereof in real-world assets but because it relied solely upon an algorithm for setting prices — something that can always fail eerily like other cryptocurrencies have done recently with huge losses suffered by investors who had put money into them as well.
Some stablecoins, like DAI, are backed by crypto assets, and given the more volatile nature of crypto assets, in order to increase the security and reduce the risk of depegging, DAI is over-collateralised to the tune of 150%. Better still are stablecoins that are backed by different forms of real-world assets, such as corporate bonds, commercial paper, US Treasury bonds, or cash. They provide a level of stability not seen in traditional fiat currencies — giving them varying levels from high to low-risk profiles depending on what’s being used for collateralization. The Binance stablecoin, BUSD is 96% backed by cash (or cash equivalents), and 4% backed by US Treasury bonds. So you can quickly see that stablecoins can be very different in nature and risk profile.
Generally, stablecoin projects seek to maintain a peg to another asset, often a fiat currency like the U.S. dollar, through a variety of mechanisms. Other projects have collateral in cryptocurrency reserves, while some use algorithms that adjust supply in order to keep prices stable. Still, others back each coin with an equivalent amount of another asset, essentially creating a tokenized version of that asset.
While there is no single blueprint for success, stablecoin projects that can successfully and sustainably minimise price volatility will undoubtedly have a bright future in the crypto space. In volatile and immature markets, such as crypto, it is important to have a reliable and stable safe haven for investors during times of trouble.
Coming back to reducing risk in a bear market, crypto projects that have an underlying business model driven by a “stable” stablecoin are an indicator that the project might not be your typical crypto fish swimming with the mainstream shoal.
Risk and return are finance’s yin and yang. Many complicated subjects break down into some very basic elements that simply form the foundations of everything else. In physics, there are four fundamental forces. In humans, there are five senses. In finance, there are six principles, the first of which is the principle of risk and return. So understanding return matters as much as understanding risk, and they are related. Put another way, and whatever any neatly crafted marketing material may say, high return low-risk crypto projects (or any other project) do not exist.
Returns can be made in a number of ways, but ultimately someone is paying for an investors’ return. Smart investors question how returns are made: who is paying for their return, is what is being received for the return commensurate with the return (i.e. is risk and return evenly matched), and how sustainable over time is the opportunity? Ring-fence your activities from crypto volatility with stablecoin projects.
The way projects use their capital can have a very significant effect on the project’s sensitivity to risk and return. Most investors are familiar with the concept of financial leverage, and how this gearing effect can be put to good use to increase returns with a given amount of capital (the corollary is, of course, also true). Fewer fully appreciate the consequences of the use of fractionalised reserve systems used in many insurance protocols where 1 dollar of capital is used to underwrite 2 or more dollars of insurance risk. More about this in an upcoming article in the pipeline.
Stablecoin projects that ring-fence their activity from crypto price volatility and minimise risks associated with the inherent price fluctuations of digital tokens offer a more reliable and sustainable investment proposition. They reduce exposure to cryptocurrency market risks.
With the bear market in full swing, it’s prudent to look for ways to protect your assets and limit their exposure to risk. When faced with danger, you behave differently. Investors in a bear market are more sensitive to risk and are more likely to take more precautions to mitigate risk.
Smart investors take an interest in psychology. Understanding the dynamics of buying and selling behaviour matters. In a bear market, there is an increased appetite for thinking about risk and protecting against risk. One risk that is getting extensive attention is the possibility that exchanges could be hacked and digital assets stolen.
That’s exactly the behaviour that drives demand for Neptune Mutual’s parametric cover platform. The platform helps protect investors against exchange hacks and dApp, DeFi, and smart contract exploits.
An increased appetite for mitigating risk would suggest that projects proposing digital asset protection would flourish in a bear market.
Protocols that protect assets, or diversify risks have the potential to provide stability and reduce losses. Minimising risk is helpful in a risk investment environment, and protocols that help do this are attracting the attention of smart investors.
Though the focus of attention for crypto traders often centres around market sentiment and hedging against price volatility, there are many who fail to take necessary precautions when it comes down to protecting their digital assets from hacks or exploits. This negligence can leave them vulnerable in ways that would never happen if more standard practices were followed by these professionals — a lesson we’ve seen time after again throughout recent months with devastating consequences across various industries.
The bear market has created some challenges for the crypto industry, but it has also opened up new opportunities. So what are the fundamentals that investors are looking for in a bear market investment opportunity?
It’s important to look for projects with a solid team that are committed to delivering value to the ecosystem they are building. The team should have an excellent track record and be transparent about their progress. A strong and engaged community is a good sign that the project has long-term potential.
Projects driven by stablecoins that help diversify assets, minimise risks, reward stakeholders with non-inflationary mechanisms (i.e. that are not endlessly printing tokens to give away), and have a sustainable long-term business model, are some of the underlying fundamentals of high-flying projects. These projects look less like your average crypto fish that a bear market might get its teeth into, and more like a sea eagle, taking its own direction, designed for its environment, the power and agility to bite back against crypto predators, and well out of the reach of the bear market below.
It’s difficult to find investment opportunities during turbulent market times. However, there are certain projects that show promise even in tough economic conditions. Neptune Mutual’s parametric cover platform allows cryptocurrency investors to purchase cover protection for their digital assets and helps them hedge against risks.
By doing your research and investing in projects with sound fundamentals, you can find great investment opportunities; you don’t need to get to the moon to fly above the bear market.
Investors have become more focused on long-term goals and HODLing investments for the longer term. This is a smart strategy, as it can help you take advantage of bear markets and make investment gains over the long term.
Bear markets are a natural part of financial market cycles, and they present opportunities for those who are patient and disciplined. Before you invest, make sure you understand the risks involved and better still make sure you take action to mitigate those risks. By taking a strategic and precautionary approach to investment and risk management, you can protect your investment portfolio from market volatility. Cover, protect, and secure.
Note: The information in this article does not constitute any form of advice or recommendation by Neptune Mutual and is not intended to be relied upon by readers in making (or refraining from making) any investment decisions.