Taking A Closer Look at Roe Finance Exploit
A price manipulation attack at Roe Finance allowed a hacker to be profited by $80,000.
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Underwriting capital (liquidity) is the lifeblood of any insurance entity. The same is…
Underwriting capital (liquidity) is the lifeblood of any insurance entity. The same is true for blockchain cover protocols where the ability to source liquidity is one of the principal factors defining a protocol’s ability to scale the amount of protection it is able to offer.
The Neptune Mutual community is familiar with dedicated cover pools, where cover pool creators design parametric cover policies specifically to protect against security risks relevant to their project community. So, what are diversified cover pools, how are they different from dedicated cover pools, for what type of projects are they helpful, and why will this new addition to the Neptune Mutual marketplace help scale adoption of cover policy protection of digital assets?
Dedicated cover pools work well for DeFi or Metaverse projects that have an established community for whom they wish to create a cover policy, and to whom they can also look for support to help fund the cover pool liquidity. The combination of protection for cover policyholders, and earnings + rewards for those funding the underwriting liquidity, provides an excellent basis for increasing community engagement and confidence in the project.
There are, however, certain types of projects for which a dedicated cover pool model may experience strong demand for cover policies, but none-the-less face challenges around sourcing liquidity to meet this demand. Take, for example, the case of a newly launched DeFi yield farming protocol with a total community of say 25k at launch. A variety of factors go into informing the underwriting community about the the security measures in place and the corresponding risks they are taking when funding the cover policy proposed by the cover creator; these were discussed at length in our article “Bootstrapping Cover Pool Liquidity: How Do We Encourage Our Community to Fund Our Cover Pool?”
It’s quite possible the DeFi project in question has an anonymous team, a closed code-base, and a limited track record of secure mainnet operations. Even if the project does in fact have an excellent standard of security and a high quality reliable team, this may not be transparent or easy to communicate. Under these circumstances, it is possible that the underwriting community feels insufficiently informed to be able to evaluate the risks they are taking in providing underwriting liquidity.
In summary, early stage DeFi projects may have a strong demand side for cover policies but struggle to bootstrap liquidity for their pool if they have a small community, or do not take all the actions recommended by Neptune Mutual for bootstrapping liquidity.
Another example of where we believe there will be demand for the diversified cover pool model is in the low security risk sector of digital assets. Given the high levels of security and correspondingly low levels of risk of hack or exploit for certain well-established sectors and players within the blockchain space, such as custodians and leading CeFi exchanges, it follows that the pricing of cover policies underwriting these risks should be correspondingly low. In this example we again might expect strong demand for cover policies as CeFi exchanges have large communities, however in this case the challenge with sourcing underwriting capital is the relatively low returns offered by the cover policy premiums to liquidity providers. Diversified cover pools offer a solution to this by combining two elements: diversification of risk, and leverage of underwriting liquidity.
Over time we expect to see a wide range of different diversified cover pools that group together projects of a similar risk profile.
A diversified cover pool refers to a cover pool that provides liquidity to a portfolio of cover pools, each with their own specific cover policy trigger parameters. No cover policies can be bought directly from the diversified cover pool, only from the project specific pools within the portfolio of the diversified cover pool. The project specific cover pools negotiate a certain percentage of the liquidity available from the diversified cover pool creator.
The diversified cover pool is created by a diversified cover pool creator. The creator of this diversified cover pool selects a certain number of projects to form part of the portfolio, and each of these projects has a cover pool which is funded by the liquidity of the diversified cover pool. Whereas dedicated cover pools are likely to be created by project founders, looking to engage and protect their community, we anticipate that diversified cover pool creators will be specialist actors in the DeFi market, or potentially asset managers / investors that have token or equity shareholdings in a portfolio of projects of a similar risk profile.
Cover policyholders can buy policies from any of the individual projects within the portfolio. In the event of an incident the reporting and incident resolution process is the same for both diversified and dedicated cover pools. Clearly, given that there are multiple projects that each have an allocation of liquidity from the diversified cover pool, if an incident is validated in one project the pay out will be limited to the amount allocated by the pool to that project, and therefore will only represent a portion of the liquidity in the diversified cover pool.
As there are a number of different projects covered by the liquidity of the diversified cover pool, diversified cover creators can choose to increase capital efficiency by providing more than $1 dollar of cover policy for $1 of liquidity, with the assumption that not all projects within a diversified pool would be hacked on the same day.
It is therefore very important for policy holders to understand that when they buy a policy from a project selected from the portfolio of a diversified cover pool, that in the unlikely event that numerous or all of the projects within the portfolio suffer an incident at the same time, there may not be sufficient funds to pay out all of the cover policyholders (if the diversified cover creator has chosen to increase capital efficiency ). Instead, payouts will be on a first come first served system whereby the first projects where an incident is validated will have first call on the liquidity within the diversified cover pool.
The principal difference is that the diversified nature of the risks covered by a diversified cover pool, as opposed to a dedicated cover pool, meaning that a single incident from a single project will at most only deplete a % of the diversified cover pool liquidity; and increased capital efficiency means that higher returns shall be generated for the same amount of capital from the liquidity providers.
The leverage factor will be an input that the diversified cover pool creator sets at the outset, and it will be identified on the card of the diversified cover pool, and in the information shown to liquidity providers before they commit to investing.
The creator of a diversified cover pool will set a common floor and ceiling price for all the projects within the portfolio. For this reason, it is very likely that all diversified pools will contain projects of a similar risk profile. Note that each project will have an allocation of liquidity, and that therefore different projects within the diversified pool portfolio are likely to have different utilisation ratios at any point in time, that is to say the amount of cover policies underwritten in relation to the allocation of liquidity capital will very likely be different for each project within the portfolio. As utilisation is a strong driver of policy pricing, one can expect the price of cover policies to be different for each project, despite the fact that the floor and ceiling price set by the cover creator for all of the projects within the portfolio are the same.
Newer blockchain projects, such as Web3, decentralized finance (DeFi) applications and non-fungible tokens (NFTs) process billions of dollars of transactions every day. This makes them super attractive to hackers.
Most of the biggest hacks and criminal exploits in recent times have been directed at these blockchain projects. Who can forget the OpenSea and Wormhole bridge attacks in early 2022 that saw over $321 million combined lost to hackers?
Whereas in 2021 alone, successful attacks on DeFi protocols resulted in the loss of over $1.3 billion .
As newer projects emerge within the blockchain ecosystem, it is imperative to ensure they have access to underwriting liquidity to provide cover policies to protect the digital assets of their communities.
As already mentioned in our article Be Aware of the Bear! Crypto Crash Heightens Awareness of Risks & Hacks, But Is This Enough to Drive Mainstream Adoption of Digital Asset Protection? convenience is one of the most important factors driving the adoption of protection for digital assets.
What makes diversified cover pools convenient is the fact they provide a means for bypassing the need for DeFi projects to bootstrap their own liquidity in order to provide cover pool protection for their respective communities.
For CeFi exchanges and custodian entities it is possible that much larger quantities of liquidity will flow into diversified cover pools, potentially institutional investment, given the relatively low and diversified nature of the security risks being underwritten for CeFi projects, and the relatively strong returns available because of the capital efficiency to provide greater policy revenue than would otherwise be the case. Opening the door to institutional investors and CeFi cover policy cover offers the potential to scale adoption of parametric cover across new sectors.
Risk and returns are two terms everyone in the blockchain space is familiar with, and for insurance and cover protocols both sides of this equation are very important to understand in depth.
Let’s start with the returns.
Liquidity providers are incentivized to contribute to pools through a number of ways, including:
All of the above earning streams are valid for both dedicated and diversified cover pool liquidity providers.
It is important to understand the risks that your liquidity is underwriting, whether it be for a dedicated cover pool or a diversified cover pool. This needs careful review of the terms of the cover policies for each project, and of course your own research on each project to evaluate its team, security and track record.
In addition, there are risks associated with the Neptune Mutual project, that is to say the investment strategies used to increase returns to liquidity providers. Whilst the Neptune Marketplace does not take custody of funds, there is the possibility that the protocol itself might suffer a hack or exploit resulting in loss of funds from the cover pool. To mitigate this risk, Neptune Mutual engaged top tier smart contract auditors and shall continue to uphold highest standard of all round security practice.
The Neptune Mutual application is a marketplace for parametric cover protection against hacks and exploits. Here, stakeholders can access both dedicated cover pools and diversified cover pools.
These pools are open to anyone looking to purchase a cover policy to protect their digital assets, as well as to people looking to earn income and other rewards by supplying liquidity to either dedicated cover pools or diversified cover pools.
What makes Neptune Mutual’s parametric cover solution so compelling is that policyholders do not have to make individual claims for proof of loss, and following incident resolution, all policyholders are eligible to receive the payment due under their policy.
The diversified cover pools open up parametric cover to a much wider spectrum of blockchain projects and offer more choice to liquidity providers in terms of the sector of activity, the type of risks underwritten, and the approach to efficient use of underwriting capital, based on either 100% minimum capital requirement for dedicated cover pools or the potential for leveraging underwriting capital for diversified cover pools.
Diversified cover pools should provide an interesting entry point for digital asset managers into the underwriting liquidity space, and this is undoubtedly needed in order to scale adoption of digital asset protection across the industry.
Neptune Mutual project safeguards the Ethereum community from cyber threats. The protocol uses parametric cover as opposed to discretionary insurance. It has an easy and reliable on-chain claim process. This means that when incidents are confirmed by our community, resolution is fast.
Join us in our mission to cover, protect, and secure on-chain digital assets.
Official Website: https://neptunemutual.com