Investing in DeFi pools offers the potential for high yields, but those yields are not without risk. Smart contract bugs and exploits, such as the ones targeting Ronin and Poly Network have collectively drained billions from investors. DeFi insurance aims to mitigate many of the risks associated with smart contracts and digital currencies. As of mid-March 2023, the TVL of DeFi insurance assets was around $330 million. In order for the blockchain ecosystem to become more resilient and more secure for users, DeFi adoption needs to grow rapidly in order to cover a large share of the $49 billion of assets in the space.
Finding the right cover protection is a challenge for many who own digital assets. In this blog, we review some of the factors to consider when selecting a DeFi insurance protocol.
What to Look for When Selecting a DeFi Insurance Protocol#
DeFi users have a lot to think about when choosing an insurance protocol, including:
- Coverage: Is a cover product available?
- Liquidity: Is there sufficient underwriting capital to receive a payout?
- Transparency: Are there any hidden risks like risk of not being paid out or risk of not being able to withdraw liquidity?
- Security: How secure is the DeFi Insurance protocol from cyber threats?
- The claims process: Can I rely on the policy to pay out in an incident, and how long will it take to receive the payout?
- UI/UX: How easy is the protocol to use and understand?
While Ethereum still dominates the DeFi marketplace, and accounts for the majority of the TVL in DeFi insurance, there are other chains in operation. BSC, Avalanche, Polygon, and Arbitrum are all examples of active chains with popular DeFi platforms. If you're looking for cover on one of these chains, then your DeFi cover options may be more limited.
Some cover products are limited to a few or even just one DeFi insurance protocol; for example, OKX Exchange cover policies are only available from the Neptune Mutual marketplace. To find out whether a cover product is available, users can either research each individual DeFi Insurance protocol or another option is to search on a DeFi Insurance aggregator such as Bright Union.
Insurance That Doesn't Pay Out Is a False Economy#
It can be tempting to select the cheapest insurance policy; however, it is important to understand the “small print”. Some of the leading DeFi insurance protocols have trackers that enable you to see what proportion of policyholder claims are accepted and what proportion are denied. If you are paying to mitigate the risk of losing digital assets, then it is quite likely that this is a scenario in which you will expect the incident resolution process of the DeFi Insurance cover you have selected to payout. It is therefore very important to understand the different types of cover and the different types of incident resolution processes.
Two common cover types are discretionary and parametric. Discretionary cover requires users to make individual claims based on the loss of an asset, and these claims each need to be assessed by a loss assessor. It is at the discretion of the loss assessor to decide whether to pay an individual claim or not, and this explains the name given to this type of cover.
Parametric cover is different. If an incident occurs, then it is the incident that is assessed, not individual claims. If the incident is deemed claimable, then all cover policies are eligible for a payout, irrespective of whether they have suffered a loss or not. This means that the incident process is much faster and more reliable. The parametric cover available in the Neptune Mutual marketplace typically pays out after 8 days.
How Safe Is Your Chosen DeFi Insurance Protocol?#
Just as DeFi protocols themselves are a target for hackers, so insurance protocols are also appealing targets. It's a good idea to do some due diligence on any protocol you're considering using:
- Does the management team have a public presence?
- Do they have a track record in the DeFi space?
- Is the source code for the protocol available and published online (e.g. on GitHub or GitLab)?
- Has an experienced third party audited the source code?
- Does the protocol have a bug bounty program?
- Does the protocol have a history of suffering any losses as a result of cyberattacks?
Many DeFi projects are open source, which means anyone can see the code that makes them work, and even make suggestions for changes to the protocol. Bug bounty programs offer ethical hackers an incentive to report any security issues or problems they find in the code, giving the managers of the DeFi protocol an opportunity to fix them. This helps them avoid issues such as the hacking attack that Nexus Mutual fell victim to, giving users some degree of reassurance that their assets are safe.
A Comparison of Popular DeFi Insurance Protocols#
There are a few websites that compare DeFi insurance protocols, the most notable of which is DeFillama which provides economic data on the DeFi insurance projects. OpenCover is a data aggregation website that focuses exclusively on providing information about DeFi insurance projects. Another comparison website is BrightUnion which is a discretionary cover policy aggregator/reseller.
There are many DeFi insurance providers to choose from. Nexus Mutual is the largest, being 2.3 times larger than the combination of the remaining 19 of the top 20 insurance protocols. Credibility is undoubtedly a key factor in a cover purchase’s selection process. DeFi insurance protocols that are designed in such a way that they can scale will clearly build a strategic moat between themselves and smaller rivals based on the notion that larger protocols are more credible than smaller ones, although obviously there are factors other than TVL that impact credibility, such as user experience.
Given the tiny proportion of digital assets that are covered by the whole DeFi insurance category, it would suggest that the current market leaders haven’t yet figured out an approach that can scale to the needs of the digital asset market.
Neptune Mutual has chosen to focus on the Ethereum and Arbitrum blockchains, differentiating itself from its rivals with its parametric cover that makes claims processing faster and more efficient.
What is clear is that in comparing different cover products, it is important to consider the full spectrum of factors that make a cover policy worthwhile.
If you'd like to know more about the cover pools we offer, take a look at the Neptune Mutual app today.
