DeFi Insurance: Managing Risks of Digital Assets
Understanding DeFi insurance and its importance in mitigating DeFi risks and threats.
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A brief overview of the Ethereum Shanghai upgrade and an introduction to Liquid Staking.
The Shanghai upgrade has been the subject of a lot of discussion (and excitement) among Ethereum developers, investors, and enthusiasts. If you're not someone who follows Ethereum closely, you may be confused as to what the upgrade means and how it affects users.
The Shanghai upgrade went live on April 12 at 22:30 UTC. If it sounds like an oddly specific time, it's because the upgrade is scheduled to happen on Epoch 194048, which will occur at that time.
The Shanghai upgrade is the biggest upgrade to happen to the platform since the Ethereum Merge of 2022. The Merge saw Ethereum change from proof of work to proof of stake, and many of those who have staked ETH have been waiting for Shanghai because it implements EIP-4895, which allows the unstaking of staked ETH.
Unstaking isn't the only addition, the upgrade also offers some other important and interesting features:
The Shanghai Upgrade is a hard fork of Ethereum, and makes several changes to the protocol, although it does not include EIP-4844, a sharding option that is eagerly awaited by many Ethereum users because of its potential to increase the protocol's scalability.
Shanghai's biggest feature, other than the ability to withdraw staked ETH, is that it reduces gas fees significantly.
Some industry analysts are concerned that the unlocking of staked ETH could lead to a rush of people looking to sell ETH that has been locked up for months or even years. Others feel this is unlikely since around 70% of staked ETH is staked via liquid staking protocols such as Lido. These protocols already allow people to sell their staked ETH, so Shanghai will have a minimal impact on them.
The remaining ETH is staked directly via the beacon chain. The investors who stake in this way are usually larger holders, and many of them staked their ETH in 2020, long before there was a clear deadline for when they'd be able to unlock their funds. As these investors are in it for the long haul, the Shanghai upgrade may not necessarily prompt them to unstake their holdings, especially given the relatively attractive yields for staking.
Liquid Staking Protocols offer investors a way to access the rewards of staking without having to be able to put down the amount of ETH required to stake on the beacon chain as a validator. They can be considered a form of derivative. The liquid staking protocol accepts deposits and pools those deposits to stake them, then gives each depositor a receipt that is redeemable for staked tokens. The receipt is backed by staked tokens and can be traded or used as collateral just as the underlying asset could be.
The value of ETH held in a major liquid staking pool, such as stETH, tends to track the value of ETH very closely. However, liquidity for trading stETH and similar tokens is much lower than liquidity for ETH itself. Many investors are willing to accept this reduced liquidity because of the perks of easier access to their ETH if they ever need it, access to staking rewards, and reduced risk.
Validators may have some of their tokens "slashed" (taken from them) if they have downtime or errors on their node. The slashing penalty deters many people from running a validator, even if they have sufficient ETH to do so. Only those who have access to reliable hardware, a fast internet connection, and enough technical knowledge to keep the node stable are likely to choose to run a validator.
Liquid Staking Pools usually stake their ETH with several different validators, and if slashing penalties occur, any losses are spread out across the whole pool. This reduces the risk faced by any individual investor and makes liquid staking appealing to those who lack the expertise or tools to run their own node.
If the Shanghai upgrade influences the price of ETH, it may have an impact on some DeFi insurance protocols if their holdings are denominated in ETH, either directly or indirectly.
Cover pools in the Neptune Mutual marketplace are denominated in stablecoins rather than ETH; this insulates the protocol from crypto price volatility and helps build Neptune Mutual’s brand resilience. Even if the price of ETH were to fall after the Shanghai upgrade, the protocol would still be offering the same level of coverage.
If you'd like to learn more about our parametric insurance, which is offered for DeFi investments on both the Ethereum base layer and Arbitrum, take a look at our website today.