Capital Pooling Risks
There are a number of reasons why Neptune Mutual has your back if you are a liquidity provider
Neptune Mutual believes that collaboration between projects is crucial for the sustainable growth of the DeFi insurance industry. To achieve this goal, it is essential to identify the weaknesses of existing DeFi insurance protocols and engage in constructive criticism to promote innovation and growth. Providing responsible disclosure and warnings is important to inform DeFi protocol users of the risks involved. The lack of transparency regarding "lock-ins" and the difficulty in exiting DeFi insurance contracts without adequate understanding has led to dissatisfaction among many users.
We recommend reviewing the risks associated with our protocol before proceeding.
If you have ever contributed liquidity to a DeFi cover protocol, you are sure to have encountered a number of challenges. We will attempt to address a few obstacles faced by DeFi insurance underwriters and liquidity providers.
Problem #1: Indefinite Lock-ins#
Underwriting always carries some level of inherent risk, but being indefinitely locked in is an unnecessary risk that should be avoided. It's important to have a clear exit strategy available if desired.
- In contrast to other DeFi insurance protocols that offer coverage for up to 12 months, Neptune Mutual offers a maximum coverage period of 3 months. This approach allows policies to expire gradually, freeing up capital for liquidity providers to withdraw as needed.
- The POD you receive as a stablecoin deposit certificate is an income (or loss) bearing asset. If you want to get out, you can sell it on the secondary market. You can redeem your PODs to get your stablecoin back.
Under special circumstances, Neptune Mutual has the ability to pause policy purchases, let covers expire, and allow full liquidity to be withdrawn from pools. Any profits or losses resulting from payouts would be factored in.
Problem #2: Offering Impossible Coverage#
If you are a liquidity provider, you do not have the choice to pick a specific pool to underwrite risks. You are exposed to all risks regardless of your preferences.
- When participating as a liquidity provider with Neptune Mutual, you have the freedom to choose which cover pool you want to join. This means that the incidents occurring in other pools will not have any positive or negative impact on your liquidity.
- Neptune Mutual's covers are only available by invitation. Before adding a new product to our platform, we conduct a thorough security review and ensure that it has stood the test of time. Our aim is not to offer hundreds of covers that could potentially put liquidity providers at risk.
- Neptune Mutual does not offer coverage for any financial risks, such as trading, liquidation, or margin calls, as well as risks related to stablecoin de-pegs, private key exploits, wallet hacks, and others. Our focus is primarily on on-chain risks, and to a certain extent, frontend attacks.
- We provide cybersecurity consultation to our portfolio cover products in exchange for allocating staking rewards to our NPM tokenholder community. This includes a comprehensive security review of smart contracts, frontend, backend, DNS, supply chain, and hosting, among other things.
- We provide additional cover funding to projects that pass our security review. Our liquidity provider community may view this positively and may wish to participate.
Problem #3: Loyal Tokenholders Punished During Incidents#
When claimants sell their payouts, the value of your tokens may continue to decrease. If you participated in staking pools, the value of your tokens may have been reduced due to a payout.
- Neptune Mutual doesn't face this issue because NPM tokens are not used for risk underwriting. When a payout occurs, stablecoins are distributed instead of NPM tokens. In fact, when an incident happens, the demand for NPM tokens increases because they are used for incident resolution. Those who vote incorrectly lose all their tokens, some of which are burned.
- The NPM tokens in Neptune Mutual's staking pools are immune to underwriting risks. NPM tokens are not distributed as payouts to claimants.
- Through our cover liquidity support program, tokenholders can stake NPM tokens and obtain a number of tokens in staking pools.
All That Glitters Is Not Gold#
The publicity surrounding new DeFi protocols generates a lot of interest, and unfortunately, this can lead to many uninformed users becoming trapped in products that they cannot easily exit.
It is well-known that underwriting comes with its own risks. As a co-underwriter, you and a large number of other users pool their capital to underwrite risks together. Participation in an underwriting activity is primarily motivated by the desire to earn policy premiums and other incentives while minimising risks, no different than traditional insurers. Although there are inherent risks in underwriting, you should not be exposed to the unnecessary risk of being locked in for an indefinite period of time. If you want to, you should have a clear way out.
We strongly believe that a successful DeFi insurance protocol should create opportunities for informed and knowledgeable DeFi users to pool their capital together in a cooperative environment. At Neptune Mutual, those who pool their capital for a cover product are known as liquidity providers. Similar to traditional cooperative societies, the liquidity pool for a cover is owned by the liquidity providers, not Neptune Mutual.
Before listing a product, a robust DeFi cover protocol must reduce LP risks by doing in-depth due diligence on the portfolio covers. The LP community will feel animosity if a they are exposed to an insecure product behind a cover pool without having a choice.
Can You Cover All DeFi Protocols?#
Maybe not. We believe that not all DeFi protocols can be successfully covered. This is the fundamental reason we refactored the protocol make the cover creation feature an invitation-only system. Before we get into the reasons, let's talk about traditional insurance companies for a minute.
Is Traditional Insurance a Profitable Business?#
Traditional insurance businesses generate profits by placing wagers on the probability of risks being low enough that they will not drain their financial resources. In order for an insurance company to generate a profit, they must be able to forecast their financial solvency.
Insurance companies are paid fees in regular installments by people who want to cover a specific risk, such as asset loss, theft or damage to property, health, or death. Insurance companies profit from the income generated by the sale of these policies minus the operational expenses.
profit = policy fees - (claims payout + operating expenses)
Insurance companies make a profit by ensuring that the likelihood of providing a payout is lower than the revenue they generate. Insurance companies rarely go bankrupt because payouts are not made all at once, and losses can be offset over time. However, in DeFi, a trigger event can affect thousands of users at once. As a result, traditional insurance models are insufficient and ineffective for DeFi native coverage.
Is Neptune Mutual a company with a profit motive? How Is Neptune Mutual Different?#
Although our cover pools operate similarly to traditional cooperative societies, it's important to note that Neptune Mutual is not a non-profit or a DAO. We believe that DeFi insurance protocols shouldn't overlook the importance of financial stability and the ability to pay out claims, just like conventional insurance firms. Our primary goal is to maximize profits while minimizing risks. Our protocol is designed to function even in the case of a black swan occurrence, as mentioned in our Risk Disclaimer.
How is Neptune Mutual Different?#
Neptune Mutual functions as an infrastructure provider and marketplace, rather than an insurance company. A comparison can be made between traditional insurance providers and the individual cover pools offered by Neptune Mutual. However, we do not earn policy premiums like typical insurers do; instead, liquidity providers earn them. In the same vein, the liquidity pools are owned by the liquidity providers, not us. In essence, we provide the DeFi community with a conduit to crowdfund the capital building part of an insurer. Before we proceed, we conduct a thorough due diligence of the protocols we are covering, including a comprehensive security review. Additionally, we offer liquidity assistance through our partner network to products that exhibit a commitment to cybersecurity.
Neptune Mutual, unlike the majority of DeFi cover protocols, does not cover financial risks such as margin calls or liquidations, stablecoin pegs, or private key exploits. We believe we are still early and that these risks are not coverable at this time due to the lack of maturity of these products. Coverage is impossible without projects spending years developing and testing their products. Neptune Mutual is not interested in liquidating LPs' hard-earned capital for the sake of our experiment. Our primary design goal is to protect liquidity providers from unwanted risks and to allow them to exit if necessary for whatever reasons they may have.
In summary, we are unable to provide coverage for projects that have not prepared and accounted for their own insurance protection fund, lack confidence in funding their own pool, and do not prioritize protecting their community in the long term. Projects that exhibit these fundamental qualities will receive stablecoin funding for their pool and technical assistance from us to programmatically and gradually bootstrap their cover liquidity through smart contract and SDK integrations.
You can select which cover pool to underwrite as a liquidity provider. Your risk exposure is limited to that pool, rather than everything on the Neptune Mutual marketplace.
Incident Reporting & Tokenholder Discontent#
In the blockchain space, it's challenging to gain long-term attention from the community. As we've observed with many projects that come and go, people quickly abandon them and move on to the next protocol. The blockchain community isn't very loyal to projects that don't provide them with compelling reasons to stay. Every few years, the top 100 projects change, which makes it critical to first establish trust and then work hard to create a loyal community around a DeFi project.
This becomes especially challenging when projects fail to communicate effectively about the risks they're exposing their community to.
Loyal Tokenholders Abandon the Project After Incidents#
When an incident occurs in some cover protocols, tokenholders sell their tokens. Some protocols penalise their loyal community for holding onto their tokens by reducing their balances as a result of the incident. This causes friction within the community because users are often unfamiliar with how DeFi insurance underwriting works. As a result, it is critical to categorize activities into different features and make it simple for users to understand.
Neptune Mutual does not have this problem because NPM tokens are not used to underwrite risks, and when there is a payout, stablecoins are given instead of NPM tokens. Furthermore, the demand for NPM tokens increases when there is an incident, as NPM tokens are used for incident resolution. People who voted incorrectly lose all of their tokens, and a portion of these tokens are burned.
Staking Pool Balance Slashed During Incidents#
Many DeFi cover users have experienced a sudden reduction in their staked token balance from a staking pool. This occurs because the slashed tokens are distributed to claimants as payouts. When purchasing tokens and proceeding to the staking pool to receive a reward, many individuals did not fully comprehend the terms they were agreeing to. This is a double-edged sword, as loyal tokenholders are penalized, yet the claimant may not wish to hold onto the tokens because they want to recover from the incident for which they received the payouts. If the token's value declined between the time the payout was finalized and the time it was received, the claimant may want to reduce their losses by selling the token as soon as possible.
The NPM tokens in Neptune Mutual's staking pools are immune to underwriting risks. NPM tokens are not distributed as compensation to claimants.