DeFi Insurance
Learn how DeFi insurers can protect your crypto
TLDR:
DeFi Insurance exists to provide protection in areas like: Smart contract exploits; Protocol failures; Stablecoin depegging; and in some cases Custodial risks.
Most platforms work through a pooled risk model where users pay a premium into a shared pool of money, which then covers claims when things go wrong.
Nexus Mutual is the biggest player in the space accounting for almost 90% by TVL, meanwhile some of the bigger players like InsurAce have faded away.
DeFi insurance is not a silver bullet though and will not cover user errors like sending funds to the wrong address or falling for phishing scams, so stay cautious.
This week I decided to take a quick look at DeFi insurance. DeFi’s growing fast and so is the creativity of hackers and scammers, so insurance in crypto is becoming ever more important.
Admittedly insurance isn’t the most exciting topic, but it’s a big deal and it’s still a nascent part of the space so it’s great to see players emerging in the market.
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DeFi Insurance
Decentralized Finance (DeFi) is a new and innovative financial system being built in the crypto space. It offers freedom, speed, and accessibility, but with this innovation comes many real risks, and that’s where insurance comes in to provide people with some safety against those risks.
DeFi Insurance is still very nascent and mostly a niche sector, however as DeFi continues to grow rapidly you can bet that DeFi insurance will follow suit. It’s worth remembering that insurance in traditional finance (TradFi) is a multi-trillion dollar industry!
At its core DeFi insurance provides a way to protect your crypto transactions from unexpected losses, you can think of it as a crypto safety net, which is pretty important considering just how many hackers and scammers the space unfortunately has.
DeFi Hacks
DeFi Llama reports that over $11.3bn has been hacked in crypto since 2017 with over half of that $6.4bn being in DeFi.
Just earlier this year we had one of the largest hacks ever in crypto where Bybit were hacked by the North Korean backed Lazarus Group for over $1.4bn, which I wrote about in the post below.
Bybit is a centralised crypto company but this specific hack was done through attacking the interface of one of its DeFi multi-sigs, in other words, it could have easily been performed on many DeFi projects too.
Since then that money’s been laundered and Bybit have had to swallow that gigantic loss. You can see that crypto’s still in many ways the Wild West of finance and so this is exactly why DeFi insurance can help.
While it can’t cover everything, it can provide peace of mind for key areas like:
Smart contract exploits
Protocol failures
Stablecoin depegging
& Custodial risks in some cases
How it works
So how does DeFi insurance actually work?
Well most platforms operate on a pooled risk model. Users pay a premium into a shared pool of money, which then covers claims when things go wrong. For example if you’re using a DeFi platform or holding funds in a yield protocol, you can purchase coverage for specific risks related to that platform, assuming an insurer supports it.
When a covered event occurs (like a protocol getting hacked), a claim can be submitted and if approved you’ll be compensated from the pool. It’s actually quite simple to understand and very similar to traditional insurance, but it’s generally managed through smart contracts and in some cases governed by DAOs.
Some policies trigger automatically based on certain conditions, while others require a community vote to validate a claim.
Biggest players
DeFi insurance is still in its early days, but several players have already emerged, the largest being Nexus Mutual with over $160m in TVL as you can see from DeFi Llama.
Nexus Mutual alone accounts for almost 90% of the entire sector in terms of TVL, and operates as a mutual meaning that its members run its governance. Similarly 3F Mutual also operates as mutual but is tailored specifically for protection if MakerDAO (now called Sky) were to shut down.
Meanwhile other players like Ease.org try to mix earning yield with insurance by allowing you to wrap your assets in an insured pool. I personally think this adds an unnecessary layer of risk to their insurance model but they are still one of the biggest projects by TVL in the space.
Yet its a tough space to win in, and some of the largest players in DeFi Insurance like InsurAce and Unslashed Finance have seemingly faded away and disappeared.
As you can see though these platforms each offer variations on coverage types and claims processes but the ultimate goal here is the same: to bring reliability and protection to an otherwise volatile space with many malicious actors.
Yet DeFi insurance is all so new that there’s still a lot of room for disruption from even bigger players, and I anticipate we’ll still see some big names in TradFi trying to muscle in here, remember that TradFi insurance is a multi-trillion dollar industry!
Stay Safe
DeFi insurance is great for reducing specific technical risks, especially when you’re engaging with new protocols or locking up large sums in smart contracts. But it’s not a silver bullet.
It’s still a very nascent space and most platforms won’t cover user errors like sending funds to the wrong address, or falling for phishing scams. That’s why you’ve still got to make sure you follow best practices with your Web3 security like:
Never click on unknown links.
Use hardware wallets for high-value funds.
Verify a protocols legitimacy before interacting with its smart contracts.
Never ever share your private keys or seedphrase with anyone.
One of my very first posts in this blog was on Web3 security where I expanded on these concepts and how you can protect your money, make sure to take a read if you haven’t ever done so:
DeFi insurance is one of the most important, yet underrated, tools in a crypto user’s toolkit. As the space matures we can expect more robust and user-friendly insurance options to emerge, and honestly I think it’s only a matter of time until traditional insurance players enter the DeFi space too.
But until then stay cautious, be informed, and consider using DeFi insurance when it makes sense for you - stay safe out there!
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