What is DeFi insurance, and why is it important?

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7 min read
What is DeFi insurance, and why is it important?

Insurance is an integral part of our lives. It gives us the confidence to invest by offering protection from losses. One profitable activity requiring insurance is trading cryptocurrencies, especially in DeFi. Currently, of the $2 trillion crypto market valuation, only $150B is in decentralized finance (DeFi). Shockingly, less than an estimated 2% of the total value locked (TVL) in DeFi is insured! With such a disparity in the TVL insured for protocols and the continuing emergence of DeFi as an asset class, what is decentralized and cryptocurrency insurance, and more specifically, what's DeFi insurance, and why is it important?

In this risky financial sector, where smart contract failures, hacks, and exploits are often rampant, decentralized insurance protects users' assets against risks and threats.

What is DeFi insurance?

DeFi Insurance protects participants in the DeFi industry from the risks existing within unforeseen catastrophic events such as hacks and exploits, among many more situations. Despite being a nascent industry, DeFi exposes participants to numerous risks with potentially massive losses due to ambiguous regulations of the industry's operations and ecosystem members with very unethical intentions. Participants thus require DeFi insurance to safeguard against these losses.

Additionally, DeFi insurance protects the future of DeFi operations by securely quantifying risks and paying out claims. As stated earlier, only 2% of the TVL is insured. A widespread hack or any widespread catastrophe event is capable of extensively damaging the entire DeFi industry.

What is decentralized insurance?

Decentralized insurance uses smart contracts to define the terms under which an insurer indemnifies a party against losses from the agreed-upon perils. These include catastrophes such as black swan events, wallet hacks, smart contract exploits, and any form of calculable cryptocurrency manipulation in the decentralized ecosystem.

Blockchain's transparency and trustless attributes provide a solid foundation for innovators building insurance solutions for the DeFi ecosystem. These innovations are coming to fruition when increasing instances of DeFi hacks necessitate a safeguard to preserve investor confidence and, ultimately, their funds.

How does smart contract insurance work?

In short, smart contracts are contained pieces of code executed on the blockchain, meaning they cannot be changed, altered or manipulated. With smart contracts, specific functions can be called if permitted by the contract's code. One can think about smart contracts like a gumball machine: if the correct item goes In something different will come out.

Simply put, smart contracts for DeFi insurance usually contain the terms of the policy. This ensures that neither party can alter the conditions once the contract is executed. The smart contract can then be used to take action In the occurrence of a risk event. For instance, Steady State aims to automate the claims process by letting the smart contract determine if the conditions of a hack or exploit fit the parameters of coverage in the policy. If so, the claim will be validated and the policyholder paid out.

What are the benefits of DeFi insurance?

To understand the benefits of DeFi insurance, we must first understand the risks of participating in DeFi. ShapeShift, in their release "Spreading the risk; Decentralized insurance" categorizes the four risks market participants expect. These include:

  • Custodial risk – where centralized exchanges lose or disappear with users' funds.
  • Smart contract risk – a bug in a smart contract causes massive losses.
  • Oracle risk – hackers exploit oracles feeding data to dApps.
  • Protocol risk – where a protocol problem affects the entire ecosystem leading to losses.

DeFi participants are constantly under threat from these risks. Therefore, the significant advantage of DeFi insurance is protection from any of the risks above. Without DeFi insurance, a risk event can wipe out an individual's entire crypto asset holdings.

Other advantages of DeFi insurance are seen in the applications of DeFi insurance, which we explain below.

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DeFi insurance has enormous room for growth

Is there crypto wallet insurance?

Periodically, news of stolen funds from crypto wallets reverberates through the crypto ecosystem. Often, platforms attribute the loss of funds to their compromised private key storage systems. Some losses from crypto wallets are purely due to hackers, while some result from poor management of security systems. Regardless of the cause, the bottom line is stolen/lost crypto assets for the users.

Undoubtedly, there's a need for crypto wallet insurance. Platforms are already offering crypto wallet insurance services; however, the benefits are not without a series of caveats. Because of the unscrupulous nature of some crypto participants, insurers only pay out verifiable claims, as mentioned earlier, to discourage participants from compromising their wallets. Policies tend to cover wallet exploits or bugs, and would seldom cover funds lost due to compromised private keys. When it comes to your private keys, the only true way to stay protected is exercises best practices with your personal security and to never reveal your private key to anybody else.

Collateral protection for crypto-backed loans

Yield farming is a popular DeFi feature available on most DeFi platforms. Participants lend and borrow to gain more cryptocurrencies from their activities. Any hack or compromise to a network is a potential loss for the lender or borrower. DeFi insurance safeguards protocols and participants in borrowing and lending pools from verifiable losses resulting from hacks or any other catastrophe event.

Smart contract cover

Smart Contract risk is a permanent risk in the DeFi ecosystem. Smart Contracts insurance cover, which we earlier touched on, protects protocols and participants from losses resulting from smart contract bugs and hacks. Smart contracts are written in a relatively new coding language known as Solidity. As it's relatively new, ensuring watertight coding devoid of errors or weak points is an uphill task. Therefore, smart contracts bugs may fly under the radar until hackers exploit them, as was the case in the infamous DAO hack. Smart contracts insurance helps insure against such occurrences.

Is DeFi insurance a strongly emerging sector in blockchain?

Definitely! The tremendous growth of DeFi makes the arguable success of DeFi insurance inevitable. To ensure the sustained success of DeFi beyond any short-term timeframe, we must protect its reputation and preserve its value – we must cover DeFi. The realization of the inherent flaws present in large parts of DeFi is primarily responsible for the emergence of DeFi insurance in blockchain as well as comprehensive DeFi insurance platforms like Steady State, which are providing comprehensive solutions. Additionally, at Steady State, we're making insurance a lucrative and necessary endeavor for users and protocols alike. Such innovations, coupled with the growing demand for DeFi insurance products, make DeFi insurance an undeniably strong emerging sector in blockchain.

Can smart contracts insurance disrupt traditional insurance?

Disruption in insurance is unfolding in front of our eyes. The effect of blockchain and smart contracts is undeniable at this point. Though it was a slow embrace, the results are being felt globally. With companies such as IBM researching insurance solutions in blockchain, the disruption of traditional insurance is unavoidable.

A pivotal aspect of smart contracts insurance is the minimal or lack of human interference in underwriting and settling the claims process. Minimal human interaction greatly reduces room for error in calculating premiums, assessing claims, and awarding claims following an insured event. By creating convenience and maximizing efficiency, smart contract insurance is on course to disrupts traditional insurance and the status quo for many decades gone by.

How Steady State improves DeFi insurance

As with all DeFi insurance platforms, Steady State focuses on ensuring we get the fundamentals of DeFi insurance right. Our platform goes a step further by providing insurance for protocols, a niche market in DeFi insurance. With our protocol insurance, we offer business-to-business insurance coverage, a first among the DeFi insurance participants, and decentralized insurance as a whole.  We're creating a Risk Analysis Database (RAD) to track all forms of exploitation in the DeFi ecosystem by implementing proprietary and innovative technology. We'll use smart contracts to automatically execute the claims process and minimize human interaction in the process. Our model aims to reduce bias and errors arising from human interaction.

Steady State has also integrated with Chainlink to provide extra incentives for our community in a way many comparable DeFi insurance protocols fail to do. With our 'Composable DeFi Insurance' model, we're ensuring liquid secondary markets in which users can trade insurance pool tokens on DEX's such as Uniswap and providing the ability to earn yields on those tokens as well. Our secondary market for exchange and swapping of contracts holding risk is a first in the market.

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FAQs about DeFi insurance

What is decentralized insurance?

Decentralized insurance is an emerging sector in the blockchain ecosystem using blockchain technology and smart contracts to cover users and protocol against exchange exploits, hacks, black swan events, and other risk factors in the blockchain ecosystem. Decentralized insurance ensures that anyone can participate, nefarious actors can't manipulate or corrupt the system, and the system is fully transparent.

How does blockchain insurance work?

Insurers and clients agree on the terms of the insurance and place it in a smart contract. Using their respective systems, insurers calculate risks to determine the premium for their client. In the event of the risk, the client initiates the claim, which smart contracts process automatically. Upon successful processing and approval, the insurer then covers the claims as per the smart contract agreement. Most importantly, users have complete custody of their funds.

Which insurers are using blockchain?

All DeFi insurance platforms, including Steady State, are using blockchain solutions. Traditional insurers are also using blockchain as a tool to improve their services. For example, State Farm, the largest auto insurer in America, and United Service Automobile Association use a blockchain-based solution to settle subrogation claims in auto insurance. Others include Anthem, Allianz, Aegon, and Swiss Re. Find out more about other insurers using blockchain here.

How does DeFi insurance work?

DeFi insurance platforms, like Steady State, protect users from losses resulting from risk events in the DeFi industry. Unlike traditional insurance, the DeFi insurance policies rely on community members to provide coverage for the insured. In Steady State, our smart contracts conduct all the risk calculations and execute the claims process.

Can I insure bitcoin?

Like every other asset, you can insure Bitcoin. One of the ways to cover your Bitcoin is by insuring your crypto wallet. Based on the contract, the insurance provider will cover all the contents in your wallet. This insurance applies to other cryptocurrencies as well.

Why do people need crypto insurance?

The blockchain ecosystem has several risk factors, such as smart contracts hacks, exchange exploits, and many other risk events. These can lead to huge losses and can even disrupt an entire industry in the blockchain ecosystem. Crypto insurance ensures the security and continuity of cryptocurrency activities such as DeFi, among others.

About Steady State

Steady State gives DeFi protocols and platforms a practical solution to safeguard their assets and users. Our platform aims to eliminate bottlenecks in DeFi insurance using automated processes, shared coverage policies, a cutting-edge risk analysis database, and Chaink Keeper technology. Steady State is creating a new paradigm for decentralized insurance by delivering DeFi’s most capital-efficient insurance platform for protocols. To learn more about Steady State and the impact of our pragmatic approach to Defi insurance, visit us at the links below:

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Steady State cautions that statements in this communication that are forward-looking, and provide information other than historical information, involve risks, contingencies and uncertainties that may impact actual results of operations and prospective transaction. Please click here for important legal notices.