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Chain News ChainNews (ID: chainnewscom)
Crypto-native insurance, that is, the kind of on-chain insurance that can cover blockchain protocols and decentralized organizations (DAOs), has the potential to become the next big germ of financial innovation in the field of decentralized finance DeFi. Its original prototype has credibility, and the market size will become huge.
As encryption technology expands to all financial and Internet applications, encryption-native insurance has the opportunity to become a "key service" supporting the broader digital economy, supporting a market size worth trillions of dollars in the future.
trust
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Why should users choose encryption-native insurance?
Over the past year, user funds in DeFi have grown tenfold from about $500 million to about $5 billion today. Vulnerabilities that may cause damage to users' property have emerged in this growth, and the risk is increasing. By enhancing trust, insurance can allow DeFi to continue to iterate rapidly while expanding its addressable market size.
speculation
Providing centralized insurance to enhance user trust was an important step we took in the early days of Coinbase. In 2014, I worked with Lloyds of London (Lloyds) to finalize their first crypto insurance (I believe the first).
For early cryptocurrency adopters with high risk tolerance, the impact of insurance is substantial, but not critical; but for mainstream users, it is of increasing importance, and for those who will eventually enter the field of encryption. It is even more necessary for institutional investors. At a guess, crypto-native insurance is likely to follow a similar adoption path to centralized crypto insurance.
Insurance also creates a prediction market for the likelihood of a protocol or DAO failing. I suspect that many cryptocurrency traders will enjoy trading in this market, and like most modern financial markets, speculators will be the key to bootstrapping the market's cold start and make up the majority of trading volume, for example, in the modern forex trading market Among them, 95% of the transaction volume comes from speculation, and 5% comes from "real demand".
"Speculation" has positive social significance here: it helps to achieve a "cold start" in the liquid market for those seeking "real" insurance coverage, and provides a barometer for the safety of different DeFi elements.
Through this lens, "insurance" can be considered closer to modern credit derivatives like credit default swaps (CDS).
The prototype of the user group
Users/investors seeking insurance, traders seeking speculation, and longer-term investors seeking income products constitute the current prototype of the insurance user group.
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Market size has huge potential
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bottom up
The continued growth of DeFi alone presents a huge opportunity. And if cryptocurrency develops into the world's digital financial system, the opportunities will become huge and "unlimited".
The current global insurance market size is about $5 trillion. But this includes all types of insurance, which are unlikely to be tied to crypto assets anytime soon. Credit derivatives are a better reference. Just like some investors take hedging measures to prevent companies from failing, some cryptocurrency users will need hedging measures to prevent the on-chain entities (protocols, DAOs or other) they rely on from failing.
experience
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experience
There are currently two classes of empirical data points in the crypto space. First, insurance costs for centralized crypto businesses run into the hundreds of millions to billions of dollars. Second, Nexus Mutual, a human-governed crypto-native mutual insurance protocol, has grown insured assets from $500,000 a year ago to $15 million today.
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When building crypto-native insurance, there are a number of design challenges to address, including:
On-chain or off-chain?
text
fluidity
market structure
The contemporary insurance market is opaque and dominated by a few large insurers. What will a successful crypto-native insurance industry look like? A protocol that allows transparent participation by a large number of private entities? Is a DAO or a series of DAOs acting as underwriters? Both? Or a completely different architecture?
fluidity
A successful system allows insurance-seeking users, traders and investors to easily deploy new markets. This is especially important because insurance is an inherently unique and fragmented market. Perpetual swap-like products can be easily self-deployed, and the design of products with multiple expiration periods avoids decentralization (option products are easy to fall into this type of trap) to achieve this goal.
How to trigger the payout?
A successful insurance system should be as clear and specific as possible on this point. To give an example of potential ambiguity: if a system collapses due to economic factors, rather than technical failure, should compensation be triggered?
What if a failure occurs, which obviously should have triggered the payout but didn't? Ironically, if payout triggers had to be defined programmatically ahead of time, most bugs covered by insurance plans would likely be missed in practice—otherwise the bug would have been discovered and fixed long ago? Specifically, in the words of Vitalik, the founder of Ethereum: "If there is a programmable oracle machine IsBroken (x), the code of x can be modified, and all transactions with the value of IsBroken (x) true will be rejected." Easy to create and evaluate insured.
capital efficiency
A successful system makes it easy to write new coverages and evaluate coverages for insurance users or investors. This is challenging because every smart contract insured, whether protocol, DAO or otherwise, is different. High-level technical security auditors may gradually evolve into risk assessors and pricers.
capital efficiency
Successful insurance systems strike a balance between capital efficiency and systemic risk. If leverage had to be fully collateralized ($1 in collateral for $1 in insured assets), it would be too capital inefficient for most investors and traders. On the other hand, high leverage poses higher risks to risk stability and will destroy the balance point of insurance in the first place.
Tolerance to market manipulation
business model
A successful insurance system will minimize the game and maintain a stable level of trust. The traditional CDS market has seen a myriad of strange and unintended consequences.
business model
This is a downstream product of the Product/Market Architecture. At present, the largest insurance company has a market value of more than 100 billion US dollars and a profit level of about 5%. The encryption-native insurance business model may be very different, it may be an "open agreement" with its own business model, it may be an underwriting DAO, or other forms. There is little opportunity to capture value sustainably.
Nexus Mutual
CDS perpetual swaps may be one of the most likely winning methods in this dimension, which can be on-chain, programmable, capable of self-deployment, maintaining liquidity and capital efficiency.
The Current Case for Crypto-Native Insurance
Further reading:
Opyn
As mentioned earlier, Nexus Mutual’s coverage has grown to $15 million from $500,000 last year, still relatively small compared to DeFi’s $4.5 billion asset base. The insurance platform has successfully completed a payment.
Understand the decentralized insurance rookie Nexus Mutual: Is it reliable to use mutual insurance to manage DeFi contracts?
Options that can act as a form of insurance. Opyn options, represented by oToken tokens, have an expiration date (vs. perpetual insurance), are on-chain and programmatic, have little governance overhead, and are in a sense protected against economic loss (options protect the price of a particular asset) below a certain point) provides comprehensive coverage.
Sure, the product is imprecise in other ways, such as not being able to pay out against specific technical glitches, and requiring full collateral from option buyers. Opyn is still in its infancy and usage is low today (~$1M).
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Adequately demonstrating this problem is tricky. One or more of the design challenges listed above may not be addressed and prevent effective product rollout.
One possibility is that the need for insurance is replaced by alternative mechanisms. For example, socialized losses become commonplace (e.g. TheDAO), or protocols/DAOs often have insurance-like mechanisms built into them, such as MakerDAO’s dilution mechanism to initiate an auction of MKR in the event of undercollateralization.
Another possibility is that formal verification eliminates the need for insurance. Formal verification of the ability to test the boundaries of code is rapidly evolving, and can feel free. But this is unlikely to be a comprehensive solution, especially insofar as economics and purely technical failures are covered.
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