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How Does DeFi Insurance Work?

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Perhaps you are familiar with insurance companies and services, and participating in Insurance in real life is prevalent. So are there any differences between actual Insurance and DeFi insurance, the practice of Insurance in the crypto space? Let’s find out in the following article.

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What Is Decentralized Insurance?

While all the services surrounding the field of Decentralized Finance (DeFi) such as Cryptocurrency lending (Lending), Cryptocurrency Derivatives (Derivatives), Commodity Futures Trading (Futures) has garnered much appreciation, one area that is not often discussed but is of great importance is Decentralized Insurance. In risk finance in general, it is imperative to have a protection mechanism from risks and threats. Decentralized Insurance is one of the concepts that can safeguard cryptocurrency investors and the DiFi sector in general. Simply put, with this type of DeFi insurance, the participants will insure themselves for each other, not through an insurance company at all.

DeFi insurance is comprised of Crypto Wallet Insurance, Smart Contract Cover, Cryptocurrency Cover, Mutuals to replace Insurance, and Collateral Protection for Crypto backed loans.

If you have participated in this market since 2017 until now, as you can see, there are many cases of exchanges being hacked: Binance, Okex, Mtgox, or recently Kucoin. Moreover, hackers can attack Dapps like the DAO hack that rocked the Ethereum community in 2017 that led to the hard fork for ETH & ETC. All of the above has caused damage up to billions of dollars to users and the exchange platforms. Decentralized Insurance will minimize the risk in such scenarios.

Furthermore, you need to understand that certain risks could stumble upon you in the DeFi sector and crypto space as follows:

Technical Risks: These are risks when smart contracts are hacked, code errors, etc.

Liquidity Risks: This is when DeFi products lose liquidity.

Admin Key Risks: This is when the private key for the protocol can be compromised.

When such risks occur, they will affect you or other users participating on DeFi platforms. That’s why DeFi insurance was created to help you and other users protect themselves when something unexpected happens.

How Does Decentralized Insurance Work?

A decentralized insurance product will have its own implementation, but basically, there will always be three key components:

Insurance buyers

They are people who want to protect themselves from the risks of participating in the crypto space or DeFi-related products. They will buy the relevant Insurance, and if something goes wrong, they will be compensated according to the contract already encoded in the smart contract.

Insurer

They are people who believe in DeFi-related systems or products. They spend money to insure others. When the buyer pays money to buy Insurance, this money will be divided among these insurers.

Insurance protocol

This party evaluates and issues insurance types and encodes them in smart contracts in their system. These systems are usually DeFi applications in the insurance field, such as 3F mutual, Nexus Mutual, etc.

These three components will work together as follows: For example, you are an insurance buyer, you put down 1ETH and buy Insurance for the MakerDAO system, with a ratio of 1:300, i.e., if MakerDAO collapses, you get 300ETH, and if it doesn’t crash, you lose 1ETH. Insurers who believe in the sustainability of MakerDAO will insure it by buying insurance shares, and they get 1ETH that you buy according to the percentage of shares they hold. And the insurance protocols will take care of coordinating all of your insurance activities, distributing it to the insurer, paying you Insurance if the risk occurs, etc.

Benefits Of Decentralized Insurance

Decentralized Insurance products offer complete protection of DeFi deposits. They hedge against cryptocurrency fluctuations and crash when prices rise and fall dramatically and provide security against the risk of theft and attacks on crypto wallets. They ensure the safety of users against any possible DeFi risks, protecting technical and financial risks, thus building a sense of security among investors. Not only that, but the platforms also make the entire submission, claim, and processing, and payment process extremely secure, reliable, and transparent.

The benefits when using DeFi insurance are as follows:

1) DeFi Deposits Protection (or commonly known as DeFi Deposits).

2) Protect you against crypto volatility and flash crash, or the sudden devaluation, for instance, when BTC drops 1-2k$, other altcoins lose 80-90%.

3) Get cryptocurrency assets instantly.

4) Protection from theft and attacks on crypto wallets

5) Protect funds from being hacked on exchanges.

6) Technical and financial hedging

7) Instant payment when you request.

8) Trust and transparency.

Common Decentralized Insurance Platforms

First is Nexus Mutual, a decentralized insurance platform built on Ethereum. It is considered a pioneer in the field of smart contract insurance. With Nexus Mutual, users who have lent money on exchanges like Compound or Dharma can opt for an insurance policy. The second common platform is Etherisc, which has built excellent crypto wallet insurance products and collateral crypto loans. Lastly is CDx, a platform that provides insurances for the loss of funds due to exchange hacks.

The Future of DeFi Insurance

Decentralized Insurance is a promising area due to the transparency and security it offers investors. Currently, there are only a few products available, but they certainly can grow and expand in the future. DeFi and its applications like Decentralized Finance will continue to dominate the market for years to come.

Bottom line

We hope that the above article has provided you with the information needed to understand the concept and usage of DeFi Insurance fully. As you may know, the crypto market in general and the DeFi sector are developing vigorously, but along with it comes news about hackers, collapses, etc. To maintain users’ trust and for this industry to continue to develop sustainably, Insurance is indispensable. It helps manage risks and brings benefits to many parties, and with transparency and fairness, decentralized Insurance will continue to thrive for many years to come. Start paying attention to DeFi insurance now, and you will seize the opportunity to succeed!

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Disclaimer : The opinion expressed here is not investment advice – it is provided for informational purposes only. It does not necessarily reflect the opinion of Coinpedia. Every investment and trading involves risk, so you should always perform your own research prior to making decisions. We do not recommend investing money you cannot afford to lose.

Guest Author

Crypto Journalist and Editor of guest articles in CoinPedia. Also, Outreach & Partnerships Manager. Contact me: [email protected]

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