Blockchain’s capabilities have grown tremendously since its inception in 2009. Envisioned as support for a medium of exchange, blockchain now realizes its true potential through the DeFi industry. Many profitable innovations have been incubated because of the technology. However, the profitability hasn’t been without risk. The total losses from the DeFi industry from risk events are over $1B and growing daily. Though some appear as orchestrations from within, many are a result of insurable risk events. These insurable risk events as well as the sustained growth of DeFi are excellent barometers as to why DeFi insurance will explode.
1.) DeFi’s explosion in prominence introduces greater risks
DeFi’s exponential growth is hardly surprising, and individuals are buying into the DeFi promise of eliminating unnecessary intermediaries through smart contracts making transactions low-cost, without any third-party involvement. Thus, the number of participants is fast rising, with potentially seismic implications for the financial sector.
Similarly, the freedom in innovation made possible through DeFi is also responsible for the industry’s rapid growth. Creatives are not short of ideas, and DeFi provides an accommodative platform to build new and disruptive applications. DeFi’s extensibility can easily translate to an endless number of applications, creating even more room for the expansion of DeFi.
However, there are caveats: Risk in DeFi is growing proportionately to DeFi’s overall growth. The greater the value of assets within the DeFi ecosystem grows, the greater the exposure to market risk factors. In the most recent $600+ million heist, the largest-ever cryptocurrency exploit, hackers exploited a vulnerability in PolyNetwork’s system, giving them access to thousands of cryptocurrencies. The figure stolen was huge because of the large deposits available in Poly Network.
Hackers can replicate similar exploits on other platforms. PolyNetwork isn’t the first to suffer at the hands of such nefarious actors and finds itself in the long list of platforms unfortunate to have their protocols compromised in 2021. These include:
- Yearn Finance Flash Loan attack — $11M lost.
- Alpha Homora Iron Bank exploit — $37M lost.
- Meerkat Finance exploit — 13M $BUSD & 73,000BNB
The Top 5 Biggest DeFi Hacks (Feb 2020 — July 2021): $FARM, $SPARTA, $ALPHA, $BUNNY, $URA
With DeFi insurance, protocols will have contingency measures preserving the value of individual deposits and avoiding the devastating effects of an exploit.
2.) Each innovation requires further sustained innovation
DeFi’s impact in the decentralized market is undeniable. It allows innovators to exploit the inadequacies inherent in modern financial institutions and provide an equal platform for all. However, once an innovation is created and popularized, the innovation cycle has to continue to ensure long-lasting sustainability. This is what we can expect with DeFi.
DeFi has the potential to penetrate mainstream markets with its universal solutions to existing financial problems. It’s therefore essential to reinforce DeFi with components that continually provide mass appeal for consumers, such as DeFi insurance. Insurance imbues the market with confidence to trade and commit without fear. DeFi insurance allows the market to take calculated risks for greater profit margins and security. The nature of smart contracts also removes uncertainty driven by excessive dependency on human intervention.
Like the smartphone industry and its yearly updates, or the car industry and its periodic releases, DeFi needs constant innovations to ensure the technology remains relevant for future network adoption.
3.) It’s very early, and the best is yet to come
DeFi is always one risk event away from disaster. Statistics show market participants have insurance for just 2% of the TVL in DeFi platforms, a shocking statistic considering the whole market is well above $100B. The inefficiency in capital allocation is glaring considering the monetary value and risks involved.
Overall TVL by DeFi Category
Likewise, we haven’t reached peak DeFi absorption. The TVL only represents a small fraction of the potential market. As the TVL grows, smart contract insurance for protocols will become inevitable. Protocols and platforms have no option but to start preparing for asset security that sustains the user growth the industry anticipates. DeFi insurance not only benefits the insured but also safeguards the future of the entire industry.
4.) There is a strong appetite for alternatives to legacy institutions
As knowledge disseminated via the internet, people became aware of the full value of their data and privacy. Legacy institutions faced increased scrutiny from their clients as they sought further transparency towards their operations. With the yearning for knowledge came discoveries of uncomfortable market practices. Combined with the inability of large masses to access financial services and products, the appetite for alternatives to legacy institutions was born.
The growing mistrust is pushing the market to evolve beyond centralized bankers and insurers. DeFi insurance is ideally placed to accommodate such desires by excluding the existing financial paradigm. DeFi insurance allows for an unbiased process free from the restrictions and inconveniences of modern finance.
5.) Mainstream investors want reliable, accessible risk protection
As DeFi aims for further mainstream recognition, the industry will have to accommodate certain mainstream practices to attract and maintain a wider pool of investors. One of the requirements of mainstream investors is a robust risk protection program to ensure the safety of their digital assets. Furthermore, considering the growing importance of institutional investors, DeFi insurance will become necessary. DeFi insurance provides solutions by giving investors a similar asset protection experience as those in mainstream or legacy institutions.
DeFi is expanding and maturing faster than the industry’s ability to prepare for such growth. The market is rapidly broadening, with participants increasing daily. Lucrative features such as passive income through yield farming contribute significantly to the impressive development of DeFi. As further innovations arise, we expect the ecosystem to continue displaying outsized progress. Demands from institutional and retail investors alike necessitate the correct foundations to sustain such growth.
With an expanding industry, DeFi insurance becomes inevitable. With the diversifying market and its changing demands, DeFi insurance is about to explode!
Frequently Asked Questions (FAQs)
How does DeFi insurance work?
Like traditional insurance, DeFi insurance protects users from losses following payment of premiums as per the insurance agreement. In DeFi insurance, the community of the insurer determines the premiums for the insured. Likewise, the community provides the funds for the potential payout of any claim. Some platforms also allow their communities to orchestrate the payout of the claims brought forward.
What is an insurance protocol?
An insurance protocol is a platform providing insurance products in exchange for a premium. Every DeFi insurance protocol is set up for the provision of insurance services.
What is smart contract insurance?
Smart contracts insurance refers to a digital insurance contract defining the nature of the insurance and the parameters necessary for the insured to receive a payout after forwarding their claim. It is the central insurance model of the blockchain industry.
In smart contracts insurance, once the insurance parameters are met, the insured receives a payout as predefined in the smart contract. The process is automated in the majority of platforms, with little human interference.
Why do people need DeFi?
DeFi embodies the ethos of blockchain. Through DeFi, innovators express their visions of a decentralized world. Problem-solving applications are constantly in creation by dedicated teams. Other benefits of DeFi include:
– Capitalizing on new and profitable technology.
– Improved access to a wide range of financial products and services.
– Profit from trading in DeFi related products.
What are the benefits of the DeFi insurance sector?
– DeFi insurance adds complexity and robustness to the DeFi industry. Through DeFi insurance, the DeFi industry gains the following:
– Preparedness for mainstream investors, including institutional investors, by the DeFi industry.
– Protection of DeFi assets following catastrophic events.
– Creation of alternative sources of income for insurance providers.
About Steady State
Steady State gives DeFi protocols and platforms a practical solution to safeguard their financial future. With the help of Chainlink Keeper technology, our platform aims to eliminate bottlenecks in DeFi insurance by using automated processes, shared coverage policies, anda cutting-edge risk analysis database. Steady State is creating a new paradigm for decentralized insurance by delivering DeFi’s best-ever 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: