How do DeFi Insurance Alternatives Work

With the total value locked (TVL) of Decentralized Finance on the Ethereum blockchain growing from an estimated 17 billion in January 2021 to the estimated 115 Billion now (https://defillama.com/chain/Ethereum), there is a lot of money at stake. With Immunefi reporting over 2.5 billion being lost to smart contract exploits in 2021 (Immunefi Top Hacks in 2021), it is important to be aware that assets are actively exposed to risk. That is why it is important to understand DeFi Insurance Alternatives.

Whether that’s investing in established projects, doxxed teams, or reading audits, a loss could still happen. The final line of defense for any investor should be DeFi insurance alternatives, commonly referred to as coverage protocols. There are two models of coverage protocols on the market right now. Traditional Analogues, and Ease’s new uninsurance model. This article will take a look at both models.

Traditional Analogues – DeFi Insurance Alternatives

This is the most common model, these protocols operate similarly to how a coverage policy would in a real-life scenario.

1. Alex deposits assets into Protocol A and wishes to purchase coverage against hacks that may occur
2. They must navigate to a coverage protocol and browses their available options
3. Then, they create a personalized coverage plan for Protocol A after choosing
   1. Type of coverage
   2. Length of plan
   3. Amount covered
4. To finish the purchase, Alex pays their premium upfront. This is generally a fee equal to a % of the covered value.
5. In the event of a hack that causes a loss of funds, Alex must submit proof of loss to the coverage protocol.
6. After review, and if approved, Alex receives reimbursement.

One departure is the DAO approval process where token holders vote to approve or deny claims. Underwriters are commonly also the token holders. This is a process that many understand, as most people have experience with this type of model from traditional insurance plans in their everyday life. Ease uninsurance aims to turn this model on its head and do what DeFi does best, taking traditional models and making them better.

“Uninsurance” by Ease

Rather than requiring an underwriter, Ease’s uninsurance coverage model operates off the idea of risk-sharing. Let’s take a look at Alex’s experience when seeking coverage through the Ease ecosystem:

1. Alex deposited assets into Protocol A and wishes to get a coverage policy for them.
2. Instead of needing to purchase a policy Alex only needs to deposit the receipt token she received from protocol A into its respective Ease vault.
3. Coverage for Alex’s assets is perpetual. As long as the receipt token remains in the Ease vault
4. Alex has no premium to pay, the only payment that occurs is if a hack occurs.
5. If a hack occurs on Protocol A and Alex loses assets. Partial liquidation of assets in Protocols B, C, and D occurs to help cover the loss event. This process requires no input from Alex.

The Ease system can operate in this way because the funds in the system are also the underwriting collateral. No middlemen risk providers exist to seek profit. Assets share risk proportionally. What this means is if Protocol B was hacked instead, assets in A would be partially liquidated to help cover the loss in B. This liquidation cost is projected to be less than the average premium payment from a traditional coverage protocol.

DeFi Safely

Regardless of the option, you decide to use, coverage is a necessary part of mitigating oneself from risk in Decentralized Finance. The blockchain ecosystem is commonly referred to as “The Dark Forest”. A potential hack or scam could lay right on the other side of the bushes, unseen by the user. However, when a user takes the correct steps and cover’s their assets. It helps make the Forest, just a little bit brighter. For additional reading on DeFi coverage see our other two articles here: Coverage Protocols.