When you invest in DeFi, there are a number of risks involved. DeFi is dependent on smart contracts. These are automated scripts that run on the blockchain. Such smart contracts handle, or in some cases hold, large amounts of cryptocurrencies.
The moment something goes wrong within a smart contract, no one can fix the problem. Everything happens fully automatically and is recorded directly on the blockchain. Transactions are irreversible, which means that an error cannot be reversed.
When you use a DeFi protocol, you should always take into account the loss of money due to errors in a smart contract. And if you lose money, that is of course very sour. There is nothing you can do about this yourself, other than not using the platform.
Fortunately, there are solutions to these kinds of risks. Several companies have come up with special insurance that can cover you against these kinds of losses.
DeFi insurance #
DeFi insurance, or DeFi insurance, is insurance that covers you against the risks of DeFi. As you have just read, using a DeFi protocol is not entirely without risk or danger. There is always a chance that something will go wrong and you will lose your bet.
DeFi insurances themselves also run as dApp on the blockchain. In this way it is possible to track hacks or errors on the blockchain. Some protocols have a built-in tool that can check for hacks and errors. In this way it is possible to determine exactly how much cryptocurrency you have lost.
Because such insurances run on the blockchain, there is no central party that can ensure the payment of claims. Instead, it is other people who take care of this. How this exactly works and how it works, of course, differs per DeFi insurance.
Nexus Mutual (NXM) #
Nexus Mutual is an application that runs on the Ethereum (ETH) blockchain. You could see it as a decentralized insurance company. Yet, unlike central insurance companies, Nexus Mutual is non-profit. It is a mutual, meaning the company is owned by the policyholders. All profits will be divided between them.
By taking out insurance with Nexus Mutual, you can protect yourself against errors in code of DeFi applications. Suppose you lose money during a token swap due to a mistake by UniSwap, Nexus Mutual will compensate the damage.
How Nexus Mutual works #
First you indicate on the Nexus Mutual website for which protocol you want insurance. You can choose from a large number of DeFi applications, such as Aave, Balancer or UniSwap. Then you will have to pay for the insurance, and you will secure a collateral. All payments from the policyholders are kept in a pool.
The moment you have suffered damage, you can submit a claim. The network will then vote on the validity of the claim. Users who attempt to defraud will be severely punished: the collateral will be taken. So, it doesn’t pay to try to cheat.
Fraud is impossible. All events are stored on the blockchain, so one can always see what happened in the past. You cannot change the history of the blockchain as a loner. You would need to own more than 51% of the network for that, which is technically impossible in many cases.
The moment you have taken out insurance and submit a valid claim, the protocol will cover the damage. The damage is covered from the pool. You will receive the amount in the form of NXM tokens sent to your wallet address. You can then convert the tokens to other cryptocurrencies or to fiat currencies.
You can cancel the insurance at any time. In that case, you will receive the collateral that you have bet back to your wallet address.
NSure Network #
NSure Network is an open insurance platform for Open Finance. Chances are it won’t tell you much. You may have heard of Lloyd’s London. This is a marketplace where insurance risks can be resold.
In such a marketplace, insurance publishers can resell the policies. If you think the risk of a claim is low, you could buy such insurance. You will then receive the premium paid by the policyholder, but you will also have to pay for the possible costs.
Insurance trading can be lucrative, but it is also very risky. It could cost you a lot of money if someone makes a claim for their insurance. You are legally obliged to cover the amount claimed when you are the purchaser of the policy.
How NSure Network works #
NSure’s decentralized protocol enables anyone to take out insurance or cover risk for policyholders. As a capital provider, you can see on the platform what kind of insurance people would like to have. Then you can decide to stake NSURE tokens on an insurance application that looks attractive. Such an application can be attractive if you expect the risk to be small. You will receive daily rewards in the form of NSURE tokens when you cover someone’s risk.
Before you can do that, you will have to secure a collateral. This way the protocol knows for sure that you could cover a possible loss. Because if something goes wrong, you as a lender will have to pay for the costs. In effect, the risk is thus transferred from the user to the lender. The lender can achieve a good return on the risk that is covered.
The costs that you have to pay as a policyholder are determined by supply and demand. When a large number of people want to cover the risk of policyholders, the policyholders pay a lower price. This also means that the lenders will receive a lower reward.
Ease #
Ease is a protocol where you can take out insurance against loss of money through DeFi protocols. This project was previously called ArmorFi, but changed its name and branding in early 2022. Users can protect themselves against hacks, scams and back pulls through Ease. According to Ease, this can be done in a way that is simpler, safer and more effective than many other insurance protocols.
Other insurance protocols require you to secure collateral. This collateral must be equal to the value of the tokens you insure. The moment the collateral decreases in value, or the covered tokens increase in value, you will have to take out a new insurance plan.
This ensures that these types of applications can only be used by a small part of the crypto traders. You must be in possession of a large amount of money before you can insure yourself against the risks. Ease has come up with a solution called Uninsurance.
How Uninsurance works #
Covering DeFi damage is done by Ease with Uninsurance. Previously, this solution was called Armor Smart Cover. All assets covered by the ecosystem immediately serve as collateral. As a result, participants do not have to put in extra collateral, and everyone can participate in Ease.
There will always be enough collateral. The value of the covered assets is equal to the value of the total collateral. In this way, Ease wants to be an insurance protocol that is as user-friendly as possible.
The moment a hack takes place, the assets of the victims are immediately liquidated to absorb the loss.
You can participate in Uninsurance without having to pay for the services. The assets of all participants serve directly as collateral, so that it is not necessary to pay any costs. You can cancel your insurance by removing your assets.
Conclusión #
Using a DeFi protocol or platform is not without risk. There is always a chance of losing money. All DeFi products use smart contracts, and something can go wrong there. Because blockchain technology is irreversible and decentralized, errors cannot be repaired.
Fortunately, you can take out insurance against these types of risks with Nexus Mutual, NSure Network, and Ease. With these kinds of protocols, you don’t have to worry about the risks, although it is important to be aware of the risks you run at all times.
