Insurers in DeFi

As in traditional finance, decentralized finance presents risks. Insurance companies are therefore necessary to protect users against these risks.

What they are and how they work

They are platforms that offer coverage against various risks present in decentralized finance. In return, they charge a commission on the insured assets for a certain period of time.

Being in decentralized finance, they use blockchain technology to carry out their activity.

The operation is similar to that of insurers in traditional finance, but with some peculiarities.

While in traditional insurers the insured persons have to prove that the event has occurred and that they have therefore received a damage and the insurers have to prove that this is true, in decentralized insurers, it is all written and automated in code. This way, if the event in question takes place, the Smart contract will send the agreed amount to the insured.

The insurers in DeFi, have a contract that lays out what is included in the coverage and all sorts of details for users to read.

And in the same way, they have a Smart contract or a set of code that performs both the validity check of the claim and the payment of the policy automatically.

In the Smart contract, the terms of the agreement are written, so that when an insured event occurs and the insured issues a claim, the Smart contract checks the claim and if approved makes the payment.

This automated process eliminates the need for intermediaries, reduces administrative costs and ensures transparent and efficient claims processing.

Risks covered

The main risks covered by insurers in DeFi are as follows:

Vulnerability in the code of a protocol: As we already know, decentralized finance companies/protocols are sustained on code.

Therefore, there is a risk of a company’s code failing or a hacker exploiting its vulnerabilities. This may result in the loss of some or all of the funds that the user has deposited with that company or platform.

This coverage, therefore, covers the user against the risk that due to a failure in the code he loses his capital.

Depeg of a stablecoin: Stablecoins are anchored to the price of an asset (usually the dollar) so that one unit of that stablecoin is worth one dollar at any given time.

The risk is that the company backing the stablecoin fails to maintain that parity and the price is different, failing in its purpose of being a cryptocurrency with a stable value.

Custody risk: The risk that you may not be able to recover the funds or part of the funds deposited in a centralized asset custody platform such as Binance or Coinbase due to negligent actions.

Liquidity providers in DeFi insurers

Decentralized insurers interact with users in two ways. One, the most common, is by providing them with hedging.

The second is by allowing users to provide liquidity to the platform so that the platform can use it in case it needs funds to pay coverages to policyholders.

In this way, decentralized insurers invest the funds provided by users and offer them a certain return on their funds in exchange for having them available in case of need.

This is very useful for the decentralized insurers because it allows them to leverage themselves and earn higher profits by not being limited in the amount they can invest by the funds received from policyholders. And for the users providing the liquidity, it allows them to benefit from the insurers’ business.