24% Investment Yields? New Crypto Insurance Platform Doubles Down On DeFi Risk

24% Investment Yields? New Crypto Insurance Platform Doubles Down On DeFi Risk

The $600 million crypto hack last week, the largest in history, shows that security remains an ongoing issue for this burgeoning industry. This goes triple for decentralized finance (DeFi) protocols and applications, which were demonstrated in a recent report from CipherTrace to be the target of 75% of all crypto threats in 2021.

Now, a new decentralized insurance platform called Unslashed is aiming to protect crypto users from losses resulting from centralized exchange failures, smart contract hacks, and other common ways that users can be victimized (excluding scams or user error).

Unslashed is the brainchild of Paris-based Marouane Hajji, who believes that the DeFi industry needs a form of insurance that does not betray crypto’s core tenets of transparency and decentralization to mature.

“[Insurance is] perceived as not super sexy, whereas it's really the bedrock on which everything else is built,” Hajji said. “It's of paramount importance for banking, trade, international commerce, anything in finance really, relies on insurance.”

The stunning growth of the DeFi industry over the past two years has generated widespread interest among crypto enthusiasts and traditional financial professionals alike, while also adding to the stakes and need for a form of responsible coverage. Today, DeFi products have $80.02 billion locked in, up from $22 billion at the start of 2021.

Since its private launch in February, Unslashed has sold policies to several platforms. Crypto staking protocol Lido purchased coverage to protect $200 million worth of staked ether from slashing, which occurs when holdings are involuntarily forfeited on Ethereum 2.0 due to non-compliance with the protocol’s rules. Other customers include decentralized exchange aggregator Paraswap and crypto token swap platform Kyber Network.

Unslashed finances these policies by creating “capital buckets,” or collections of insurance policies which are designed, assessed, priced, and grouped for investors. To date, the protocol has around 4,000 investors and has provided 300,000 ETH ($786 million) worth of insurance coverage across ~30 policies.

The only current capital bucket is the “Spartan Bucket,” which allows insurers to offer capital for the lowest risk policies, as determined by risk models developed by the Unslashed team. To date, the company has been able to pay investors an interest rate of 24%. Hajji says the plan is to offer two more buckets with progressively riskier policies included, which could offer yields as high as 70% to investors.

Unslashed intends to pay these large returns by putting its pool of capital to work via a decentralized asset management platform started by Swiss company MelonAG, Enzyme Finance, formerly Melon Protocol, which now operates as a decentralized autonomous organization (DAO). “With a few quick clicks you can think about [compare] strategies from automated market maker pools, to lending, to borrowing to farming strategies, because of all of our native integrations,” Mona El Isa, Founder of Enzyme Finance, said.

Of the 28,000 ETH supplied by capital providers in Unslashed, about 50% of those funds (up to 80% can be invested as per current DAO guidelines) are being put to work on DeFi platforms like Curve Finance through Enzyme. For an individual user who deposited 1 ETH into the Spartan Bucket, they would have 1 ETH exposure distributed across all of the policies in the bucket. All decisions pertaining to the evolution of Unslashed, including investment strategies and asset management decisions, are made through a vote by members of the Unslashed DAO that operates with the use of its own token, USF.

There are 86 million USF tokens in circulation, half of which are owned by the DAO. The other half are owned by the development team, early investors, and the Unslashed Foundation. Both team and early investor tokens are locked for one year and vested for four and two years, respectively. To date, the USF token does not have any utility aside from voting power, however the DAO is in the process of discussing other applications for the token.

Building a decentralized insurance platform backed largely by DeFi assets would in and of itself appear to be wildly risky. For one, there is nothing preventing USF token holders from voting to invest even higher percentages of its investable assets. Additionally, while there appears to be an unwritten rule to not invest in platforms that have taken out coverage from Unslashed, the nature of a DAO means that this cannot be guaranteed in the future. However, the DAO has not listed Curve Finance insurance policies because it is likely to invest heavily through the protocol, Hajji said.

Additionally, given the interconnected nature of DeFi, even if Unslashed is diligent not to invest in protocols that it is insuring against, it can still be a victim of collateral damage if an outside DeFi platform gets hacked.

Although this model is tangentially based on how the traditional insurance industry works, there are some significant differences, particularly when it comes to investable assets. According to John Barnidge, Managing Director of Equity Research at PSC Insurance Group, one useful comparison outside of crypto would be deposit insurance, which is typically provided by the Federal Deposit Insurance Corporation (FDIC). However there are private deposit insurers like American Share Insurance (ASI). The majority of funds with ASI are held in either cash or relatively safe securities such as US treasuries, and US government agency bonds. Additionally, independent actuaries annually evaluate whether ASI has sufficient reserve to cover potential losses. There is also a vibrant reinsurance industry, which acts as a safeguard against insurance companies themselves becoming insolvent.

Despite these risks, Unslashed could be forging ahead with a new model for DeFi insurance. Shortly after Unslashed announced its vote in favor of incorporating investment into the protocol, competing DeFi insurance protocol Nexus Mutual introduced and voted in favor of an upgrade that allowed the platform to do the same.

“Most other insurance protocols in DeFi don't think about earning yield, although after Unslashed announced that they were going to do that we saw Nexus do it too,” El Isa said. “So it's definitely a trend.”

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