The global insurance industry has a market capitalization of trillions of dollars and is growing. The chart below shows the global insurance industry data from 2016–2020. The global insurance market size declined due to the impact of the new crown epidemic in 2020, but it also resumed growth as the epidemic gradually eased and the economy gradually recovered (insurance market size data for 2021 and 2022 are not yet available). Insurance has become a necessity in daily life. With the emergence of blockchain and smart contract technology, its decentralized, open and transparent characteristics also bring new development opportunities to the traditional insurance industry.

1. What is decentralized insurance?

Decentralized insurance is a new insurance model based on blockchain technology. It manages operations in a decentralized manner and reduces intermediate links to improve efficiency and transparency. At present, in addition to the application of decentralized insurance business in the field of Web3 digital assets, although the volume and scale of traditional industries are small, some progress has also been made.

Decentralized insurance is implemented by smart contracts and blockchain technology to ensure the reliability and security of contracts. Suppose you are a farmer and you need to purchase weather insurance to hedge against drought risk. Your crops need at least 20 inches of rainfall to be marketable. So you want to insure your crops that you’ll be covered if there’s less than 20 inches of rain. If the rainfall exceeds 20 inches, you will not be compensated. Since the smart contract runs on a decentralized infrastructure, all parameters of the contract have been set, such as the geographical location of the crops, risk parameters, and the amount of insurance. The insurance will be based on predefined parameters and weather data in a deterministic manner. way to execute.

1.1 Advantages of decentralized insurance

Combining insurance with blockchain and smart contracts to upgrade the insurance infrastructure can not only solve the transparency problem, but also simplify the insurance process. The advantages of decentralized insurance mainly include the following aspects:

(1) Decentralization: Decentralized insurance realizes decentralized management and operation through blockchain technology, reduces intermediate links, and improves efficiency and transparency.

(2) Low cost: Decentralized insurance can reduce the operating costs of insurance companies, thereby reducing insurance costs.

(3) High efficiency: Decentralized insurance can realize automatic claims settlement and fast compensation through smart contracts, improving the efficiency of claims settlement.

(4) Safe and reliable: Decentralized insurance realizes decentralized storage and encrypted transmission of data through blockchain technology to ensure the reliability and security of insurance contracts.

1.2 Categories of decentralized insurance

With the continuous development of blockchain and smart contract technology, more and more users have begun to join this emerging industry. As the field is still in its infancy, DeFi security has also become a pressing issue. In 2022, security incidents will continue to increase, and the cumulative loss will reach 3.8 billion US dollars. Among them, the loss caused by contract loopholes and project party fraud is huge, and the overall situation is very grim.

In order to help users reduce losses, DeFi insurance expands into eight main categories:

(1) Protocol Loss Insurance: Prevents economic losses caused by the use of DeFi protocols, usually including smart contract exploits, smart contract errors, economic design failures, and Oracle failures or manipulations.

(2) Stablecoin unanchoring insurance: to prevent losses caused by the loss of the peg between the stablecoin and the target fiat currency

(3) Yield Token Insurance: To prevent losses caused by the serious deviation of the face value of the LP token that generates income from the market value of its reference currency.

(4) Escrow account insurance: Prevent possible losses of digital assets held in escrow accounts (such as centralized exchanges), such as theft, suspension of withdrawals, etc.

(5) Bridge Insurance: Prevents loss of funds when using a bridge to transfer funds from one blockchain to another. On March 23, 2022, Ronin Bridge lost $624 million due to private key leaks.

(6) Audit (smart contract bug) insurance: purchased by protocol developers to protect the protocol from vulnerabilities not detected during audits. Audit Failure Case: Euler protocol lost $197 million due to a vulnerability in account health checks, which remained undiscovered for 8 months despite multiple audits.

(7) Professional validator insurance: prevent professional validators from losing funds due to being slashed on the PoS blockchain. Slashing events include: validator misconfiguration, bugs or unknown issues in validator client software, downtime due to external factors such as network outages, external exploitation of software vulnerabilities exposed by node operators.

(8) Other customized insurance: insurance tailored according to the needs of users.

1.3 Data analysis on chain of decentralized insurance agreement

The figure below shows the TVL data of insurance agreements in the DeFi field. On June 13, 2021, the TVL of insurance agreements reached the maximum at $1.4B, while the total TVL of DeFi at that time was $88.13B, accounting for 1.5%. After that, the total TVL of DeFi continued to rise, but the TVL of insurance began to decline, accounting for narrowed down further. By May 2022, the DeFi field will be in a bear market, and the total TVL will drop. By April 18, 2023, insurance agreements will account for 0.72% of the total DeFi TVL.

Due to the instability of the blockchain market, the previous Luna incident caused its market value of up to 40 billion to return to zero within a few days, and security incidents such as FTX thunderstorms and stablecoin unanchoring caused the total value of cryptocurrencies to shrink sharply. Therefore, market participants need to take some measures to minimize or resist unknown risks and losses. The figure below is a comparison chart of the 2019–2022 encryption market value and the estimated encryption insurance capacity. It can be seen that the encryption insurance market is still relatively small and has not yet been fully developed.

(1) Nexus Mutual

Nexus Mutual is a decentralized insurance alternative that allows members to join and share risk. Members can purchase insurance products that cover different types of risks. Built on Ethereum, the Nexus Mutual protocol provides members with the infrastructure to purchase insurance, underwrite risks, evaluate claims, and build risk management businesses. The condition for becoming a member is to pass KYC certification and pay a fee of 0.0020ETH. Everyone who passes the membership process becomes a Nexus Mutual DAO member. The Nexus Mutual DAO operates as a carte blanche mutual — people can join, share risk, and enjoy membership benefits. Members coordinate with each other through the Nexus Mutual agreement. Members can purchase insurance products that cover different types of risks. When members with insurance suffer material damage, they can submit a claim and complete the claim assessment process. The result of the claim settlement is decided by the voting of the members who hold NXM.

Nexus Mutual accounts for a large proportion of the entire DeFi insurance agreement. Only in the bull market, the emergence of various insurance agreements reduces the proportion of Nexus Mutual to about 40%. As of now, Nexus Mutual accounts for about 80%.

The figure below shows the changes in weekly trading volume and price-earnings ratio (circulating market value/annualized fee) in 2023. The total transaction volume of Nexus Mutual in 2023 will reach 115 million US dollars, and the average weekly transaction volume will be 8,278,367 US dollars. The price-earnings ratio at the beginning of the year was 10.65, and then the price-earnings ratio continued to increase. By April 17, the price-earnings ratio increased to 64.09.

The figure below shows the distribution of holders of $NXM tokens. The token currently has a total supply of 6,760,592.83 on Ethereum and a total token holder of 4080. The number of tokens owned by the token contract address accounts for 34.50% of the total tokens, and Nexus Mutual accounts for 4.55%. Mutual fund members of the agreement have now paid more than $17.9 million in claims.

(2) Eaze

Ease was originally called Armor.Fi, and its developer was a core developer of Cover. The protocol is positioned as a distribution agent for Nexus Mutual, providing it with liquidity and transforming DeFi insurance from static insurance to a tradable existence. arNXM and arNFT are the two main products of Ease. Ease users can convert insurance policies purchased on Nexus Mutual into arNFT and trade them in the secondary market.

The figure below shows the total premium of arNFT. Premiums, mostly provided by ETH, fell in May and fell by 72% by July before rising again. As of April 19, 2023, total premiums are $6,461,808.

2. Risk Analysis of Decentralized Insurance Business

Since the decentralized insurance market is still relatively new and lacks supervision and regulation, there is a risk of being maliciously used for fraudulent insurance. The business risks of decentralized insurance mainly include the following:

(1) False publicity: Some decentralized insurance projects will exaggerate their own strength and benefits to attract investors to participate, but in fact there are risks. Such actions may result in loss of property for investors.

(2) Create accidents: In order to obtain insurance compensation, some people will deliberately create accidents to obtain improper benefits. This behavior not only causes losses to the insurance company, but may also pose a threat to the life and property of other people. Case: In October 2020, a case involving insurance fraud on the chain was cracked. The criminal suspect defrauded the insurance company for compensation by fabricating a car accident and providing false evidence. They also use blockchain technology to conceal their identities, making crime more difficult.

(3) Providing false evidence: In order to obtain insurance compensation, some people will provide false evidence to deceive the insurance company. Such behavior may cause economic losses to the parties involved in the agreement and affect the reputation of the agreement.

(4) Group insurance fraud: Some people will form insurance fraud gangs, apply for insurance as a gang, and then fraudulently obtain compensation. This behavior will cause serious economic losses to the agreement and affect the reputation of the market.

(5) Malicious attacks: Hackers may use the loopholes in blockchain technology to carry out malicious attacks in order to obtain improper benefits. This kind of behavior may cause serious harm to the decentralized insurance market and affect the stability and healthy development of the market. Case: In December 2020, the decentralized insurance project Cover Protocol was hacked, resulting in the theft of approximately $4 million in tokens. The hacker took advantage of the loopholes in the smart contract, successfully attacked the insurance pool of the project, and obtained tokens. This incident has aroused widespread concern in the market, and also reminded that decentralized insurance projects need to strengthen security.

Security incidents can cause serious harm to the decentralized insurance market, including:

(1) Harm the interests of the parties to the agreement: Insurance fraud on the chain will lead to an increase in the amount of compensation in the agreement, which will affect the profitability and development of the project.

(2) Affect market reputation: security accidents will damage the reputation of the decentralized insurance market, reduce the trust of investors, and thus affect the development of the market.

(3) Damage to the interests of consumers: Safety accidents will lead to insurance companies strengthening audits, thereby increasing consumers’ audit costs and time costs.

At present, although there are relatively few insurance fraud cases and attacks against decentralized insurance, with the development of the decentralized insurance market, malicious attacks and insurance fraud cases may continue to increase. Therefore, the decentralized insurance protocol needs to strengthen regulation and security to prevent the occurrence of safety accidents and ensure the stability and healthy development of the market.

About us

SharkTeam’s vision is to comprehensively protect the security of the Web3 world. The team is composed of experienced security professionals and senior researchers from all over the world. They are proficient in the underlying theory of blockchain and smart contracts, and provide services including smart contract auditing, on-chain analysis, and emergency response. It has established long-term cooperative relationships with key players in various fields of the blockchain ecosystem, such as Polkadot, Moonbeam, polygon, OKC, Huobi Global, imToken, ChainIDE, etc.Official website: https://www.sharkteam.org/Twitter: https://twitter.com/sharkteamorgDiscord: https://discord.gg/jGH9xXCjDZTelegram: https://t.me/sharkteamorg