Insurance, the next big player

Emergence and Evolution of DeFi Coverage Protocols

With a record of $3 billion lost just last year, and with the limited adoption by the broader public, it’s likely that security and insurance will become strategic and essential services for individuals, businesses, and institutions. The management of private keys and the purchase of insurance to protect our assets, whether they are in our wallet or in some DeFi protocol, emerge as the primary solution to the technical and economic risks in the sector.

Mitigating risk in DeFi remains an ongoing issue and debate due to the limited use and interest in DeFi coverage protocols, despite being the primary solution to the risks inherent in decentralized finance. In practice, DeFi coverage is an emerging sector with various approaches to risk management, governance, and claims assessment. Therefore, this vertical is expected to play a key role in the normalization and democratization of coverage use within the blockchain.

The DeFi coverage sector currently comprises more than 23 protocols, some governed by DAOs (Decentralized Autonomous Organizations), and others are regulated companies. Initially, the early protocols focused on custody and the pegging of stablecoins, then they began covering the risk associated with providing liquidity or making deposits in more advanced protocols. Currently, efforts are underway to protect and insure against credit defaults, meaning coverage is evolving in parallel with the overall ecosystem.

Between 2022 and 2023, the coverage system has performed quite well, even when subjected to significant stress due to the events we’ve witnessed. In terms of numbers, approximately 20,000 coverages were issued, nearly 600 claims were filed, and 379 were paid out (in 2022 alone, $34.4 million in claims were paid out, serving as a litmus test for these coverage protocols). In the eyes of institutional players, this successful performance has boosted their confidence in increasing their involvement and subsequent adoption. We are talking about an industry worth $6 trillion, which covers not only one type of risk, such as custody, but also has a wide range of products to secure, especially those related to native risks in DeFi, such as smart contract vulnerabilities, governance, or economic risks.

Given that a Smart Contract is a function of reading and writing, attacking it is relatively easy, which is why the most common attack vectors are identified; Protocol, Infrastructure, Ecosystem, and Smart Contract Language. The primary attack vector is the theft of private keys, which resulted in losses of nearly $2 billion, with bridges being the main focal points of attack (let’s not forget the attack on Ronin, which was the largest loss in this category, totaling $624 million). Here, I would like to pause and provide a clarification: ‘The problem is not created by the technology; compromised private keys are often the result of serious user errors, either due to falling for social engineering and phishing attacks. Hence, current coverage solutions often exclude losses due to compromised private keys. We have a significant problem as a society regarding healthy internet culture and habits, and the numbers don’t lie.

In conclusion, there are two relevant aspects:

1) We have a system for being secure (2017) that was created before having a system for being profitable (2019) with our assets (DeFi). Therefore, we have no right or reason to complain when we become victims of an attack.

2) On the other hand, it’s not just about acting against DeFi protocols. In the end, what we aim for is to protect our assets, and most of the time, these assets are stored on centralized exchanges. Hence, efforts should be focused on protecting everything a user has deposited outside of their custody, whether it’s a CEX (Centralized Exchange) or DEX (Decentralized Exchange). If we work in that direction, many more people, businesses, and institutions will see the sector in a different light, moving away from the worn-out narrative of the ‘wild west’ and focusing on building a new financial system that is vastly improved compared to the current one.