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Even though on-chain insurance has been since 2017, just 1% of all crypto assets are insured. Therefore the business remains a "sleeping giant," according to a crypto insurance executive.
Dan Thomson, chief marketing officer of decentralized cover system InsurAce, told Cointelegraph that there is a large difference between the total value locked (TVL) in crypto and decentralized finance (DeFi) protocols and the proportion of that TVL that is insured:
"DeFi insurance is a titan in slumber. There is a massive untapped business opportunity with less than 1% of all crypto and less than 3% of DeFi covered."
Even if considerable resources have been invested in smart contract security audits, on-chain insurance is a potential solution for digital asset protection — for example, when a smart contract is abused or the front end of a Web3 protocol is hacked.
Thompson writes that the collapse of Terra (LUNA) and the subsequent depeg of Terra USD is a textbook illustration of how on-chain insurance may protect investors, noting that InsurAce “paid out $11.7 million to 155 impacted UST victims.”
“Hacks in 2021 in DeFi alone caused $2.6 billion in damages,” equating to $10 billion in the broader crypto industry, and “we’re already far over that in 2022,” Thomson noted, highlighting the necessity for on-chain insurance for digital assets.
While it has caught the curiosity of traditional corporations, they have not yet gone into the field “due to their own rules and compliance,” according to Thomson, who was asked whether traditional insurers will ultimately provide crypto-focused products.
“I do not expect the major traditional insurance firms to create their own native applications for the market. Instead, they will opt to sell reinsurance as a means of gaining exposure.”
However, according to Thomson, on-chain insurance processes have seen obstacles since capacity constraints have slowed their expansion.
“Capacity is restricted by underwriting, which is normally done with reinsurance, but in DeFi, it is done by stakers and consequently limited by TVL, making it difficult for most protocols to generate adequate liquidity.”
He added that this challenge is worsened by the inability of on-chain insurance providers to give attractive investment returns to capital providers, which inhibits liquidity provision.
Thomson stated that his company is attempting to address this capital efficiency issue by employing reinsurance from traditional insurance companies to “turbo-charge expansion through the bear market.”
“We will be one of the first procedures capable of bridging back to traditional reinsurance to enhance our current underwriting from staked assets.”
Currently, certain cryptocurrency exchanges provide insurance services, but there are relatively few crypto-native protocols that specialize in on-chain insurance.
To create a quote for on-chain insurance services, most protocols ask customers to indicate the smart contract address they want coverage for, along with the amount, currency, and duration.
Many protocols employ a DAO and a token to let token holders vote on the legitimacy of claims.
Nexus Mutual and inSure DeFi are two of the most prominent on-chain insurance systems.