According to the ShapeShift report, decentralized insurance can save DeFi from contamination

Decentralized financing has many of the hallmarks of previous cryptocurrency bull markets: incredible profits, extreme volatility, and massive risk. In a new report, leading non-custodial cryptocurrency exchange ShapeShift explains the four biggest risks DeFi investors face and why the emerging field of decentralized insurance could provide a solution.

The report, entitled “Spreading the Risk: Decentralized Insurance”, categorizes the DeFi risk into the following “landmines”: custody risk, smart contract risk, protocol risk, and oracle risk.

The history of crypto is filled with examples of centralized exchanges “losing or absconding users’ money,” said report author Kent Barton. For smart contract risk, one only has to consider “the DAO incident” in 2016, where 3.6 million Ether (ETH) was tapped.

Major risks at the protocol level have not yet been noticed, but that could change quickly as the market continues to evolve. Oracle risk falls in the same category, but one that is much more difficult to quantify or predict. Still, Barton reminds readers that the so-called DeFi summer of 2020 was rife with cases where “flash loans were used to artificially manipulate oracles’ price feeds.”

The report says that decentralized insurance protocols, which provide crypto users with a way to limit downside exposure, are widespread to solve these challenges. Barton explains:

“The decentralized, community aspect of DeFi has meant that it lacks many of the risk mitigation features of traditional financial capabilities. However, the DeFi community itself comes to the rescue by creating a decentralized solution. It is an emerging field worth keeping an eye on. “

The author identified two protocols, Nexus Mutual and Cover Protocol, as early innovators in decentralized insurance. Neither company is affiliated with ShapeShift.

Nexus Mutual has emerged as the largest player in the decentralized insurance industry, with total value increasing nineteenfold to $ 200 million in the past year. The Nexus model is all about creating a pool of funds that can be used to handle claims about smart contract bugs and exploits. The Nexus ecosystem consists of three players: risk assessors, claims assessors and policymakers, with the native NXM token being the common thread among the participants.

Cover Protocol, a peer-to-peer insurance marketplace, is a more recent entrant to the space, launched in November 2020. The platform allows users to purchase coverage for just about anything, but the governance token – in this case, COVER – has not been used for underwriting risk. Unlike Nexus, Cover issues separate ERC-20 CLAIM tokens for each application and coverage expiration date. As Barton points out, it is possible for a decentralized exchange to facilitate trading of these ERC-20 tokens against other insurance projects.

Ironically, both protocols have been targeted by hackers in the recent past. Cover Protocol suffered an infinite mining attack in December 2020, which resulted in a 97% drop in the price of its token. The same month, Nexus Mutual founder Hugh Karp lost $ 8 million after an attacker installed a compromised version of the popular MetaMask wallet on his mobile device.

DeFi has been an incredible boon to early adopters who have hit the market in the past 12 months. The DeFi sector is one of crypto’s biggest success stories in terms of adoption, return on investment, and total value locked in different ecosystems. The top projects are collectively worth $ 100 billion, which is about 20% lower than last week’s peak. Total locked-in value peaked at more than $ 123 billion on April 16, according to industry data.

As for ShapeShift, the organization has expanded its research reach in recent months, having only recently launched a report on derivatives letting. The exchange also made headlines last week after integrating cross-chain swaps through ThorCHAIN. Mobile users can now trade Bitcoin (BTC) directly with Ether and Litecoin (LTC) without the intervention of a custodian, counterparty or intermediary.