The ideal insurance product thrives on premiums while minimizing payouts, but the volatility and unpredictability of large-scale hacks pose significant challenges. DeFi insurance is indeed a necessity, but it grapples with critical issues. Current solutions create a zero-sum game, shifting one investor's misfortune to another.
1. Risk and Capital Efficiency
Traditional project staking for insurance links the fate of staked assets with a particular project. This connection leads to a permanent loss of staked assets when claims are paid due to the high correlation of risk. Project pools require full collateralization to offer coverage, resulting in capital inefficiency. Premiums often fall short, leading to insurance providers temporarily subsidizing liquidity providers.
2. Liquidity and Diversification
Returns from coverage are confined to specific pools, diminishing liquidity provider returns as more stakeholders join. Moreover, the limited coverage scope necessitates policyholders to buy multiple policies for diverse risks.
3. Governance and Claims
Claims adjudication relies on a stake-to-vote mechanism, leading to skewed results and lack of consensus. Voting shareholders face a dilemma: they're either liquidated for not paying out the claim or liquidated for paying out the claim.
Existing DeFi insurance protocols claim to be decentralized but often fall short. For instance, InsurAce, while paying out claims, exposes itself to substantial concentration risk. Kleros, known for decentralized arbitration, faced conflicts of interest that impacted claims decisions, raising questions about fairness.
Beyond these flaws, there's been little innovation in decentralized insurance. DeFi offers lucrative yields, often at the cost of higher risk. The lending aspect of permissionless insurance poses challenges. Why earn a 1% annualized premium when you can lend at 5%?
Traditional insurance benefits from government enforcement, such as banks requiring life and home insurance for mortgages. The Opencover platform seeks to address these issues with aggregated covers and potential software for API integrations, allowing dApps to offer insurance seamlessly, much like booking a flight with insurance options. This approach brings the crucial element of fear-induced insurance to the DeFi realm.