Problem

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.

Centralization Concerns

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.

“Proof of Loss” Required for Payouts

• Proof-of-loss required, otherwise it allows anyone to make bets on a protocol getting hacked and could lead to situations like where the payout is higher than what was actually lost or hackers taking advantage of insurance products.
• e.g. buy $1M of coverage, then if any smart contract hack happens it’ll payout that amount. so if a hack only lost $100k I think you’d still get paid out $1M.
• People need coverage but there is a limitation on the amount of underwriting funds available.
• Lenders would pay out much more, since calculations for risk will be done based on the risk of the entire protocol rather than what can be bought.
  • Easy for a hacker to purchase coverage (KYCed), execute a fairly small hack, and get a huge payout.
• The more lenient you are with payouts, the more you need to charge users.

Traditional Insurance vs. DeFi Insurance