How Will Decentralized Insurance Work?
DeFi, General - August 25, 2020
Insurance is an important DeFi solution. Companies like Nexus Mutual and Opyn Protection are building decentralized insurance that can be used in the blockchain and DeFi coins world. In this video, we unpack why decentralized insurance is so important.
Nobody likes risk. Let me clarify, nobody likes risks that actually materialize. Why? Because it creates a financial cost, one which could’ve been prevented or at least protected against.
How does one protect against this cost? Simple, through insurance.
Insurance simply means pooling together financial resources, so that if a risk materializes, there’s a safety net. Everyday things that are insured are – houses, cars, and health.
Broadly, insurance policies work according to the three-Ps principle:
- Premiums: The periodic payment you make
- Pooling of money: The period payment everyone makes
- Payout: The payout you receive when the risk materializes and you have to bear a financial cost
This is the basic structure of all types of insurance. But, in centralized insurance there a few problems:
- The problem of specificity: Insurance companies don’t allow specific insurance policies based on a set of risks that you have and no one else does. You’ll have to always go for insurance contracts based on buckets for pools of insurance takers.
- The problem of selection: Since insurance policies are broad-based, if you happen to take these policies and fall immediately outside the affected circle, your claims can’t be enforced because the larger population were unaffected
These are basic problems. But there are a whole host of fees attached to the centralized model because insurance companies have to pay for rent, salary to the employees, and a range of administrative costs.
In the decentralized insurance model, the following operations traditionally done by humans in a centralized company are done by computer programs through code:
- Assessing the risk
- Determining the premium
- Determining when or if the risk materializes
- Assessing the damage
- Eventually offering the payout to the insured
These functions are done through the various tools of the DeFi ecosystem like blockchain technology, oracles, smart contracts, and digital currencies. And, all this is automated, calculated on the go, and immediately dispersed without any intermediary charging unnecessary fees or causing unnecessary friction.
DeFi solutions like these are building the next generation insurance for all financial assets on the blockchain. Clients investing in the cryptocurrency and DeFi coins space need to be protected, one of the ways financial advisors can help is by understanding how DeFi insurance works.
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