What is Decentralized Insurance? Best Defi Insurance Platforms

Investing in crypto is much safer than it used to be, but it isn’t risk-free. 

Decentralized insurance is a response to this risk. It’s a way of protecting your assets and yourself against things like theft, hacks, and real-world catastrophes.

Decentralized insurance can be a fantastic tool if you want to protect yourself against many of the risks involved in crypto. That said, there are lots of things to be aware of here: DeFi insurance is different from traditional insurance and has some unique characteristics and challenges.

We’re here to help. This article will explain what decentralized insurance is, how it works, what it usually covers, and when you should consider it.

What is Decentralized Insurance?

Decentralized insurance follows the same basic principle as traditional insurance: users can pay to be covered against specific events and risks, and if they successfully make a claim, they’ll receive money.

Unlike traditional insurance, decentralized insurance is built on blockchain technology. This allows it to operate without a centralized third party, and gives it a high level of transparency. Policies are underwritten by a decentralized network of peers, and decisions around claims are made by referring to blockchain records or by democratic review.

The idea is to provide insurance that anyone can access, and where claims are dealt with in the fairest way possible.

How Does Defi Insurance Work?

Instead of relying on a centralized middleman, decentralized insurance operates like a collective. Individual users decide to contribute to a pool of shared money, where they earn interest in exchange for exposing themselves to risk. 

These users play the role of underwriters, and they get to decide which specific policies they want to cover. This means they can mitigate their risk by choosing to cover only events that they consider to be unlikely.

If you purchase DeFi insurance, you’re then covered for the specific events and occurrences you chose. If they happen, you’ll be able to submit a claim, and a smart contract will automatically process the claim and pay you.

Occasionally, there may be a need for humans to review your claim. Different insurance providers have different processes here, but typically, a group of community members will consult and reach a decision democratically.

Traditional Insurance vs. Decentralized Insurance

Decentralized insurance was designed to have some specific advantages over traditional legacy insurance. It’s intended to be fairer, more transparent, faster, and more accessible. Here’s a bit more on how these advantages work.

Transparency

Traditional insurers can often be extremely opaque with their claims processes and decision-making. Decentralized insurance is much more transparent, and users can clearly see how much capital is staked, how much is paid out, and the terms of coverage.

Speed

Because decentralized insurance is largely automated and decentralized, it avoids a lot of the delays and complications involved in traditional insurance. There’s no need for lengthy, involved claims processing, which saves a ton of time.

Accessibility

It can be difficult to qualify for traditional insurance. Insurers often ask for a huge amount of information, like your personal details, claims history, and financial records, and this can make it very difficult for certain groups to access insurance at all. Decentralized insurance, by comparison, is available to everyone, with no information required.

Trustlessness

Because of its decentralized nature, DeFi insurance is trustless. It has no need for a third party like traditional insurance does, which allows it to operate much more smoothly.

Some Use Cases of Decentralized Insurance

So, what does decentralized insurance actually look like in practice? Let’s check out a few scenarios and how DeFi insurance works in each case.

Smart Contract Exploit Coverage

Unfortunately, smart contracts are not infallible. Occasionally, malicious actors can exploit bugs or vulnerabilities in the code of smart contracts to steal large amounts of crypto. A high-profile example here involved The DAO in 2016, where hackers took advantage of a bug that allowed them to repeatedly withdraw money. They stole roughly 3.6 million ETH, about $60 million at the time.

DeFi insurance can offer some protection here by insuring your assets against this specific type of attack.

Exchange Hack Protection

Another common use case for decentralized insurance is hacked exchanges. The biggest example here is the 2022 hack of the Ronin Network, where criminals used hacked private keys to access the exchange and steal $625 worth of crypto. Several DeFi insurance providers offer protection against this type of event.

Real-World Event-Based Coverage

It’s easy to think of decentralized insurance as something that applies solely to the digital world, but it can also be used to insure against real-world events. Many DeFi insurance platforms offer protection against things like extreme weather events, crop loss, and flight delays. Etherisc, for example, offers protection against train delays, hurricane damage, and natural disasters.

Wallet Insurance

Sometimes, hackers will target the wallets of individual crypto owners. One type of attack here is called “address poisoning”, where hackers will send you a small amount of money from an account that looks very similar to one you regularly send funds to. This is designed to trick you into sending money to the sham account instead.

Some decentralized insurance providers, like Boost, offer protection against wallet hacks.

Parametric Insurance for Real-World Events

Parametric insurance is set up to provide fast, simple payouts for specific scenarios. It works by creating a smart contract that agrees to pay out a certain amount when certain criteria are met. 

For example, when USDT became unpegged from the U.S. dollar in 2022, some insurers paid out to their users based on smart contracts, which triggered as soon as USDT’s value fell below a pre-determined point.  

Crypto Lending Default Protection

If you loan crypto to others on DeFi lending platforms like Aave, there’s always the risk that borrowers will default and leave you out of pocket. Some DeFi insurers offer protection against this, which gives peace of mind to lenders.

Insurance for DAOs (Decentralized Autonomous Organizations)

DAOs (Decentralized Autonomous Organizations) are organizations built on smart contracts that operate in a decentralized and democratic way. Many DAOs handle millions of dollars worth of crypto assets, which makes them big targets for criminals.

Decentralized insurers can and do offer protection here. In 2023, a platform called Euler Finance lost $197 million in funds in an attack. Many DAOs that used the platform were affected, but received payouts from Nexus Mutual.

Benefits of DeFi Insurance

DeFi insurance offers a faster, cheaper, more accessible, and more transparent alternative to traditional, legacy insurance. Here’s a summary of the main benefits of decentralized insurance.

Transparent Claims With Fraud Prevention

Decentralized insurance is extremely transparent. All claims are visible on-chain and can be viewed by anyone. This is a sharp contrast to traditional insurers, who often reveal very little about their processes and claims history.

Because of this transparency, there’s a much lower risk of fraud and manipulation. Underwriters can get a better idea of the risk of contributing, and policy buyers can learn about the reliability of the provider and their track record of paying out claims.

Automated Payouts

In many cases, decentralized exchanges can process claims and execute payouts automatically without the need for any human intervention. This is based on smart contracts, which are able to review claims, verify their validity by drawing on data from the blockchain, and then pay out funds. This entire process can happen very quickly, unlike traditional insurance, which can be painfully slow.

Accessible Globally

Traditional insurance can often be exclusive and even discriminatory. It can be very difficult for certain people and groups to access insurance, and even eligible people may have to submit piles of documentation just to qualify. This is because of a process called Know Your Customer, where insurers are required to build detailed profiles of their clients.

DeFi insurance is the opposite of this. Anyone can access these platforms, regardless of who they are, where they’re located, and what they’ve done in the past. This makes decentralized insurance truly borderless and permissionless.

Reduced Costs

Decentralized insurance operates in a way that’s much leaner and simpler than legacy insurance. There are no intermediaries involved, and much less infrastructure required. This reduces fees for everyone involved and makes things faster and more accessible.

Users Can Pick and Choose

Users of DeFi insurers have a high amount of autonomy when it comes to what they want to cover. These platforms typically allow you to customize cover amounts, choose specific risks to cover, and decide on the right duration of cover for your needs.

User Confidence Through Trust and Security

Blockchain technology is inherently transparent, trustless, and immutable. This makes it hard for users to defraud, trick, or exploit other people, since all information is made public and easily accessible. Because of this, DeFi insurance has a high level of security and trust, and users (underwriters and buyers) can be confident that their interests will be protected.

Challenges and Limitations

We’ve spent some time looking at the advantages of DeFi insurance, but it’s only fair to explore a few of the downsides, too. Here are some of the biggest challenges currently facing the decentralized insurance space, and what they mean for users like you.

Regulatory uncertainty

Traditional insurance is heavily regulated all around the world, it’s one of the reasons why it’s so slow and convoluted. DeFi insurance owes a lot of its speed and agility to the fact that it isn’t yet regulated in this way, but that may well change.

DeFi insurers that cover real-world events like extreme weather and delays already have to consider local insurance laws and regulations. And as time goes on and DeFi insurance becomes more widespread, it’s likely that governments will take steps to regulate it more and more. Insurers and their customers will have to consider this.

Oracle dependencies

Decentralized insurance platforms make decisions using oracles. Oracles pull data from real-world sources and feed it into blockchains. In the case of insurance, this means smart contracts can access accurate, up-to-date data (about things like hacks and natural disasters) to make decisions on claims and payouts.

However, this also means DeFI platforms are heavily reliant on oracles working as intended. If there are issues with data collection and processing, this can lead to erroneous payouts, denials, and delays.

To mitigate this problem, some chains use multiple oracles at the same time to make decisions, so they aren’t reliant on a single, fallible source.

Lack of coverage standardization

Traditional insurance is highly standardized and regulated, which means all insurers play by the same rules and follow common, agreed-upon definitions for their policies.

Decentralized insurance, however, is comparatively unregulated. This means each protocol sets its own rules and definitions for things like hacks, exploits, natural disasters, and depegs. Protocols also have their own standards for processing claims and calculating payout amounts.

This lack of standardization can confuse users and make it difficult to accurately compare different options. It can lead to people receiving smaller payouts than planned, or not receiving any payout due to misunderstanding the insurer’s terms.

DeFi insurers are working on this problem by trying to make terms as objective and clear as possible, but it’s a work in progress.

Top DeFi Insurance Platforms 

What are your options when it comes to choosing a decentralized insurance platform? The space is growing, so let’s check out some of the best protocols out there.

Nexus Mutual

Nexus Mutual is a DeFi insurer with $194 million in active cover and $18 million in claims paid. It was founded in 2017 and has since grown into the biggest decentralized insurance provider out there, with a strong community of users and a solid reputation. They offer coverage for a wide range of events.

InsurAce

InsurAce is a multi-chain, mutual-style insurance protocol. It offers competitive pricing and has a record of paying out claims, with $12.5M in total claims paid. InsurAce offers protection against smart contract vulnerability, custodian risk, and stablecoin depeg risk, among others.

Etherisc

Etherisc specializes in parametric blockchain insurance. Their platform allows users to create and share their own parametric insurance products, and they cover a wide range of areas, including flight and train delays, health insurance, and natural disaster insurance.

Tidal Finance

Tidal Finance allows security professionals, project teams and liquidity funds to build their own custom insurance policies and terms. Users can then access smart contract protection and cover against de-pegging, insolvency, and real-world events. They protect more than 10 asset times, and have paid out more than $1.1 million.

ease

ease was built to make DeFi insurance simpler and more accessible by removing the need for underwriters and adding flexibility. They charge no costs for cover, and allow users to deposit and remove DeFi assets without fees. Users are covered on all protocols they’re exposed to, and are covered against events like hacks, scams and rug pulls.

OpenCover

OpenCover’s decentralized insurance platform makes it easy to protect your crypto assets against risks like depegs, oracle manipulation, and smart contract attacks. They use a network of vetted onchain underwriters. Since 2019 they’ve paid out more than $18 million, and claim to have more than $95 million in active cover.

Bright Union

Bright Union brings together a number of different providers of DeFi insurance in one marketplace. Users can access 15 different chains and multiple liquidity providers, and Bright Union claims to have covered more than $70 million in assets and protected over 300 wallets.

Want to Learn More About DeFi Platforms?

We get it, DeFi can be confusing. That’s especially true when talking about complex and potentially high-stakes issues like insurance.
But don’t worry: our DeFi explorer is here to help clear things up. You can learn about all kinds of DeFi platforms for a ton of use cases.