Why insurance is needed for DeFi, and what it looks like

NFTs busted the door to decentralized finance wide open. CGI artist Beeple (Mike Winkelmann) had already captured the headlines by selling his collections for over $6 million worth of ETH. But on March 11, Beeple broke another two ceilings – getting his NFT listed on traditional auction house Christie’s and selling it for an astronomically high price of $69.3 million. This too is comparable to exorbitant traditional artwork pricing.

Effectively, this means we can expect a new wave of people joining DeFi, a new class of users represented by digital artists and their hordes of fans. After all, the first thing one associates with NFTs is the programmable Ethereum blockchain with its native ETH token, the second-largest cryptocurrency by market cap (and popularity in general). Almost all NFTs are listed in ETH and all NFT marketplaces are a click away from DeFi dApps.

However, there is something missing to greet the new DeFi explorers: Peace of mind, in the form of insurance. Let’s find out how insurance would be implemented in the blockchain space.

Why DeFi Insurance Is Needed

Just as crypto exchanges have become the favorite target of cybercriminals, reflecting Bitcoin’s popularity growth, so too have DeFi protocols. Last year, when the DeFi space ramped up in activity, CipherTrace reported a $2.7 billion loss in hacks and fraud. Although this is still lower than the $4.5 billion worth of damages in 2019, it still represents a cause for concern.

The year 2021 didn’t start any better. On February 5th, one of the most popular DeFi platforms – Yearn Finance – suffered a loss worth $11 million. Without going further into detail, it was a so-called flash loan attack, falling into the category of exploits. Just like in the video gaming industry, it is a form of hack, but one that pinpoints and exploits an existing flaw in a given system.

If this sounds familiar, it’s because Yearn Finance was the same DeFi platform that had reportedly fixed an attack vector for a flash loan exploit last November. The unfortunate protocol that suffered the attack then was Harvest Finance, with users losing $30 million worth of tokens from their accounts. These events point to a sobering reality – not even preparation in the wake of similar exploits in the past is sufficient to erect an impervious barrier against them.

Like with crops and the unpredictability of weather, the only course of action is to institute insurance as a stabilizing force. Andre Cronje, the founder of Yearn Finance, informed the affected investors who were insured that all of them will be reimbursed.

One could read this as a signal to all DeFi participants to get insurance. Although Yearn Finance’s native YFI token has recovered since, it suffered a 12% value drop in the immediate aftermath of the flash loan exploit.

Outside of malicious attacks, it is worth noting that funds can sometimes be lost due to glitches. After all, we are dealing with the digital space in which nothing is 100% bug-free 100% of the time. For these reasons, any serious DeFi stakeholders should consider taking an insurance policy ASAP.

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