Ethereum’s success has proven the demand for smart contracts, but not without risks, as many high-profile hacks have shown. The rise of the smart contract insurance market is helping to fix these issues, with companies like Nexus Mutual and Nayms at the forefront.
Nexus Mutual Founder Hugh Karp explained how the company is a decentralized alternative to insurance with the ambitious goal to become the blockchain-based Lloyd’s of London, saying,
“Anyone should be able to bring any risk to us, and we should be able to cover it…starting with crypto risks for now.”
Karp explained the problem they are looking to solve, pointing to security breaches like the DAO Hack and other big events to illustrate that the Ethereum ecosystem needed insurance-type solutions to cover risk if it is going to develop, saying “otherwise it won’t be adopted.”
He explained the mechanics of it, saying that with code, which operates as you write it, there will always be the question of ‘is it a bug or is it not a bug?’ At Nexus, if an event clearly went against the intention of what the developers were writing, then the company pays a claim. In most cases, this will be easy to determine.
“The only real way to assess if that’s happened is to put humans in the process to assess and have some judgement involved, which is kind of a bit strange in our whole programmatic world of DeFi. But having that approach actually gives us a lot of flexibility,” said Karp.
He added that this is how Nexus operates, with a group of people voting on claims to determine which ones are legitimate.
Karp addressed the alignment of interest among the people voting, explaining that the mechanics are two-pronged. On one hand, you must stake as part of the claims assessment process, with a minimum of 5x the amount of cover required to approve a claim. If Nexus Mutual denied all valid claims, it would have no value. This is a high-level incentive for those who are staking.
There is also a lower-level incentive, which involves a group of people who can punish the claims assessors if there is a clear attacking of the system, which he says is a “good threat to prevent things from going awry.”
For its part, Nayms is starting from a more generalized approach. The problem they are looking to solve derives from a huge amount of emerging risk across different categories — including smart contracts. This poses a big opportunity for the brokers and underwriters in the traditional space. Big brokers as well as grass roots brokers were coming out of the woodwork to serve this new area of risk, each with their own approach. Nayms from its own calculations determined that to be constantly using traditional dollar-based capital to cover the liabilities would create a scaling issue.
“If the space is really going to grow as we are all expecting, then you need infrastructure and capital that will scale alongside that growth,” said Nayms CEO and Co-Founder Dan Roberts. “There’s always going to be this asset liability mismatch of dollars covering a big bitcoin loss or an ether loss that feeds into pricing problems, caps in dollar values, meaning that capital is technically underexposed or overexposed.”
As a result, the company started by focusing on the needs of the brokers and came to the conclusion that the insurance problem A.) would be a collaboration between underwriters, brokers and the capital markets, and B.) underwriters in the space that can assess different types of risk will be the gateway to bridging the capital markets and native crypto markets into different types of risk.
The two companies are quite compatible, with Nayms solving the problem for the underlying capital base because insuring crypto with fiat creates an FX risk. By underwriting the policy in crypto, you mitigate that risk. Nexus Mutual is providing new types of products surrounding smart contract risk, and the two can be combined together.