Finding the Fair Premium For DeFi Insurance

2% premium should be fair for blue-chip DeFi project, 2.6% for average projects

How much are you expected to lose if you are in DeFi?

Let’s consider hacks/exploits in the whole year of 2020. And to make thing simple, we only consider major ones.

There were 20 hacks/exploits through 2020, causing a total loss of $24m. TVL (Total Locked Value) by end of 2020 is $11576m.

2.03% of DeFi was lost in 2020, with each hacked protocol losing an average of 4.6% of the TVL

To make things simple,we consider Alice as the only DeFi investor and invested $11576m in DeFi in 2020.Because of the hacks/exploits, she lost $24m in 2020.

Loss ratio for Alice was $24m/$11576m=2%

What does this mean?

It means if you invested $100 in DeFi, you are expected to lose $2 through the year.

If a protocol was hacked/exploited,how much will be lost?

As shown in the picture above, 11 of the projects lost up to 30% of their own TVL, with an average of 4.6%.

What does that mean?

It means if the DeFi project you participated was hacked, you are expected to lose 4.6%.

What do you do to secure your funds in DeFi and have a good sleep?

Buy coverage.

How much should average DeFi coverage cost?

For coverage providers to profit, premium should surely cover the expected loss, that is 2%.Let give a resonable number of 2.6% (which is also premium of most of Nexus Mutual coverages).

But 2.6% is the average, and we all know projects are of different quality, based on team,history and user base. Blue-chip projects should be safer and pay less than 2.6% while new,small projects should pay much higher than 2.6%.

We could not estimate premium of low small and new projects since risk could be very high. But it must be above 2.6%.

How much should blue-chip project coverage cost?

For blue-chip projects, it should be below 2.6% since they are safer than average DeFi projects.

What determins the premium?

1. The likelihood that a project is hacked/exploited.
2. The loss ratio when hacked/exploited.

Loss ratio of blue-chip projects?

Balancer,Compound and Yearn lost 0.3%($0.4m /$127m),6%($90m/$1633m) and 1.2%($11m/$900m) respectively during hacks, with an average of 3.8%.

Blue-chip projects lose an average of 3.8% during hacks

As discussed above, average DeFi projects are expected to lose 4.6%.

How much should the premium be for blue-chip project coverage?

If we don’t consider the likelihood that a project is hacked, the premium should be (3.8%/4.6%)*2.6%=2.1%.

So taking the likelihood to be hacked/exploited as a factor, it is safe to say, 2% premium for blue-chip project coverage is fair.