The past few weeks have witnessed an awesome period of growth and activity at Steady State, and we’ve seen some very exciting developments. Rest assured, the team has been plugging away at its mission to build complete, scalable and comprehensive insurance for DeFi’s ever-growing number of users and assets locked inside smart contracts.
As many may already know, decentralized insurance is one of the trickier fields for blockchain developers and problem-solvers, and obtaining full coverage for crypto held in smart contracts usually comes with a sea of challenges. As a result, no single provider has captured the market yet, indicating a lack of innovative, fit-for-purpose insurance solutions. Over the next several weeks, we will discuss these challenges and how Steady State solves them in a way that is mutually beneficial for protocols and users.
Today’s article examines Steady State’s unique use of staking pools, or “coverage pools”, to build personalized insurance policies for DeFi protocols and CeFi platforms. Coverage pools are a foundation of Steady State’s architecture and, most importantly, secure the capital for the claims process. Lastly, we’ll introduce RISQ, Steady State’s native governance token, and how users can earn RISQ tokens when staking crypto in a coverage pool.
As of June 12, 2021, less than 1% of DeFi’s total value locked (TVL) was covered by insurance platforms. Despite the potential risk of smart contract vulnerability or exploits, users are not inclined to insure their funds in any way. The lack of viable, decentralized options for insurance has been a valid concern for DeFi since it began to blossom in early 2020. While many of the most successful protocols have battle-tested smart contracts, history demonstrates that no absolutes exist in DeFi, particularly when it comes to security. This raises the question: Why has decentralized insurance failed to reach the maturity of its TradFi-inspired tools such as borrowing, lending, trading and saving?
Put simply, there are some considerable hurdles, inefficiencies and limitations impeding the advance of decentralized insurance. Moreover, high barriers to entry such as KYC (“know your customer”) rebuff DeFi’s principles of anonymity, accessibility, and freedom from censorship. Many DeFi users have simply accepted the hacks, exploits and irretrievable theft of funds as a basic reality for networks with no central authority or mechanisms of accountability — a fair bargain for complete financial autonomy. Some protocols that have suffered exploits have paid out of their treasuries, reserves, or future earnings to affected users. In these cases, both insured and uninsured users are reimbursed regardless, which disincentivizes users from purchasing additional coverage.
A bigger problem is that even if users wanted coverage from the current offerings, they may not even be able to get it. This is largely due to the lack of liquidity flowing into the insurance pools, which is a far reach from adequate at this stage. For instance, Nexus Mutual — perhaps the most recognizable DeFi insurance platform — has a TVL of approximately $400 million (DeFi Llama). To put that into perspective, DeFi’s biggest lending platform Aave recently topped $12 billion in TVL. Nexus Mutual’s entire available liquidity would, in short, cover just 3.3% of the assets held on one single protocol.
Coverage pools are a type of staking pool in which locked funds represent the insurance collateral for any given protocol or platform. These are the building blocks of Steady State’s ecosystem. Coverage pools allow DeFi protocols and centralized finance (CeFi) platforms to create an insurance policy tailored to their own unique requirements. Flexibility in coverage is an attractive proposition for those seeking insurance policies, and customizable coverage pools achieve that.
Rather than requiring users to buy “off the shelf” insurance policies, Steady State works by allowing protocols to insure themselves against specific and defined risks. Coverage pools allow users to become the insurance policy’s underwriter, helping solve the issue of insufficient liquidity. Unlike the user-centric insurance options currently available, Steady State reverses the roles of the insurer and insured, allowing users to earn rewards by staking their assets in coverage pools. Steady State also allows up to 100% coverage of a protocol’s TVL or the size of a liquidity pool. Policyholders can supply the necessary amount of capital required to be fully collateralized if desired, or they can raise liquidity from their community — who benefit from their assets being fully insured — and those looking to buy risk from the insured party in return for rewards.
Steady State’s customizable coverage pools solve these and a multitude of other problems and inefficiencies in DeFi insurance. A standard cycle for a coverage pool’s entire term looks like the following:
Note that users can claim rewards from premiums and liquidity mining daily, but collateral is not returned until the end of a term.
Customization is essential so that protocols can get exactly the coverage they want. When designing their policy, protocols choose from the following parameters:
In addition to the standard coverage pools representing individual policies, multiple protocols can band together to create index pools, or shared insurance policies in an index pool. Index pools will offer protocols higher collateralization and lower costs on their policies while offering CPs reduced risk. In a standard coverage pool, collateral put down by CPs only covers one protocol. In an index pool, that collateral will instead be available to cover a basket of participating protocols. As an example, there may be three protocols with policies that are 80% collateralized. If these protocols band together to create an index pool, they will instead be 240% collateralized through a shared policy, assuming all are buying the same amount of coverage.
Index pools benefit protocols since they reduce the required amount of staked capital in order to be fully collateralized. They’re also useful for coverage providers since they reduce risk by spreading the capital across multiple pools, making them less vulnerable to the impact of an individual hack. When a CP enters a standard pool, they are essentially providing a loan in exchange for risk, which includes events like a hack, smart contract vulnerability, or flash loan exploit. If one of these events occurred and the claim is approved, the CP loses their initial collateral.
Index pools, on the other hand, greatly reduce the chance of this happening. The more protocols band together in the same pool, the less coverage each needs to buy for themselves, and the more diversified CPs are when they invest in the pool. For these reasons, we expect index pools to be more popular than the standard coverage pools once they are released.
RISQ tokens have several uses in the Steady State ecosystem and governance model. More than a third (37.5%) of the RISQ supply (150,000,000) will be allocated for liquidity mining for coverage providers. RISQ adds additional incentive to participate as an underwriter. Aside from governance, RISQ tokens provide users an opportunity to increase their returns and can be staked separately for additional RISQ. Over time, Steady State’s DAO can greater influence protocol such as deciding the outcome of a potentially fraudulent claim and creating new coverage and index pools.
Users should take note of the inherent risks of liquidity mining such as impermanent loss, Steady State has also considered the opportunity for users to stake their collateral (such as ETH, USDC or USDT) on reputable platforms such as Aave to generate more interest. A smart contract vulnerability at any stage of this process could result in the partial or total loss of funds. Reward tokens are also subject to price volatility, meaning returns may be lower (or higher) than expected depending on token price performance and market conditions.
The distinctive features of Steady State’s coverage and index pools provide the insuree and with a diverse range of functions. In the next article, we will dig into how the protocol uses open-source DeFi risk analysis and machine learning to monitor blockchain activity and using parameters to determine if an event qualifies as an exploit or hack. To learn more about Steady State, join our Telegram channel and check out our website to sign up for our newsletter and read the Steady State litepaper. And, of course, don’t forget to follow us here on Medium for the most up-to-date information and announcements!Steady State cautions that statements in this communication that are forward-looking, and provide information other than historical information, involve risks, contingencies and uncertainties that may impact actual results of operations and prospective transactions. Please click here for important legal notices.