Nexus Mutual, an alternative insurance provider for a variety of Ethereum-based DeFi protocols, has seen its risk pool double over the past 90 days to more than $4 million.
Indeed, Nexus can barely keep up with the demand for smart-contract cover in the exploding decentralized finance (DeFi) arena.
“We are in this position where there are lots of people that want heaps of cover, but we don’t quite have enough assets to cover everything we would like to right now,” said Nexus Mutual CEO and founder Hugh Karp. “So it’s a good problem to have and we’re working on it.”
The recent boost has been due to a few large covers, especially on Balancer, a newly launched protocol that is offering bonuses for people providing liquidity. Other significant deals for Nexus stem from DeFi platforms Aave and Compound.
Stepping back, the London-based Nexus may be using bleeding-edge tech but the mutual insurance model dates back to the 17th century and potentially aligns the interests of participants better than today’s profit-maximizing insurance firms.
Nexus is exploiting an unregulated pocket within the British insurance sector called a “discretionary mutual,” where members have no contractual obligations to pay claims. As a provider of insurance, the platform recently proved to be worth its salt, however, making its first payout following an exploit of the smart contract code of DeFi lender bZx.
The way Nexus works is members of the mutual join by purchasing NXM tokens that allow them to participate in the decentralized autonomous organization (DAO). All decisions are voted on by members, who are incentivized to pay genuine claims.
“DeFi is expanding rapidly so I’m expecting the number of yield-bearing options to increase exponentially over the next few years,” said Karp.“DeFi users want the returns available, but want to avoid the smart-contract risk. A new protocol wants liquidity, so they offer some bonus to enhance yield, and more professional users take out Nexus cover to access yield safely.”
Two areas Nexus is updating to help it scale are risk assessment and pricing. Karp said members are about to vote on the changes, and the upgrades should go live in about a week.
Risk assessors effectively choose and price the risks that Nexus Mutual covers, said Karp, which should encourage more participants and ultimately enable more cover to be provided to the wider DeFi ecosystem.
“We’re also updating the pricing mechanism to be simpler but also more flexible. It’s another step towards our vision of allowing Nexus to take on any type of risk, like a super-efficient Lloyd’s of London,” he said.
Eth 2.0 looms
Nexus sees plenty of opportunity in Ethereum’s gradual transition to Eth 2.0, which is expected to begin sometime later this year. Eth 2.0 moves the network from its more energy-hungry Proof-of-Work (PoW) consensus algorithm to Proof-of-Stake (PoS), a method of staking cryptocurrency in order to keep the network afloat.
Earning a steady yield from staking ether (ETH), is somewhat comparable to the way insurance firms in the real world invest the premiums they collect.
Traditional insurers tend to invest the majority of their funds in relatively low-risk, yield-bearing assets – such as government bonds, high-grade corporate bonds and infrastructure investments, which ideally have a similar cash flow to future expected claim payments.
“From our point of view, [Eth 2.0 staking] will be very interesting because we want to earn investment returns from the float,” said Karp, referring to the risk pool of capital held by Nexus. “We hold a chunk of ETH so we will be able to start staking that and earning a return, which is obviously very important for insurance entities.”
Once staking commences on Ethereum, the Nexus DAO can delegate a large portion of its assets to Eth 2.0 staking, which is “conceptually comparable to a very highly rated government bond and therefore will be very well suited to Nexus from a risk perspective,” Karp said.
DeFi also has the ability for yield to be “stacked,” where one yield-bearing token is deposited into another protocol where it earns additional yield. This comes with additional risks, noted Karp, and must be carefully managed, but Nexus will also look to take advantage of yield stacking, which is something that is not readily available in the regular financial world.
“The medium-term goal for Nexus is to start earning something like 5% on the $4 million float,” which Karp said would likely be a few months after Ethereum’s beacon chain launch in the latter half of this year.
“We are quite likely to purchase a tokenized version of staked ETH, which we are expecting will become available soon after the beacon chain launch,” he said. “That token would earn staking returns immediately and not require Eth 1.x and Eth 2.0 being merged yet.”