Last Friday was the one year anniversary of the collapse of the Terra Luna Stablecoin. This event marked the end of the 2020-2022 crypto bull market and started a chain of events that would lead to the high-profile collapse of corporate crypto exchanges like FTX, BlockFi, Celsius, and Voyager.
As the irrational exuberance of the 2020-2022 crypto bull market cycle has receded, the one-year anniversary of the Terra Luna collapse presents many opportunities to reflect on the current state of the crypto industry. For the purposes of today’s article, however, I will focus on the outlook for DeFi protocols one year after the crypto bubble burst.
For those that are unfamiliar with DeFi, a DeFi protocol is code built on top of an existing blockchain (such as Ethereum) that is designed to provide a specific financial product or service (e.g., crypto trading, crypto lending, crypto insurance, etc.). DeFi code executes transactions without traditional financial intermediaries between parties. Significant changes to DeFi protocols can typically only be made if the majority of the community votes for the change.
Over the last 12 months, despite all of the headlines around corporate crypto exchanges bankruptcies and regulatory action in the United States, the leading DeFi protocols have largely continued to run smoothly and operate as expected. In fact, headlines about regulatory uncertainty in the United States seem to only lead to spikes in interest in DeFi services.
It is also important to understand the global nature of DeFi. Because DeFi protocols are not traditional financial corporations tied to a particular jurisdiction, DeFi services can typically be accessed with a few clicks of a button from almost anywhere in the world with an internet connection. Cryptocurrency usage is strongest in countries in the developing world, where weak rule of law, unstable currencies and untrustworthy financial institutions incentivize crypto and DeFi adoption.
DeFi is not a monolith however. To broadly generalize, there are five types of DeFi that are most relevant to the average consumer: DeFi lending, DeFi trading, DeFi asset management, DeFi payments and DeFi insurance. And not all types of DeFi have thrived over the last year or so. I worked with research and consulting firm Corporate Insight to write a detailed study on the DeFi ecosystem in honor of this anniversary – the DeFi 2030 report. According to Corporate Insight CEO Michael Ellison, “the end of the 2020-2022 crypto bull market led to a marked decline in both consumer and venture capital activity in the crypto space. Therefore, the last twelve months have revealed the real prospects of different types of DeFi. For example, DeFi lending and DeFi trading have performed relatively well, while DeFi asset management and DeFi payments are still nascent but have demonstrated potential. On the other hand, some DeFi concepts do not yet appear to have meaningful traction.”
Today, let’s examine one of the five DeFi verticals that generally does not get as much attention as other areas of DeFi – DeFi insurance. There are approximately 20 different DeFi projects offering some kind of insurance for the crypto ecosystem. These protocols provide insurance against crypto theft, hacks, or bugs. While none of these insurance protocols have the traction or scale seen at other types of DeFi protocols, the pooling of crypto assets is already common within the crypto ecosystem. Therefore, the P2P pooling of crypto assets to provide insurance against cryptocurrency hacks or bugs seems likely to succeed in the long term. So long as the overall crypto ecosystem continues to grow over the course of the 2020s, “winners” will emerge and DeFi crypto insurance will likely grow and achieve scale.
When it comes to DeFi insurance for real-world assets, however, the outlook is much less clear. Several projects that used to offer some form of DeFi insurance for real-world assets have pivoted and changed their business model in the last twelve months. Despite some initial hype around DeFi insurance for real-world assets, there does not appear to be any DeFi protocol that is selling insurance for real-world assets with meaningful traction.
DeFi insurance for real-world assets faces several challenges, and DeFi’s ability to deal with things like insurance fraud at scale is untested and unproven. Insurance is also a highly regulated industry in many jurisdictions, and regulators may force DeFi protocols that attempt to offer real-world insurance products to act in a less decentralized manner. According to Michael Beck, Project Lead for DeFi insurance protocol UNION Finance, “Properly executed, DeFi protection protocols do not have actuaries, underwriters, or adjusters. Instead, they use market expectations of risk and yield to inform price and oracles or token holders vote on claims. Decentralized protection protocols can be used to address some of the shortcomings of the traditional insurance industry, but being a protocol and a regulated insurer are two very different things.”
In the long-term, DeFi may be able to offer event-related insurance (e.g., weather-related insurance, flight delay insurance, etc.) as this type of insurance does not require a manual and/or in-person claim review process. At this stage, however, it is unclear if DeFi protocols will be able to disrupt traditional insurers selling home, life and auto policies to consumers.
That said, as the crypto industry grows, DeFi protocols that have achieved scale may expand and start to develop more traditional insurance products for real-world assets. In addition, some projects specifically highlight their long-term plans to offer traditional insurance products on the blockchain. For example, the Nexus Mutual homepage highlights that the firm plans to offer insurance for real-world events in the future. The next crypto bull market may see another attempt to develop DeFi insurance for real world assets.
Of course, DeFi insurance is just one of many types of DeFi services, and arguably has the lowest levels of traction of the five types of DeFi protocols discussed earlier. DeFi protocols such as Aave ($5.2B), Curve Finance ($4.2B), and Uniswap ($4.1B) all manage billions of dollars based on code. According to Kevin Goldstein, Co-Founder & Managing Partner of Kee Global Advisors, “the last 12 months have proven that DeFi protocols are here to stay. While not every DeFi concept will succeed, DeFi as a whole will fundamentally challenge the established financial services industry.”
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