Several problems permeate the current market and result in mismatched supply and demand for DeFi insurance products
Here are some finding based on our research and analysis:
The locked up pool of insurance reserve capital is underutilized and the long-term return on capital invested is low, and thus failing to incentivize reserve providers (RPs) to deposit capital into the reserve capital pool, especially compared to other more lucrative DeFi yield farming products. To raise the return on these depository instruments, insurance providers have introduced token rewards, which lacks long-term economic viability. Without the implementation of token rewards to artificially boost yield, insurance products struggle to reach a 1% APY from contract premiums.
At TIDAL Protocol, we believe in maximizing capital utilization and returns, and thus leverage must be increased by offering bundled insurance protocols with low correlation to increase the cover supply, at the same time controlling the risk of insolvency through multiple levels of reserves, and other risk mitigation practices.
As a byproduct of the low efficiency of insurance capital, reserve providers raise the cost of insurance to increase the returns on their capital. As a result, the cover buyer must pay a higher rate for the insurance of their covered protocols than the underlying products themselves yield. TIDAL Protocol plans to offer highly competitive insurance premiums by allowing RP’s capital to get exposure to multiple protocols - driving down the price of each protocol’s premium while increasing the returns of RP’s capital.
The open market nature of TIDAL will greatly increase capital efficiency by offering leverage and customizable risk exposure portfolios. To minimize insolvency risk, auditors thoroughly vet each mutual cover pool to ensure the risk level is acceptable, and that the controlling parameters within each pool, such as reserve level, contract correlation and coverage period limitations, are in line with the product’s objective.
Because of the high degree of uncertainty involved, coverage is often unavailable for most new smart contracts. As the DeFi space grows exponentially, the gap between market supply and demand is widening fast. To mitigate this problem, TIDAL will implement a "Guarantor" concept to provide additional capital to cover the risk. Guarantor capital will be used as the first source of funds to pay out the insurance claims ahead of capital supplied by regular reserve providers. This allows founders of new projects to act as Guarantors of their own project, earning yield from cover premium while attracting other regular LPs to provide coverage.