It’s Important for DeFi to Know About Catastrophic Risk

When it comes to risk coverage in insurance, ensuring that you’ve chosen the right solution is crucial. Risk can vary in type and extent, which makes finding an appropriate one difficult.

It’s essential to understand what kinds of risks are covered before moving forward with any plans or solutions. After all, what’s the point of risk coverage if it can’t keep your funds safe?

Speculation and risk-taking are a normal part of economic life and can only be partially managed. Innovation, regulatory intervention, and changing social behavior lead to a fluid state of affairs. This is both in the traditional financial world and Decentralized Finance (DeFi). Approaches to systemic risk mitigation must therefore adapt to such changes.

Catastrophic risk in the DeFi space

DeFi participants should understand that catastrophic risk not only includes technological calamities but natural disasters as well.

A flood could destroy your home, taking vital records like your private keys with it. Due to natural disasters, telecommunications grids can also go down, taking the infrastructure underpinning decentralized networks with it. 

Catastrophes happen at a global level, leaving a lasting impact on the economies and societies. As it stands, those who want to do more than HODL are taking on many risks and should be protected.

Full coverage on cryptocurrency might not be available today, but smart contract technology and DeFi insurance are undoubtedly a step in the right direction. 

Currently, if a person wants DeFi insurance, they usually obtain it through mutual coverage. This is a system that relies on users to validate or deny claims.

Unfortunately, mutual coverage creates a unique set of issues. Rules can be neglected, best interests can be overlooked, and participation can be scant.

In the spirit of blockchain, let’s automate the process. Automated smart contracts can challenge the mutual system by bringing in unbiased claims adjudication.

By doing so, payouts can be made akin to an option or derivative. If an event happens, cover it; if it doesn’t happen, don’t cover it.

In the end, people need to cover their holdings, and catastrophic risk coverage is a better option than the current status quo of mutual insurance. 

DeFi and systematic risk

It’s never too early to talk about how the existing DeFi infrastructure can be susceptible to systemic risk. Security tools, risk management systems, and fair payout distribution for losses are valuable aspects that must exist for DeFi to have proper consumer coverage.

Whenever calamitous failures occur, minimizing collateral damage should be our priority. Open-source code and public ledgers simplify automated systems that reduce collateral damage while preserving user privacy.

Systemic risk can result in more than financial loss. Entire institutions, networks, or software protocols could fail, threatening global economic and social stability. As the DeFi ecosystem becomes more complicated, deficiencies in security practices, counterparty risk management, transparency, and fraud prevention put DeFi capital at risk.

Catastrophic risk coverage, including parametric modeling, is leading the way in insurance innovation. There is always another new kind of catastrophe, and the industry figures out how to cover it with a new approach.

Bitcoiners should be looking towards the future of insuretech to understand new opportunities to protect their holdings. 

Avoiding becoming overleveraged

As the DeFi industry explores covering risk, it must be careful not to become overleveraged. When covering alternative risks, it must be ensured that there is no over-promise and underperform.

A platform can calculate the risks and understand the likelihood of an event. If an event happens, however, they must be able to payout. Overleveraging is dangerous, and risk coverage providers must be careful of that.

Individual users, communities, protocols, and networks all have a role in mitigating the systemic risk DeFi faces. This includes helping disseminate pertinent knowledge and tools and promoting standardized best practices.

Insurance underwriters bear a particularly great responsibility to encourage a set of best practices for DeFi. Due to the open-source and communal nature of DeFi technology, risk insurers, DeFi service providers, and end-users see their incentives aligned, as all stand to benefit from increased systemic safety.