Safeguarding Digital Assets with DeFi-based Insurances

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Putting your digital assets to work in the decentralized finance space carries underestimated and generally unpredictable risks. Stakes are high. Almost $2+ trillion of digital assets circulating to date, the value of investments has increased dramatically.

There are some fundamental differences between DeFi and TradFi: where the traditional financial sector has always been controlled by centralized authorities, decentralized finance does exactly the opposite. In decentralized markets, token holders may take part in regulating consensus over protocol parameter changes, and collectively-held treasury spending, while the financial protection of those who use DeFi applications intends to be safeguarded by the underlying technology of a blockchain consensus mechanism.

Nevertheless, history has proved that the reality of decentralized finance is utterly different; billions in crypto have been lost or stolen over the years, jeopardizing networks and community trust. As a result, traditional insurers typically lack the knowledge to properly assess risks, resulting in investors seeking new and additional forms of on-chain and off-chain security to protect their funds. 

The lack of protection surrounding digital assets has been an inhibiting factor to the ecosystem's growth. Institutional investors, in particular, require novel yet scalable coverage options that will ultimately encourage and safeguard their involvement in the space while scaling with their growth. With traditional insurance options poorly addressing these needs, DeFi-native coverage could potentially fill such a gap, mitigating risk exposure while stimulating more institutional funds into the game.

Staking-type risks

Proof of Stake reaches consensus by deterministically selecting validators based on the amount of staked tokens. By contrast, in Proof-of-Work consensus models (such as Bitcoin, Litecoin, and Ethereum before its Proof-of-Stake upgrade) miners do not have incentives to act dishonestly, as they will have spent money on electricity in vain on blocks that will not get propagated. 

Proof of Stake networks operate differently from the computation-based consensus mechanism found in Proof of Work. The staking process is straightforward: investors (known contextually as ‘token holders’ delegate their Proof of Stake (PoS) tokens to a staking provider’s validator, which is responsible for validating blocks within the network. If validators perform their role as expected, they are rewarded with tokens native to the network. 

Additionally, to guarantee the optimal operational standard and to disincentivize validator misconduct, PoS networks often penalize validators that perform below a certain threshold or act nefariously by slashing their stake.

Slashing generally affects both the staking provider and delegators. The most common penalties are downtime and double signing, with downtime considered less severe.

  • Downtime: validators do not sign transactions on the blockchain over a certain period. It typically occurs when a validator’s node goes offline or is not synced with the chain. 
  • Double signing: a validator’s node signs two blocks at the same height. This is considered the more severe offense, as it makes it more difficult to achieve consensus within the network by forking the chain away from the majority of the network.

Slashing penalties vary depending on the network; they generally involve partial or entire loss of existing funds and/or a temporary suspension from the active set, resulting in missed yield opportunities during the time the validator is not in the active set.

Having multiple sources of coverage addressing both types of staking risks is key to preventing asset losses and a significant reduction in APY. A combination of three types of coverage may be necessary to adequately address staking-type risks: coverage of the staking provider’s balance sheet, traditional off-chain insurance, and on-chain insurance.

Figment takes its customers' financial security seriously. Figment has opted to provide these three tiers of insurance to best protect our clients from slashing risks.

About Figment

Figment’s purpose is to build a better Internet by increasing usage of the next generation of Proof of Stake blockchains. These efficient blockchains give people greater control of their data, more privacy, and increase financial inclusion. By eliminating intermediaries they also limit the power of centralized data monopolies, rent-seeking financial institutions and anti-social algorithms. We bring our mission to reality by helping investors stake their tokens; earn yield and participate in securing the blockchain. 

We bring our mission to reality by helping investors stake their tokens; earn yield and participate in securing the blockchain. Our Prime application as well as our governance expertise allow token holders to analyze, monitor and make informed decisions. We build Web 3 developer communities via our Learn education program and then make it simple for these developers to launch applications and manage smart contracts via our DataHub platform. And finally by building and operating The Graph based indexers we enable the efficient search and querying of blockchain data.

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