Economics of Nexus Mutual
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Economics of Nexus Mutual
A full economics breakdown of Nexus Mutual
Welcome, premium subscribers! Thank you for subscribing. I appreciate you very much. TLDR below. This is not financial advice.
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General Conclusion
Nexus Mutual is a decentralized Insurance protocol based on the Ethereum platform. It is used to cover smart contract risks only.
The token $NXM is used to align incentives of the various users in the system. $NXM is used for staking in the system in terms of buying insurance covers, participate in work to be done or governance.
$NXM token price is determined by 2 main things — total $ETH in the capital pool and minimum capital requirement. That is determined via a bonding curve function.
1. Getting Involved with $NXM
a) Directly
If you want to participate directly then you have to join nexus mutual and pay a membership fee. Once you are a member, there are different ways to participate. E.g. buying insurance covers, staking or participating in governance.
b) Indirectly
The indirect way is to buy a Wrapped NXM. $NXM is the token that's used in nexus mutual and you can buy it indirectly with this thing called Wrapped NXM or wNXM.
Now it's a concept similar to BTC and wBTC. Instead of paying for the membership fee and buying the $NXM token, people can buy $wNXM instead.
2. How does Nexus Mutual Work?
Nexus Mutual includes 3 types of participants :
1) Insurance Cover Buyers: People who paid for the membership and can purchase insurance covers with $NXM
2) Risk Assessor: Checks the code, and general information on a project and thinks the contract is secure (aka no bugs)
3) Claim Assessor: Votes to accept or reject claims to pay the buyers, if something happens
Nexus Mutual is a platform that aggregates all these three participants together, aggregates the insurance covers, and aggregates the funds available to facilitate the insurance.
Let's say I'm a member and I buy cover from Nexus Mutual. Nexus Mutual has some funds available to cover my insurance cover for lending and borrowing on Aave.
Now for example let's say insurance coverage price is 0.5 ETH and I want to cover 300,000 ETH. That is the amount I am adding on Aave.
These are just arbitrary numbers but just imagine 300,000 for borrowing and lending on Aave and the cost for insurance is 0.5.
That 0.5 ETH goes into Nexus Mutual, which is a big pot of funds. Part of the funds will be used to reward the risk and claim assessors.
3. Economics Design of Nexus Mutual
Market Design
Market Thickness
$NXM price is a proxy to show the level of adoption of the DeFi market. DeFi insurance is that it's very related to the adoption of DeFi in general.
First, you have adoption of crypto. Then you have adoption of DeFi. Lastly, adoption of insurance in DeFi. It's like a chicken and egg dilemma. If you don't have the market maturity or market adoption for DeFi then it's going to be very difficult to scale nexus mutual because it's really dependent on the market size of DeFi.
In creating market thickness, we look at how do we increase the participants or increase the network of users in the system.
B2B Market — Nexus Mutual provides insurance to users. At the same time, it can work as a base insurance technology stack for protocols.
Currently, we have two systems that kind of white label Nexus Mutual’s insurance to resell it in a different way to its users
The first one is Yinsure finance. It takes the insurance cover that's provided by NXM (Nexus Mutual) and then they white label this insurance and sell it in its ecosystem as a form of NFT.
There's one called Cover protocol, they are trying to do a peer-to-peer coverage market. They also white label the insurance models provided by Nexus Mutual and they resell it to their market.
Note that these are not direct competitors to $NXM as they only insure their protocols.
B2C Participants — B2C is figuring out how to increase the different users by having them participate in the various roles.
There are four functions of using $NXM.
Buy cover
Risk assessor
Claims assessor
Participate in governance
There are ways to increase their participation with users or members. You want them to be purchasing more insurance covers.
As DeFi continues to grow and new people coming into the system, that’s how you get new users. For risk and claims assessors, more protocols need to be assessed to be covering more and different types of smart contract risks.
For governance, there's a lot of improvement proposals out there so that's where the governance role will kick in and people will be voting with a time-weighted or stake weighted vote.
That is how Nexus Mutual increases the participation from a B2C, peer to peer level.
Mechanism Design
Decision Making
Macro Decisions
Before any decision is made, a proposal is submitted through the nexus mutual improvement proposals. Since it is all peer-to-peer, anyone can participate and anyone can propose something.
The proposal is created by anyone and then if it's approved, it goes to governance. At governance stage, people will stake their tokens to vote yes or no to this proposed change. People stake their tokens and say "yes we want this proposal" to be executed. Or stake their tokens and say "no this proposal is bad".
Micro Decisions
The other way to look at decision making is at more micro level, which is where you are assessing your claims:
Is there a bug that is exploited?
Is there an error in the smart contract?
This is where the claim assessors come in.
Claim assessors stake their NXM tokens and say yes or no to "should we return or should we accept this claim and return the losses?". This is crowdsourced by all the different participants which are all the various claim assessors. This is how governance decision making is made in nexus mutual.
Governance Resolution
Governance resolution is answering "how do we resolve when governance goes wrong". This is where nexus mutual thought about it and established an advisory board.
Now, not everyone gets to be part of the advisory board. These are people who are experts, who have experience, and who actually understand everything that's going on. They can do three things:
The first one is to punish bad actors. With claim assessors, you've got the machine part, which is the oracles. And you’ve got the human part, which is crowdsourced. And sometimes humans are bad actors. So this is where the advisory board comes in.
The second thing is they can implement emergency pauses. If the stock market crashes or if the DeFi market crashes or if there's some issue that's going on that's external to the nexus mutual platform, we need a massive pause. It's an emergency pause. The advisory board can come in and implement an emergency pause that stop all activities for the moment and see how things are doing or how things are happening.
They can vote on proposals if required. If there aren't enough proposals or there aren't enough people to be voting or if it's very technical that regular people don't really understand or regular users need a bit more knowledge to be understanding, the advisory board can come in to be voting on those proposals.
Non-Financial Incentives
Truthful Voting
We're more in a closed-loop system in nexus mutual and we can look at how we align incentives of the different agents to get the truth out through voting so how does it work?
Firstly the claim assessor has to stake some NXM tokens and their behavior is to either vote yes or no for the claims then the advisory board will determine if the behavior of these assessors is good or bad so the assessors will determine the behavior of the smart contract and then the advisory board would determine the behavior of these assessors if they are behaving well it's all fine and good then they will get some tokens back as a reward for participating but if they behave badly then their tokens will be burnt or the tokens will be locked up. This is done to incentivize the assessors to behave well.
Token Design
In this segment, the focus is on NXM, not wNXM.
Monetary Policy
In the monetary policy of NXM, there are two variables that are fixed and two variables that are flexible so a and c are fixed variables, and the variables that change are the MCR and the total capital or capital pool
MCR — Short Term Driver
MCR is the minimum capital requirement it's kind of like the reserve in the bank. NXM does something similar to banks so if I put 100 ETH as capital into the NXM pool then a part of it has to go to the reserve and the other part is available.
Total Capital — Long Term Driver
You can think about the total capital increase as the increase in DeFi adoption or DeFi market adoption so as more DeFi protocols are being adopted you can argue that there's a correlation to an increase in the total capital so these are two variables that are included in this model
This is very important because MCR is like a short-term forecast or short-term variable to understanding the growth of Nexus Mutual's protocol whereas the total capital variable is a way to look at the long-term growth of nexus mutual.
Three elements in the token bonding curve
Total Capital
MCR so the minimum capital requirement and this capital requirement is important so in case anything happens this minimum capital can be used to cover the insurance
MCR ratio is the total capital divided by MCR so the linking between these two variables
Token Supply :
The supply of the token changes based on the capital required and then the price is determined by math. We can increase the price through performing risk assessment, performing claim assessment, participating in governance.
But we can not increase the supply of tokens by doing these things because if you are part of risk assessment or part of claim assessment or if you participate in governance you get additional NXM tokens so you stake your NXM tokens and then you can get additional NXM tokens.
To decrease the supply the advisory board will burn fraudulent claims so for a claim assessor when they stake their NXM token and people find out that they're bad actors then their tokens will be burnt and when tokens are burnt the overall value of tokens actually increases.
The other way is also when you're purchasing covers, you can purchase covers in two ways you can purchase in ETH or you can purchase using NXM tokens, and when you use NXM tokens to purchase covers 90% of that will be burnt because when these tokens are burnt the value of the remaining tokens actually increases and that's how the token supply changes
Token Policy : Valuation
The valuation is done via the bonding curve and it's priced in ETH.
NXM token is really an aggregator of everything that's happening in the DeFi ecosystem and giving you a price and value to show you the risk or potential.
Then another thing that they're looking at in the near future is this thing called a gearing factor which will change a little bit of the math but gearing factor is really how diversified their insurance cover is.
Financial Incentives of Nexus Mutual :
Buy Cover
If you buy the cover then ninety percent of the NXM used to buy the cover would burn. When you burn the NXM, the value of the remaining NXM increases and 10% of the NXM will be retained by the member and would go to the collateral pool from which the rewards are given out.
Claim assessment
You stake your nexus mutual to be voting on claims and if you vote with consensus i.e. if you vote alongside majority (70% of the people) then you get more NXM tokens and if you vote against the majority then you get to keep your NXM tokens but it would be locked up for a while. If you vote fraudulently or if you're a bad actor then your tokens will be burnt which would increase the overall value of the NXM token.
Risk Assessment
You stake against a smart contract so that's where you put your NXM token and when a cover is purchased and nothing goes wrong then you can get some of the NXM tokens or you can get some amount of money that's given by the cover buyers and if there is a claim then some of the sticks will be burnt so the NXM that you staked some of it will be burnt.
Governance
You can stake your NXM token to be voting on this and it would be a weighted vote.
ROI Risk
In financial incentives, we look at ROI and the risks involved. One of the risks is if in nexus mutual 90% of the insurance cover is used to cover just one of these protocols, and that protocol fails, the pay out is huge and can destory the system.
So one thing for Nexus Mutual is to diversify their risks as in giving insurance covers to a lot of different protocols, different segments of protocols, different DeFi categories, DeFi industries so basically you really want to diversify your risk
TLDR:
The value of $NXM is a proxy to the adoption rate of DeFi. It can be seen as a tool to bet for the rise of DeFi, for more people entering suggests a need for more insurance coverage. However, also beware of the hidden risks — the unknown unknown. DeFi is still new, and highly correlated. With protocols forking each other's codes, a bug in the code could be a large exploit of many DeFi systems, with require an insurance payout.
Get smart: $NXM can be seen as a bet for DeFi adoption.
Get smarter: Still plenty of risks and opportunities out there.