EP 26 Economics of Insurance | NXM 1/2
Insurance going from decentralised to centralised to decentralised again
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General Conclusion
Insurance is inefficient. Insurance has a ton of opportunities. Get the economics of insurance right by incentivising the right people, and BAM, jackpot!
It is something that's still relatively quite new in the crypto, yet insurance is one of the oldest industries in the world today. We're going to deep dive into the insurance industry and split it into two parts because it is actually quite long.
This is a two-part episode.
The first part is going to be on the economics of insurance, and the second part we're going to do a deep dive into Nexus Mutual, one of the insurance providers in crypto today.
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1. Inefficiencies in Insurance
Current market size of insurance industry: US$ 5 trillion
Online insurance in this segment: US $ 31 billion
Crypto insurance (via NXM): US$ 213 million
It just shows that there is a huge room for growth because online insurance allows us to aggregate more data, get more information, underwrite different types of risks, or have a better understanding of the different risks available to be providing the insurance coverage. This is just online in general and crypto and blockchain which is an even smaller niche that's another big untapped opportunity.
Lack of trust — insurance companies are meant to act in your best interest, but they don't always do
Opaque information — this industry exists because of the unknown, and people try to avoid this unknown danger by using an insurance agency. But typically their opaque information is difficult to access. It is hard to assess how safe an insurer is, if they are going to go bankrupt, if they have bad debts, if they invest wisely, and so on
Expensive overheads — If you put in $100 in premiums, you can expect only about 60 or 70 of that to go into the fund’s pool. The rest is covering costs for admins, regulations, and other boring things that COULD be automated in today’s world. We have machines, smart contracts, business logic that can be turned to code, and so on.
2. 4 Economics of Insurance
Economics is about risk and managing it.
Economics of Signalling — Signaling is where we use different kinds of actions to share or hint hidden information. Compare it to poker. Signaling is similar in the fact that in poker, you are trying to share the information of how strong your hand is by the actions you make. In the insurance space, pricing is a signal, a way to show and share information. As we said, there is a lot of opaque information when it comes to insurance, so we use pricing as a signal to figure out what info needs to be subtly shared.
Principle-Agent relationship — back to moral hazards, the solution is to align incentive of both parties. We want both parties aligned. If both parties are benefiting from each other it helps them grow. In the crypto world, it is difficult to define the PA Relationship because we have anonymity. With smart contracts and data, it’s easier to rely on code to underwrite different risks available.
3. Economics of Nexus Mutual (High Level)
High level summary: It is a decentralized insurance protocol that is on the Ethereum platform. They pull all the different assets together. For example, you have your DAI and your Ether and it's pulled together to be governed by the three types of users we mentioned before.
So what does the NXM token do? The entire purpose of the NXM token is to be traded in the primary internal economy. The bonding curve balances the token prices with the collaterals that are available. NXM is not fixed but rather changes based on the number of collaterals, with the amount of funds it covers changing. So, if you think about it, the NXM price is a signal to the information on how much people trust NXM and how many people are willing to use it. As mentioned earlier, we need signals in this industry, and this is exactly what NXM is providing to those looking to purchase or sell. The foundational principles never change, but how we use signaling in a new technology stack is mind-blowing!
What Else Did You Miss?
How the physical "real" world reduces inefficiency
Economics of moral hazard in insurance
Law of large numbers in DeFi
Risks in DeFi and Crypto
5 hacks in the systems — DAO, Polkadot, YAM, Maker, bZx
3 Risk Profiles in Crypto
P2P risk sharing model
High level economics of NXM token
What price signals of NXM tokens represent
TLDR:
Decentralised insurance is basically going back to where insurance first started — it was decentralised. We are now looking at reducing the inefficiencies by having various incentives to motivate the right behaviours. Right now, we are getting the low hanging fruits of risks in smart contracts. There are more risks in DeFi, of course. Especially since we are designing various incentive mechanisms! We are still in the early days.
If you are keen to learn more, we are currently having a discount for the Token Economics Blueprint course! It's a 10 lesson session and you can choose which section you are interested in. Total lesson time: 15 hours.