Perspectives | DeFi Insurance Design: Always Start with General Equilibrium and Reduce Systemic Arbitrage

On March 1, 2020, the blockchain professional media platform Planet Daily Odaily and the NEST enthusiast-Jiuzhangtianwen started a deep exchange of dialogue on the development trend of the DeFi insurance industry. What are the design ideas of DeFi insurance products and the development trend of DeFi insurance? All these hot issues are in this wonderful dialogue. The following is the content of the conversation, to share with you:

Odaily: What do you think is the significance and role of DeFi insurance for the entire DeFi ecosystem?

Jiuzhangtian asked : DeFi insurance is a kind of security protection for some DeFi products, which is mainly a compensation for the risks of DeFi development and the risk of fluctuations in assets in DeFi. These two risks are not the same. As far as development risks (code loopholes, backdoors, arbitrage algorithms, etc.) are concerned, the value of DeFi insurance is higher, which is also the core direction of the industry development. As for the insurance of asset fluctuation, it is essentially a swap or an option, which more reflects the derivative structure of the asset price. It cannot be completely called insurance. This type of products will be included in the derivative ranks in the future. But its value is also great, just not a strictly insurance product.

Odaily: In your opinion, where is the ceiling for this segment of DeFi insurance? Is DeFi locked up?

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Chapter N asks : The ceiling of DeFi products is ultimately the market value of ETH, because all on-chain risks can be hedged by insurance. Only the code risk of ETH cannot be offset by insurance, because your insurance is also developed in On the chain. If we say that the market value of ETH measures the code risk and consensus risk of ETH, then without changing the current structure of ETH (anti-attack), the ceiling of insurance is the market value of ETH. But in terms of supply and demand, it may be far below this standard. It has a certain relationship with DeFi's hedging, but it is not entirely, for example, if the asset fluctuation insurance in question 1 is also included, it is larger than the size of the hedging. It mainly depends on the type 2 demand mentioned earlier, which is difficult to estimate. If the type 2 demand is not considered, it is indeed limited by the size of the insured DeFi lockup.

Odaily: Due to the high interoperability and composability of DeFi products, the capital loss event on DeFi is often not an independent probability event. The funds of a product are often damaged and are associated with other products. To address this problem, at present Does your insurance product have a better coping strategy?

Jiuzhangtian asked : This is a good thing, not a bad thing. This reflects the effectiveness of the financial market. The solution is not to provide more insurance. Even if it provides more, it will be included in the entire arbitrage system by the arbitrageur. The core is to enhance the overall view of DeFi product developers. Partial equilibrium thinking develops financial products, but from the perspective of general equilibrium, that is, all variables in the entire market are your product to consider, your products should constantly attack and arbitrage existing products! Only based on such a development starting point is it correct.

The problem of traditional Internet development is to use requirements as a starting point, such as user experience, user experience, and efficiency. However, in the financial field, especially the contract product field, there is only one demand: arbitrage (or making money). The needs of all participants are Homogeneous, so consider market-wide behavior. Does your product help reduce market arbitrage or increase arbitrage? If it decreases, your product will stand up. If it increases, you will be arbitrage, the product is meaningless. So, this is not a question of insurance, but a question of thinking change for all DeFi developers.

The NEST system is based on this assumption to build a modern DeFi system. From the oracle to the trading market, the interest rate market, the derivatives market, and the insurance market, all of them are based on whether to reduce the arbitrage opportunities of the entire market as a starting point for development. We need to know that as long as arbitrage is increased, it means that a group of people have an advantageous strategy, which will cause the entire market to disappear! The design and development of DeFi is a big thing, and there are many pitfalls for tryrs to follow, about centralized risk or contract code security.

Odaily: A few days ago, Nexus Mutual was exposed for governance loopholes. This can't help but raise a big question mark for the DeFi insurance platform: Who can insure DeFi's insurance acceptor? From this perspective, does it mean that a fully decentralized DeFi insurance platform cannot guarantee the security of DeFi?

Jiuzhangtian asked : This is a question of product design. I mentioned in the article "First Principles of Decentralization" that if the so-called governance on the chain is still in breach of contract, the essence is centralized and it is to be eliminated of. This kind of product and phenomenon that should not be included in the discussion, is to be criticized on a large scale.

Odaily: In addition to DeFi insurance, what do you think is the technically feasible risk prevention for the risks caused by the combinability of DeFi?

Jiuzhangtian asked : We have stated in the answer to the third question above that this is a good thing. The problem is not in the thinking of the combination, but in the thinking of the combination, because they are following the wrong product development thinking. Eventually it will be eliminated. The new generation of DeFi will have a global perspective, which is the general balanced thinking we mentioned in 3: The development of each product is designed to reduce market arbitrage opportunities. Some people say that you don't consider demand? Obviously, arbitrage opportunities are indicated if demand is not met (note that demand here does not refer to the demand that is used quickly and looks good, but refers to the demand for which risk returns are not properly allocated and priced). We have to embrace a new DeFi development thinking and enter the era of efficient finance.

Odaily: Among the existing DeFi insurance products and platforms, what are your personal preferences? (Etherisc, CDx, Nexus Mutual, Opyn, VouchForMe, KeeperDAO, etc.)

Jiuzhangtian asked : As we mentioned earlier, I think they are all partially balanced products. Be careful of your own arbitrage. Someone should systematically analyze such products. If the thinking does not change, over time, such partially balanced products are destined to be eliminated by the market.

Odaily: Can you talk about philosophical thinking about the design of DeFi insurance products? Can also suggest some improvements to existing products?

Jiuzhangtian asked : Always start from the general equilibrium, reduce the arbitrage of the entire system, and always improve the pricing efficiency of the entire system. What is insurance? Insurance is negative securities. Why are there negative securities? To the market completely. Why should the market be complete? Only then can effective pricing be achieved. What does effective pricing mean? The market is efficient. What does market efficiency mean? Financial resources are most efficiently and optimally allocated.

Odaily: Finally, please summarize, will DeFi insurance become a trend in the future? What do you think are the necessary conditions for decentralized insurance to become a trend?

Jiuzhangtian asked : I think DeFi is the mega trend, and DeFi insurance is just one important part of it. As mentioned earlier: the oracles, trading market, interest rate market, insurance market, and derivatives market are all very important. They have developed together. Because this is a super-rational world on the chain, the arbitrage of code completion is only a moment, and no link is slow. I think it is a trend of comprehensive development. The necessary condition is the oracle first. With this, the future will flourish. . I hope everyone pays more attention to the NEST distributed price oracle network, a better oracle problem solution.

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