Decentralized finance (DeFi for short) is an innovative approach to financial services. It is based on smart contracts and blockchain to ensure transaction transparency and avoid third-party influence. The rapid development of the system expands opportunities for investors. However, certain risks arise. That is why DeFi insurance occupies an integral part of the structure.
How Decentralized Finance Works
First, it is worth understanding how decentralized finance works. DeFi uses security protocols, software, and hardware. It allows you to avoid third-party interference in the transaction. Also, users do not need to pay a commission to intermediaries.
Among the key advantages of decentralized finance are:
- Availability. DeFi is available to all users who have access to the Internet.
- Transparency and anonymity. Contracts that are used to conduct information are stored in blockchains. Anyone can view them, but the data of the person who performed the transaction is hidden.
- Autonomy. DeFi operates independently of banks and other organizations.
- Complete control over assets. All wallet keys belong to their owners, and no one can access finances without permission;access to a vast number of tools. DeFi is constantly evolving and offers users a wide range of financial instruments.
Decentralized finance provides users with flexibility, anonymity, and security. On the ICOholder website, you can get acquainted with all the tools in detail. You can also choose the best wallet for storing assets.
With the help of the DeFi system, users can quickly conduct financial transactions with minimal fees. Decentralized finance gives full control over assets and reliably protects information. There are many different programs, so users can choose the most convenient option for conducting financial transactions.
Why DeFi Insurance Is Necessary
Traditional financial companies provide insurance services to protect users' assets. However, decentralized finance has no central authority to provide this. Therefore, users often face certain risks.
The principal risks of DeFi are:
- Smart contract vulnerability. Some contacts may contain errors, which makes them vulnerable to attacks and hacks;
- Market liquidity. Market fluctuations can affect the value of assets;
- Creditor attacks. Some companies may use quick loans, which provokes market instability.
The decentralized finance system is constantly evolving. New tools for protection and security, additional functions, and other features appear regularly. In parallel, the level of hacker attacks is rising, which can make DeFi quite vulnerable. This is why decentralized finance insurance is necessary.
Decentralized Finance Insurance Options
Even though DeFi has no central regulatory body, several insurance options remain. And the most popular option is mutual insurance. In the case of P2P, users create a particular pool where they deposit funds. They cover possible losses and damages. In the event of an incident, users receive assets that help compensate for the loss. This option is considered quite democratic and transparent. Users decide on compensation details, and transactions can be tracked in the blockchain. On the other hand, conflicts of interest and disagreements are possible when calculating compensation.
Another protection option is smart contract insurance. We have already discussed possible errors that can occur during data transfer. To avoid them, users buy special policies. If a smart contract is hacked, the policies cover losses. This option allows you to avoid technical errors and increases the overall security level of the decentralized finance system.
Liquidity insurance is another option to protect your assets. Users give up part of their assets to support the system's operation. For this, they receive rewards and simultaneously maintain the level of DeFi security. In the event of a hack, users receive compensation from these frozen assets. The main disadvantage of this option is high liquidity. If there are many requests for compensation, there may not be enough assets. Plus, decisions on payments are made by voting. And large investors can compromise it.
The last option is the use of artificial intelligence. Some projects use technology that calculates potential risks and errors. This allows you to make decisions faster and understand which contracts may be dangerous. However, because this is new technology, errors in assessment are possible.
Opportunities and Risks of Decentralized Finance Insurance
Insurance provides DeFi users with protection against various risks. It compensates for possible losses, makes decentralized finance more secure, and increases the overall level of user trust. Thanks to insurance, transactions become more transparent. Users can quickly check all the information in the blockchain. In addition, it helps to avoid uneven distribution of funds and minimize fraudulent activities.
Insurance through liquidity allows users to protect assets and receive additional tokens. Users who lease assets receive a reward, which can become an additional source of income.
Among the main insurance risks, we can highlight the validity of assets. The value of cryptocurrencies can change at an incredible speed. Because of this, difficulties may arise in calculating compensation. Plus, there is no guarantee that compensation will accurately cover losses. In the event of a mass hack, there may not be enough assets to cover the losses of all users. This is most often the case on small, closed platforms. In the event of a loss of assets, there will simply not be enough funds in the pool to compensate for the loss of all users.
Despite the constant testing of smart contracts and new security technologies, attacks on decentralized finance are always risky. Even the most minor errors can become a target for scammers.
Decentralized finance operates outside the framework of traditional legislation. This has advantages, such as a high level of security, fast transactions, and minimal fees. However, in the event of a hack, users have no legal protection, which increases the risks of hacking and hacker attacks.
Separately, it is worth noting that only some users still trust DeFi. Despite the transparency of all operations, the system remains incomprehensible to many users.
Last words
Decentralized finance insurance provides a high level of asset protection. The DeFi system reliably protects investments, but the risk of hacking and theft is still relatively high. Because there are different insurance options, users can choose the most comfortable option for themselves. Choosing reliable platforms that use robust security systems and protect users' assets is also essential. Although insurance has risks, it helps minimize the likelihood of loss and compensate for losses.