DeFi Insight: Wallet Insurance by Solace

DeFi has accounted for over 75% of crypto hacks in 2021 totaling $361 million of lost funds. The hacks can be summarized as follows: smart contract code flaw, flash loan attacks, rug pulls, and oracle and network manipulation. As DeFi is expected to grow exponentially in the next years, the risk associated with hacks and frauds will also be higher. The good news, however, is that illicit cryptocurrency activity is declining as a percentage of overall volumes. Insurance can be considered one of the missing links in DeFi. Solace is one of many DeFi insurance protocols giving users cover for their investments across DeFi platforms(e.g., Aave, Uniswap, Compound, Yearn Finance, etc.). Currently, the DeFi insurance space is very limited and experimental. There are around 20 active insurance protocols, according to DeFi Lama. At the moment, the top protocols are Armor and Nexus Mutual, each of them with around $180m of TVL, while Solace is still at $180k TVL. The first coverage product offered by Solace is portfolio insurance.

Authors: Valentin Kalinov, Christian Viehof

Challenges

DeFi insurance TVL is not catching up with overall DeFi TVL. One of the significant challenges in DeFi is insurance underwriting.

Insurance underwriting is the way an insurance company assesses the risk and profitability of offering a policy to someone. (source: thebalancemoney.com)

As the crypto space is still under rapid development, the risk of breaking things is high. Insurance protocols must deal with high insurance risk and low rewards for providing such policies. In traditional insurance, capital is often locked long-term. In DeFi, locking capital long-term from a wider pool of participants is challenging. As the traditional insurance industry is heavily regulated, the use of KYC is also often mandatory, which would add additional cost and will reduce protocol flexibility. Risk management is also a big question. The crypto space can not rely on existing risk models from traditional insurance and needs to develop new models. Developing and testing such models is quite time-consuming and expensive.

Figure 1: Top 15 insurance protocols on Ethereum ranked by TVL.
Figure 1: Top 15 insurance protocols on Ethereum ranked by TVL (source: https://defillama.com/protocols/Insurance)

Wallet Insurance

Solace offers a crypto wallet insurance policy with a unique technical design. Wallet insurance offers the possibility to cover the user’s entire DeFi activity with one insurance policy. The risk rating of the policy is dynamic, and the protocol’s risk engine determines it. If the user’s positions are in safer investments, they will be charged less than someone investing in high-risk protocols. Solace utilizes an in-house developed rating system for protocols. Depending on the risk profile of each protocol Solace determines what insurance premium each individual must pay. The rating engine assesses each protocol’s risk, the portfolio’s value, and the positions’ diversity. For example, someone who is invested in Aave will have to pay less for insurance compared to a user investing in Popsicle Finance. Users pay the policy coverage in a similar way to pre-paid sim cards. A user can pre-load a balance(for example with DAI) for their policy starting from one week. Once the balance is pre-loaded, Solace starts covering the wallet while the user continues to trade and use the wallet. The risk profile gets adjusted every week.

Solace’s four risk ranks: S,A,D,F
Figure 2: The Solace Rating Engine has four risk categories. (source:https://www.solace.fi/)

Solace Native

The latest product Solace offers is Solace Native, and allows any protocol, no matter the size, to get covered with Solace Native. Solace Native insures protocols against smart contract risk. Solace also helps these protocols with bug bounty sponsorships, audits, smart contract monitoring, and coding best practices. The protocols bootstrap the needed capital for Solace’s risk pool by depositing native tokens and getting coverage limits in stablecoins.

Figure 3: Solace Native: coverage capacity model (source:https://www.solace.fi/)

Bonding, staking and governance

Solace protocol is powered by an ERC-20(SOLACE) token on the Ethereum network. The SOLACE token is used for bonding, staking, and governance. One way to get SOLACE is through bonding. Users purchase SOLACE vested over five days with various assets, including ETH, USDC, and DAI. By bonding, users fund the Underwriting Pool in exchange for discounted & vested $SOLACE tokens. The bonding mechanism doesn’t depend on the market price of SOLACE, so it can have a positive (bond is at a discount compared to the open market value) and negative ROI. Bondholders can choose to stake their SOLACE for money from policy sales, investment activity in the pool, or any new token emissions. As of today, SOLACE is a centralized protocol run by a company. The plan is to gradually transition the protocol to a DAO structure and use the SOLACE token as the governance token.

Classifying SOLACE according to the ITC

Figure 4: ITC Classification of TOKE (Source: https://itin.itsa.global/)

Economic Purpose (EEP): The SOLACE token is listed as a Settlement and Governance Token(EEP22TU03) due to its design as an insurance protocol and a DAO.

Industry Type (EIN): The issuer behind the SOLACE Token is a private company, active in the field of Decentralized Derivatives, Synthetic Assets and Insurance(EIN06DF03).

Technological Setup (TTS): SOLACE is an Ethereum ERC-20 Standard Token(TTS42ET01), running on the Ethereum blockchain.

Legal Claim (LLC): SOLACE does not entitle its holder to any legal claim or rights against the issuing organization, therefore it is listed as a No-Claim Token(LLC31).

Issuer Type (LIT): The dimension “Issuer Type” provides information on the nature of the issuer of the token. SOLACE is issued by a private company with an office in Malta. Hence, its Issuer Type is Private Sector Legal Entity(LIT61PV).

Regulatory Framework (EU) (REU): SOLACE qualifies as an Crypto AssetOut of Scope of MiCA(REU52) according to the definition provided in Article 3 (5) of Regulation Proposal COM/2020/593 final. The dimension “Regulatory Status EU” provides information on the potential classification of a token according to the European Commission’s proposal for a Regulation on Markets in Crypto Assets (MiCA, Regulation Proposal COM/2020/593 final).

The International Token Standardization Association (ITSA) e.V.

The International Token Standardization Association (ITSA) e.V. is a not-for-profit association of German law that aims at promoting the development and implementation of comprehensive market standards for the identification, classification, and analysis of DLT- and blockchain-based cryptographic tokens. As an independent industry membership body, ITSA unites over 100 international associated founding members from various interest groups. In order to increase transparency and safety on global token markets, ITSA currently develops and implements the International Token Identification Number (ITIN) as a market standard for the identification of cryptographic tokens, the International Token Classification (ITC) as a standard framework for the classification of cryptographic tokens according to their inherent characteristics. ITSA then adds the identified and classified token to the world’s largest register for tokens in our Tokenbase.

  • The International Token Identification Number (ITIN) is a 9-digit alphanumeric technical identifier for both fungible and non-fungible DLT-based tokens. Thanks to its underlying Uniform Token Locator (UTL), ITIN presents a unique and fork-resilient identification of tokens. The ITIN also allows for the connecting and matching of other media and data to the token, such as legal contracts or price data, and increases safety and operational transparency when handling these tokens.
  • The International Token Classification (ITC) is a multi-dimensional, expandable framework for the classification of tokens. Current dimensions include technological, economic, legal, and regulatory dimensions with multiple sub-dimensions. By mid-2021, there will be at least two new dimensions added, including a tax dimension. So far, our classification framework has been applied to 99% of the token market according to market capitalization of classified tokens.
  • ITSA’s Tokenbase currently holds data on over 4000 tokens. Tokenbase is a holistic database for the analysis of tokens and combines our identification and classification data with market and blockchain data from external providers. Third-party data of several partners is already integrated, and API access is also in development.

Remarks

If you like this article, we would be happy if you forward it to your colleagues or share it on social networks. More information about the International Token Standardization Association can be found on the Internet, on Twitter, or on LinkedIn.

Valentin Kalinov is an Executive Director at International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database, including a classification framework and unique token identifiers and locators. He has over five years of experience working at BlockchainHub Berlin in content creation and token analysis, as a project manager at the Research Institute for Cryptoeconomics at the Vienna University of Economics and token analyst at Token Kitchen. You can contact Valentin via valentin.kalinov@itsa.global and connect on Linkedin if you would like to further discuss ITSA e.V. or have any other open questions.

Christian Viehof is an Executive Director at the International Token Standardization Association (ITSA) e.V., working to create the world’s largest token database including a classification framework and unique token identifiers and locators. He completed his Bachelor in Economics at the University of Bonn, the Hong Kong University and the London School of Economics and Political Science with a focus on Behavioral Economics and Finance. Currently pursuing his Master of Finance at the Frankfurt School of Finance and Management, you can contact him via christian.viehof@itsa.global and connect with him on Linkedin, if you would like to further discuss ITSA e.V. or have any open questions.

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International Token Standardization Association

The International Token Standardization Association (ITSA) is a not for profit organization working on holistic market standards for the global token economy.