Insurance is a capital-intensive business. An insurer should be able to meet contingency claims from its customers. As many exploits, most recently the Euler Finance case, taught us that sometimes claim payout could far exceed insurance premiums. That’s the problem Ensuro aims to solve. Ensuro is a decentralized capital provider for Insurtech companies.
It works as follows. Liquidity providers (LP) deposit capital in stablecoins (USDC) into pools called eTokens. The capital is used to provide underwriting capital for insurers called Risk Partners. To generate interest for LP on the capital, it is reinvested into blue-chip DeFi protocols, such as Aave or Compound. When a Risk Partner decides to sell an insurance policy, it transfers premiums to Ensuro which allocates solvency capital for that policy. Once the premium is received, smart contract checks the availability of sufficient capital in the liquidity pool. If there are enough funds, capital is allocated to that policy and locked until the end of the policy.
To guarantee that Ensure will be able to cover losses that is inevitable in insurance business the Quant team develops a model with 99.5% confidence level. (This means that in 99.5% cases loss will never exceed this level. For those understanding risk management, it is same thing as Value-at-Risk or VaR, the most popular risk measure in financial risk management). The calculation produces the collateralization ratio, which multiplied by the maximum payout for the policy gives solvency capital for that policy.
Though not directly an insurance protocol, Y2K Finance offers products developed for exotic peg derivatives. Users can purchase these products for hedging their stablecoin positions or betting on a depeg event of a stablecoin. At the time of this writing, the protocol has two products: Earthquake and Wildfire.
Earthquake is similar to what is known in traditional finance as catastrophe bonds. These securities allow insurance companies to transfer part of the risks they would bear if a particular catastrophe occurred to investors. An insurer issues a catastrophe bond which is then sold to investors. Investors will receive coupon payments if no catastrophe occurs until the maturity date of the bond. If the specified catastrophe does occur, the principal amount will be forgiven and will be used by the insurance company to meet obligations of claimholders.
In Earthquake, there are two kinds of vaults — Risk vaults and Hedge vaults. Those who bets on the stablecoin depeg event — those purchasing catastrophe bonds in the example above — deposit funds in Hedge vaults. Users who don’t believe that the depeg will realize, (i.e., that stablecoins will not deviate from their market value and) are ready to underwrite depeg insurance deposit funds into Risk vaults. For playing the role of an insurer, Risk vaults depositors will receive premiums irrespective of whether the depeg occurs or not. But if the depeg event does occur during the epoch, Hedge vaults depositors will receive the principal of Risk vaults.
The graphics below taken from the protocol documentation clarifies the mechanics described above.
Wildfire is a secondary market for Earthquake depositors. Earthquake vaults have Weekly and Monthly epochs. This means that depositors’ funds will be locked during a week or a month depending on the epoch. Wildfire creates a market for depositors where they can trade their ERC-1155 tokens they received for their deposits. If a user’s position is profitable, she can sell part of her tokens which without Wildfire would be illiquid. This is also true for those who seek to get exposure to Earthquake after the deposit period ends.
