MakerDAO Protocol Cover using Nexus Mutual

To be clear, I’m not speaking of Nexus exclusively when I say “everyone wins,” but of insurance products in general. Different investors have different risk profiles. If the MKR holders can offload the parts of the risk profile that they are not comfortable pricing, even if it’s at a net loss in the long run, they “win” via the certainty they get. While certainty can be intangible, it should be beneficial as the DAO grows. For instance, if the DAO is already taking a significant amount of default risk on a specific asset, and an insurance policy allows it to “lock in” a return on that asset, loan growth can happen at a higher pace than if the underwriting risk is unknown and constantly has to be repriced.

Otherwise I agree with most of your sentiment. At this scale, there will be a loser by the end of the policy. But if Nexus can grow its risk distribution business and MakerDAO continues to grow Dai distribution, both companies can help each other reach scale via specialization.

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Thanks for the comments everyone.

It seems like there are three main items to expand on further at this stage. 1) Would MakerDAO benefit from cover, 2) Pricing, 3) Claims determination

1. Is this beneficial to MakerDAO?

Obviously not my call to make, I’d just like to raise one main point and that is the negative reflexive nature of Makers mint/burn approach.

MKR minting/burning is basically designed to buy low and sell high. And while mcap is $0.5bn, that is a very long way from the debt that the protocol could handle in one go. If there was any significant debt accrued, then mcap would likely drop materially, and then more MKR are minted and more sell pressure is placed in the market. To be clear, I’m not being critical of the current model as I can’t see any other alternatives, I’m just pointing out that even $12m at a point where there is material debt will significantly dampen the impact.

This is about giving MakerDAO cash at a time of need. So while that appears to have negative EV on the surface, it is very likely to have positive EV if you consider the perspective of how much MKR is avoided being minted vs the cost of MKR not being burned by purchasing the cover. Cover is purchased using a high MKR price and MKR minting at a low price is avoided.

2. Pricing

Nexus Mutual currently has a minimum price of 5.2% pa, which was increased recently. There is some discussion about lowering this price again, as it was increased in response to SAFE mining which has now ended. While I can’t guarantee anything, I think it’s reasonably likely that there is sufficient staking interest and the price is at or close to the minimum.

Pricing moves with staking, but not for existing purchases. So if you bought a years worth of cover the price may be different if you wish to renew but it wouldn’t change for that year.

One main reason I suggested the structure I did, effectively paying 60% of the debt (up to limits), is to ensure there still remains an alignment of interest between MakerDAO risk management and Nexus. If Nexus covered all downside that could cause issues on both sides.

3. Claims Assessment

Nexus Mutual operates as a discretionary mutual, this means all claims are at the discretion of members. There is also no specific legal recourse here like there would be for regulated insurance products.

Apart from the claims assessment staking mechanisms designed to prevent fradulent and/or malicious voting Nexus Mutual’s key objective in all it’s incentive structures is to encourage the payment of genuine claims. If Nexus members decline genuine claims there is no reason for Nexus to exist, paying claims is actually in the long term interest of the mutual.

I’m happy to attend a governance call or provide further info as required. Assuming there is interest in pursuing further it would be great to discuss with a few experts on your side to get into more details, but please guide me here as I’m not in the weeds of MakerDAO governance processes.

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Barn Bridge seems to be wise to the solutions offered by TradFi. They are doing a 70/30 senior/junior tranche. This is the kind of securitization that I had envisioned for providing insurance. Insurance against natural disasters is structured in this way and they are known as catastrophe bonds. We should strongly consider the merits of such a product.

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Hey @Hugh_Karp, I think there is sufficient interest here to warrant having you on the governance and risk meeting to present on this and to open a discussion.

Are you able to make October 29th at 16:00 UTC? Perhaps a 10 minute presentation?

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Sounds great, that works for me.

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Great, I’ll add you to the agenda for next week.

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Nexus Mutual is not able to insure our tail risks so it’s unlikely to have any impact on our customers. Insurance should therefore be viewed as a corporate finance decision. Basically, we will pay when things are great so we might be less diluted when things are really bad.

Obviously, Nexus will make a profit so sum(paid premium) > sum(paid claims). But we shouldn’t look that way. We should use sum(paid premium / MKR price in good times) > sum(paid claims / MKR price in bad times) as a metric. I expect MKR_price_in_good_times / MKR_price_in_bad_times > 2. Therefore, up to a 50% margin for Nexus, it is still a good deal for us.

It would even be better to have Strategic Reserves which also solve the Risk of pro cyclical MKR issuance.

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Was the project well received on the call?

Hello @Hugh_Karp --can you please explain a little more in as simple as possible detail why the price range for 12M of cover, can cost 320K DAI to 1M DAI? It’s a bit of a wide range.

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Also, How can the Maker Community get the “Minimum pricing” to under 1.5% per annum?

TY in advanced Hugh.

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Hey @ElProgreso

Pricing is based entirely on the amount of staking Nexus Mutual members want to back the cover with (in NXM tokens). This can only be determined once the structure of the cover is finalised and it’s made available on main-net. So price is market driven.

I’m relatively confident this would get enough attention to be close to or at the minimum price, but I can’t guarantee anything. The minimum price of 2.6% pa is a global parameter in the Nexus system which applies to all covers the mutual takes on. It can be changed via Nexus governance.

The most direct thing the Maker community can do to get the lowest price is to convince Nexus mutual stakers the risk is low and/or join Nexus and stake themselves.

If the MakerDAO community wishes to progress then the next steps would be:

  1. finalising the structure and write up a formal cover wording document that reflects the agreed structure
  2. listing this product on Nexus for staking
  3. MakerDAO to proceed through governance and then buy cover (assuming approved)

I’m happy to proceed with #1, as there appears to be sufficient interest to warrant next steps.

@LongForWisdom I’m not sure on process from here, what you need etc. Can you guide me please?

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Hey there @Hugh_Karp, thanks again for the presentation, I felt it was useful.

Figuring out this part is the tough bit! There is a brief overview of MakerDAO’s governance processes here: MakerDAO Standard Governance Processes.

In my opinion the best way to move forward would be to great a Declaration of Intent. Stating something like the following: “Maker Governance wishes to engage nexus mutual to provide insurance for the Maker Protocol.” This declaration could include as much detail as you wanted to provide at this stage (given that it is uncertain whether the Declaration would pass).

Here’s two examples of what these look like for reference:

This would help confirm that Maker Governance wanted to pursue this. The details (payment, terms, etc) would then be written up in a full MIP and submitted to governance for confirmation.

The question is whether you want to engage with our governance processes yourself @Hugh_Karp or whether there is a community member (Either from Maker or from Nexus Mutual) that wants to help champion the proposal.

Myself or @charlesstlouis are happy to help with the structure and process around creating a Declaration of Intent, and later a full MIP.

I would note that it’s somewhat risky to assume that community interest equates to MKR Holder interest. It’s great that the community is interested and it’s a positive sign, but the community and MKR Holders are not a 1:1 group. The Declaration of Intent process was designed to confirm MKR Holder interest.

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Thank you for the response Hugh. It would be interesting to know if the Maker Community members (including MKR Holders), would be interested in Staking NXM for the sake of MKR.

If I understand correctly, I as an MKR holder would need to Stake NXM in the MakerDAO Protocol cover, correct? If we can motivate–say 70% of that MakerDAO Nexus Mutual Cover to be sponsor/staked by MKR Holders–then we could get a lower rate per annum? Is that right–or, MKR Holders would need to be majority owners of NXM tokens within the Nexus Mutual protocol, and vote on quoting MakerDAO a low rate Per Annum?

I would also be interested in hearing from @SebVentures and others, if they believe a Strategic Reserve is sufficient enough to cover–or a combination of both would be even, lovelier?

@ElProgreso NXM holders stake on specific risks, in this case MakerDAO Protocol Cover. The more stakers the lower the price.

So if MKR holders wish to join Nexus and start staking that would lower the cost, with the lowest outcome being 2.6%.

The 2.6% is a Nexus Mutual global parameter that applies to all risks Nexus covers, not just MakerDAO Protocol Cover. To change this a successful Nexus Mutual governance action is required.

@LongForWisdom thanks for the detail, I’ll review those examples and go from there.

If there is a MakerDAO community member that wishes to champion this then please reach out. I’m more than happy to do the leg work pulling the details together.

In most insurance businesses, if you pay the premium for a long time you would be better off by saving the same amount. The critical notion is how long? After (maximum benefit / annual premium) years insurance is a losing proposition (that’s a cap). As @g_dip said, it’s just math.

First, it is needed that MKR holder want to have those reserves. Then come the issue on the kind of reserve. DAI is great but pressure the peg, ETH is risky but can have an increasing value, farming opportunities can have a yield but also a risk. Nothing too hard, but this a something to work on.

Then, we might want to have a full protection from day 1 (for instance 5M DAI protection). We might want to save let’s say 1M each year in strategic reserves and pay a premium to cover the risk (a notional of 4,5M the first year, 3.5M the second year, …). It’s quite similar to a whole life insurance which is more or less a saving product with a term insurance.

We should also check if our risks are linked to Nexus Mutual or not. For instance, the DeFi bubble popping can be harmful for Maker and Nexus at the same time. I haven’t looked at Nexus too much yet.

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Yep–I agree with you Seb. This was one question I wanted to ask @Hugh_Karp on the Gov & Risk meeting. On a recent Podcast (Delphi Digital) I heard a Guest comment that Nexus Mutual would only be able to cover approximately $65M of the TVL in DeFi. To be fair this observation was made by the “guest” in August, 2020. I can imagine now, Nexus Mutual can cover more.

Hugh, in another Black Swan event–how much of DeFi can Nexus Mutual cover? If possible, can you please give an opinion on how that would breakdown. When possible, no rush.

Would be good to hear from @ejbarraza about this :point_up: as well. Your opinion is appreciated Erick :slightly_smiling_face:

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Maximum cover Nexus could provide right now for MakerDAO Protocol Cover is in the order of $12M.

Nexus puts caps on individual risks to make sure we have enough money to pay all claims (diversification of risk in a similar way that Maker chooses many assets for collateral).

The $65M was referring to how much Nexus could cover in total across all risks. That number has grown a lot and is in the order of $300M right now.

Due to the caps per risk, Nexus can handle up to 5 large protocols completely failing at once before it runs out of funds.

Nexus Mutual’s Current Assets = $70m
Cap per Risk = $12m
Maximum Cover Across all risks = ~$300m

Just like regular insurance companies Nexus aims to be geared, meaning total cover is much greater than total assets.

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I would advocate for 3 distinct buckets as insurance. The first should be self-insurance (i.e. equity tranche) via a strategic reserve which I think should be wBTC since it is highly liquid, it is less volatile than other digital assets, and it is gaining capital inflows from publicly traded companies. The second should be a liquidity pool (i.e. mezzanine tranche) of DAI that is staked for 30 days for a fixed premium in the event that there are no losses. If losses past a certain point materialize, then they lose their principal and interest. The third should be Nexus cover (i.e. senior-secured tranche) which acts as a kind of reinsurance product. Taken together you have diversified your smart-contract risk amongst wBTC, DAI, and NXM shareholders and provided them with a small return for hedging your exposure to a black swan event (e.g. Black Thursday). Obviously, this should be done in conjunction with proper risk management. I think it would give people peace of mind similar to the way FDIC insurance alleviates some customer’s reservations about bank failure.

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Sorry if this is a dumb question, but can you give us a quote on the 12M of coverage? Or at least what they likely monthly premium would be? I know 2.6% is a minimum, but do you have some kind of system to give out non-committal quotes so that our community can decide if it’s worth the effort?

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Perfectly sensible question! As this is a tailored cover, specific for MakerDAO, and prices are market driven we have to create the market first. This means defining the precise details on when a claim would be paid. Only then can we get a real quote. If I had to guess, I would expect a price of 5% pa or lower, as I know many members of the Nexus community want to help this go ahead.

I will draft up some more details on the specific claims triggers with a view to including them in a declaration of intent.

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I’ve now categorised this proposal as a Formal Submission.

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