Bankless - 31 - Nexus Mutual to Billions | Hugh Karp

Episode Date: September 21, 2020

Episode: #31 September 21, 2020 ----- Tools from our sponsors to go bankless: 🌐 UNSTOPPABLE DOMAINS - GET A HUMAN READABLE CRYPTO DOMAIN 🌈 ZAPPER - ULTIMATE HUB FOR DEFI - ZAP INTO DEFI �� MONOLITH - GET THE HOLY GRAIL OF BANKLESS VISA CARDS 💸 AAVE - LEND AND BORROW DEFI ASSETS ---- Nexus Mutual to Billions | Hugh Karp Hugh Karp is the founder of Nexus Mutual, a DeFi insurance protocol Nexus Mutual has $80M ETH covering over $240 worth of DeFi insurance, up from $8M last July. Nexus has paid out millions in insurance claims to previous DeFi hacks, and is one of the fastest-growing protocols in DeFi. Hugh comes from the world of insurance and worked as an actuary before moving into crypto. He brings his real-world insurance knowledge to the DeFi universe through Nexus Mutual, a reconstruction of real-world insurance mechanisms, but built on Ethereum. Nexus Mutual has over $80M in assets deposited into the Nexus contracts, up from just $8M in July 2020. This $80M is the backstop for $240M of cover purchased by Nexus customers. Join us as we go through the history of Nexus Mutual, the NXM token, and the future road map with founder Hugh Karp! WE COVER: 1) Current state of DeFi insurance / safety 2) Benefits of smart-contract based insurance 3) Quick history of insurance  4) Building Nexus 5) Integrating NXM 6) NXM Bonding Curve 7) Future vision of Nexus ------ Resources: Read: How to assess the risks of a lending protocol?https://bankless.substack.com/p/how-to-assess-the-risk-of-lending Read: how to protect against hacks with Nexus https://bankless.substack.com/p/how-to-protect-against-hacks-with Nexus Metrics Tracker: https://nexustracker.io/ DeFi Dad Explainer Video: https://www.youtube.com/watch?v=rnzInsKPLR0   Rate the Podcast 5 Stars ----- Subscribe to podcast on iTunes | Spotify | YouTube | RSS Feed Leave a review on iTunes Share the episode with someone you know! ----- Don't stop at the podcast! Subscribe to the Bankless newsletter program Watch Bankless shows and tutorials on YouTube Visit official Bankless website for resources Follow Bankless on Twitter Follow Ryan on Twitter Follow David on Twitter ----- Not financial or tax advice. This podcast is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions.  Do your own research.

Welcome to bankless where we explore the frontier internet money and internet finance. This is how to get started, how to get better, and how to front-run the opportunity. This is Ryan John Adams. I'm here with David Hoffman, and we're here to help you become more bankless. David, how you doing after this epic episode? Just fantastic, Ryan. We brought on Hugh Karp from the Nexus Mutual Project. Nexus Mutual and insurance on DeFi, insurance on Ethereum, is one of those things that when I first saw, I was like, you know what, that's never going to work. In my bare market mind, I was like, that's never going to work.

Like, you can't do insurance on defy. And, you know, shame on me for being a bare market pessimist. But now that the bull market is here and looking deeper into Nexus Mutual, it just makes so much sense. Like, if you wanted to just like take the institution of insurance and make. a D-5 version of it, what you get is nexus, right? And so tip of the hat for Hugh for building something throughout the bear market, blood, sweat and tears to build something that he's passionate about that he really understands and then have it come to absolute success over the last few months as the need for insurance on D-Fi has absolutely exploded. You know, this has become a basically

trilogy with our D-Fi builders, right? These are the bear market builders. So at one point during our conversation with Hugh, he said something that surprised me. I didn't know, but they almost shut down in 2019. Like, Hugh almost stopped working on Nexus Mutual because he and his team, he had to do layoffs, and it didn't seem like it was going to work out. I'm glad he didn't didn't because now here we are in 2020 and we have a protocol with 230 million in insurance coverage in the defy market so necessary glad he was uh i guess he persevered through that with his team and kept on building and i think that's a that's a hallmark of the last three guests that we've had on the show these defy builders uh they didn't quit you know they kept going they kept going they

had the vision even when no one believed in Ethereum, no one believed in Defi. And I think that's what makes these projects really special. I think nowadays with the DeFi bull market and the crypto bull market starting to heat up again, we're starting to see a lot of fair weather builders coming to the space, you know, maybe more of the tourist crowd. And we'll have to see how many of them stick around and stay? How many of them have the quality of these bare market builders and who are able to stick it out and build something lasting? Or are they just here for the gains? So really enjoyed the last three episodes in this series. It's been a lot of fun. And these are these are the protocols to pay attention to. There's also something unique here with Nexus Mutual

that's different from our previous episodes with synthetics and with AVE. Right. So, So, you know, Nexus and insurance needs defy or something like it to exist in order to have product market fit, right? And, you know, while Kane expressed, you know, his apprehensions and his tests of faith during the 2018 bear market, and Stani from Avey said the same thing, they didn't, it didn't really hit me as hard as when Hugh said some of the things that he said in this podcast, right? Like Hugh even went so far to pull out a personal loan to make sure that that Nexus Mutual would survive. And the thing is, like, Nexus Mutual could have done exactly what it needed to have done,

like gone down the exact same phases of the roadmap, built the same exact things. But if it wasn't for other products like synthetics, like Avey, like ChainLink, like MakerDA, like Compound, then synthetics wouldn't have anything to have insured, right? And so part of this ecosystem is composability. And not only did Nexus need to make it through the bear market, but other projects also needed to have made it through the bare market too in order for Nexus to be able to insure them and grow into success later. And that's one of my favorite takeaways, I think, from this podcast,

is specifically the construction of Nexus and how its token model is linked to upside in the Nexus system in ways that tokens like the lend token is, not so incredibly codified to upside in AVE and how the SNX token isn't so explicitly linked to upside in synthetics. The NXM token has this one-to-one relationship with usage of Nexus, and therefore, Nexus needs other applications to ensure. So Nexus can almost like say, like, tip of that hat to Hugh, but Nexus can also say thank you to synthetics and Avey and all these other projects for also making it through the bear market so that it has other protocols to ensure. Absolutely. The ecosystem grows together and it also, you know, dies together if that's

the case. But right now, it is growing. It is growing fast. And this is a new money Lego added to the stack, the insurance money Lego. Hey, David, one other thing. So listeners, you guys are hearing this on a Monday. So this episode is being published on that day. But we're also putting together a special bonus episode for you guys this week. So that will be published on the podcast on Thursday morning. David, what's our bonus episode? You want to tease that a little bit? Yam speaks.

Yam speaks. The original vegetable. The original vegetable farm is finally coming out and talking. Okay. The media embargo is over. I didn't know everyone who put the yamom farm together, but I did know Will and I did know Dan. And so as soon as the Yam farm came together, I messaged them and say, hey, like, we want you on the podcast. We got to get you guys on the

podcast. And, you know, in an abundance of caution and not wanting to appear as like the figureheads of the protocol, which totally fair take, they said that there is a media embargo. But that embargo ends on Thursday. And so mark your calendars on Thursday on the podcast, on the bankless YouTube. Yam speaks. Wow. I want to hear what they say because this week is the replanting week where YAMV3 is coming out. And I'm pretty shocked that they put it together so quickly after all of the issues that that it had in the first version. Pretty phenomenal. I'm really looking forward to hearing what they have to say. hearing the original vegetable token actually speak for itself. Yeah, really looking forward to this one, so stay tuned.

All right, so we're going to go ahead and get right into the interview with Hugh of Nexus Mutual, but first we're going to talk about some of the fantastic sponsors that make the bankless nation possible. One of the tools I've started to use recently is Zapper. For those of you that were part of the 2017 bull market, it was characterized by just opening up blockfolio and refreshing it over and over and over again. And also, anytime you ever made a trade, you would have to go into blockfolio and manually input that trade information to make sure that your portfolio that you think that you have matches what you actually have. With Zapper, you don't have to do any of that anymore because all you have to do is Zapper is input your Ethereum addresses, and then Zapper will give you a really elegant report as to where all your money is. So there will never ever be any disconnect between the money that you think that you have and the money that Zapper reports to you.

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They're beautiful bankless visa cards. It makes me realize that they're really. Revolution is here. Search Monolith in the App Store. All right, guys, let's go ahead and get right into the episode with Hugh Carp of Nexus Mutual. Bankless Nation, we are so excited to have Hugh Carp. He is the founder of Nexus Mutual. He is the father of smart contract insurance. He's an actuary with over two decades of experience. Nexus Mutual, the protocol, has brought over $230 million in contract cover to the space. Hugh, how you doing? Welcome to the nation.

Thank you. Yeah, great to be here, guys. All right. Hey, first question. Is DFI safe yet? No, I don't think so. I think we're in the early days. We're getting there in the right direction, but definitely a long way to go, in my opinion. So, like, what percentage are we like, are we 1%, are we 10%, are we 30%? Yeah, maybe 5. I think we're starting to focus on the right stuff. But we definitely have a long way to go. Education. stuff that we're doing, stuff that other people are doing, more open information that people can easily access that's more readily available, that type of stuff.

We get there, we'll get there. We want to understand a bit more about Nexus and how you are helping Defi get there. But could we start with some background? Because I think you have a fascinating background. We've had some other crypto-native Defi founders on the podcast lately. This has been sort of a trilogy for us, and you're the conclusion, Hugh.

But you're the only one that we've met and that we've had on that has a ton of real world, I guess, almost like traditional experience. Like you were in the insurance industry, the traditional insurance industry as an actuary for almost two decades. Can you tell us about that and how you stumbled upon this whole defy crypto thing and decided to start something here? Yeah, so, yeah, I've been working in traditional insurance for a while. 10 years in Australia and then quite a bit of time in London and the UK. So yeah, I think I've always been fascinated by ways of like doing things a bit differently and stuff. I guess I stumbled across Bitcoin like many other people did quite a while ago.

And it really fascinated me that you could do something where like I could send money to you and there was no one else in the middle and like I just could just do that. I didn't really know how it worked from a tech point of view, but I found it really fascinating. And then after, I put it down, I investigated for a while, but I put it down. But then I heard about Ethereum a bit after it launched. And that's kind of, I guess that's what really triggered it for me, because if you can, you know, write an if-then statement, then you can kind of write an insurance contract. And that was my area of expertise. And I was really fascinated by this way of coordinating people or a community together.

like directly because actually that's that's really what insurance is all about like if you go if you go back like millennia like it's it's just about a group of people coming together and sharing risk like you know you had like people like one of the the big example i guess is chinese river merchants like way back um they used to like share the load of um of their goods but um with in different boats and So if one of them capsized or whatever, they lost their load, then they don't only lose part of their own cargo. And so they were all kind of more resilient as a whole.

And so that's kind of like how insurance started, like a group of community coming together and sharing risk. And it's evolved from there and went through many iterations and things. But it's now transformed into a shareholder company predominantly rather than the kind of mutual community aspect. And I guess our real goal or vision here is that you, you can really do it better if you can use that community approach, but now we have had this new tech that can really scale that direct community

peer-to-peer approach. So that's kind of like at a very high level of what we're trying to do. I want to get into just the history of insurance as you were going down that path, but like just one more, I guess, question on this. It's a curiosity point for me. So what about crypto first drew you in? was it some sort of a, you know, a hobby or an interest or, you know, a way that you were brought up. We talked to Kane from synthetics and he has sort of a crypto anarchist type of background.

We talked to Stani from Ave and he was a tinker. You know, his brother dabbled in Linux when they were younger and growing up. So he came from a tech background. What about your background drew you immediately to Bitcoin, that first spark of interest and then later Ethereum? in. I guess I've always been interested in tech stuff, though I haven't done, like I have done coding in the past, but I've not like a coder or a techie heavily. Yeah, I'm more kind of on the actual real side of things, which is more like stats and economics type stuff. I guess, I guess a couple of things. I've always been interested in tech kind of off to the side, but yeah, not a

massive kind of tinkerer, I guess. I guess the aspect to me that perhaps sparked it more was the kind of philosophy and principles behind it. My dad actually, well, he's retired now, but he used to be, he worked in the insurance industry for a long time as well. He used to be one of the regulators of the Australian insurance industry. And that perhaps sounds a bit odd, but the point is that it's always, they've always got the customer focus here and the individual focus, making sure that it's done right by the people are protecting them. And so it's kind of like, I kind of got a bit jaded by the insurance industry as such because it felt like you were just shifting big money around balance sheets rather than actually

focusing on the end customer. And here was a technology that you could actually like really just put in the people's hands. And so I guess that's kind of where it's come from. So it's more from a philosophical point of view rather than a kind of really tech-trigger. So when did Ethereum come into the people? picture. Yeah, so I guess basically it was pretty much a year after they launched, I guess, early 2016. I guess the light bulb moment. I mean, I was kind of, I was interested in space to kind of dive back into the stuff there. But the light bulb moment for me was seeing the

Dow be drained live. And I thought, oh, here we go. This, this needs, we need to do something here. We can't, we can't just let that stuff happen. I mean, you know, hard. or no hard fork, whatever, you know, that's a different discussion. But like, if, if people are going to adopt this thing, we needed to address those types of issues. A lot of people couldn't see past the Dow at the time, though. They thought that would be the fall of Ethereum and that it would never work. I guess you were able to see past to a world where we can have lower risk, smart contracts. Yeah, I mean, I guess, I guess so. I mean, there was definitely a stage there when everyone thought, oh, it's, you know, it's not, I'm not going too far from here. But I mean,

I still fundamentally thought that the tech was like doing something incredibly new that no one else had done before. And so to me, that had to evolve and progress from there. So when you grew to understand Ethereum in the concept of a smart contract, did the light bulb immediately go off as with the marriage between smart contracts and insurance? Or how long did that take to make that connection? Well, not too long because a lot of people, we're just always talking about insurance as like a very natural use case for for blockchain like from the really early days um it's you know it's a financial product um it's about bringing a bunch

of people together it's effectively a Dow so it like all of the stuff people were talking about um it will kind of it fit very naturally um so it didn't take me long and i and to kind of work out that you know there is something here i need to dive in and work out how to do it um and so yeah i guess i started that process. So Hugh, let's go into that a little bit more. Why is it so obvious for people that insurance and smart contracts are just like this match made in heaven? Well, in my mind, it's basically this fact that insurance is all about risk sharing between people and creating a community that is more resilient as a whole because it can more able to take on risk or downside as a group than you can as an individual. And so if you have this technology that can coordinate people, then

then you kind of like can supercharge this whole thing. And so to kind of make that work, what you need to do is have essentially, you know, a pool of funds and an incentive mechanism to kind of make sure that people do the right thing without pool of funds. And so it's sort very early, like you can coordinate a group of people and a pool of funds really easy, like, you know, the kind of the Dow is like a good example of that potentially working really well. And then if you can put that right incentive mechanism on the top with, you know, tokens or whatever it is, then that forms the genesis of the whole of the whole thing. Obviously, there's a whole bunch of details to work through and how do you make those mechanics work

and the incentives aligned and all the rest of it. But fundamentally, if you can get those things to work, then that's really what insurance is. So it seems to be that with Nexus and building insurance, on quote unquote on the blockchain that you know you're not disrupting anything in the same way that like maker Dow is perhaps disrupting central banks or um you know uniswap is disrupting centralized exchanges it really seems to be that when you build something like insurance on using smart contracts that you're just building this age old primitive on this new substrate does that resonate with you i mean it does for a certain extent, but you can also do a whole lot more. And I kind of think that puts it in the

kind of disruptive category, really. I mean, you can you can strip out massive layers of cost. I mean, one of the one of the key things here is that you can actually get a better outcome for the customers, because you have, you no longer need that shareholder-based entity that has a potential conflict of interest and you have a much reduced level of conflict between the members of the mutual because they're all the members and they can all be working together. There will always be some level of conflict but you don't have that natural just are we going to pay this claim or not because it's a shareholder profit versus paying claim. You know, and that's largely handled by regulation right now obviously, but we just think that there's a much better way and if you can

coordinate this on a community basis, you're going to have much more flexibility. So we definitely want to dive into nexus and how it does some of the things you just mentioned. But I think it would be helpful both for our listeners and for me is if we could get a quick history lesson of insurance and mutual funds. And I've listened to a few of your talks and you kind of give it a nice like account of how insurance came to be. So like to the best of your ability, can you kind of give us like the early, early instances of how insurance came to be in this world? Yeah, sure. I'll just pick a few like different points and then we can you know that kind of tells a bit the ball wider story but yeah so you kind of have these really like small community stuff to start with you know like ancient

history type stuff where you know that those Chinese river merchants or a different community over here that would pull together and you know if someone um one of the like workers died then the rest of the family would get looked after because the elders had some funds or whatever to look after things and you know it didn't necessarily start as monetary based but um but you you get food for them or whatever. And so that's kind of like it really started in that local community side of things. Then you kind of move into like I guess a bit more advanced when you had, and a lot of it comes from shipping.

And so the first kind of like insurance contracts that are closer to modern day stuff is when you had like loan contracts or something where you go, here's a merchant that's going to deliver a whole bunch of goods to the other side of the world. and you've got some backers who will give them a loan to do that. And they would share in the profits assuming it went well. But if it didn't and the ship was lost at sea or whatever, then they'd write off the loan. And so that's kind of an early form of insurance.

And they kind of started with like, here, the shipping people, here are a few merchants that got some more money. And it kind of started at a very small community level. And then what turns to happen, it gets institutionalized. And so you put like standard structures in place, there's a bigger group of financial backers that come in, rules start getting set up, and it becomes more standardized, and a big market type happens. And that's kind of how the shipping industry started.

And that's kind of a lot of where insurance has really come from. So I guess the other thread going through all of this is that they generally have started new markets or new industries where insurance is kind of needed, generally starts with the community first. And so the regular industry is not there or doesn't exist. So the people that need the cover just band together themselves to do it. And so then it progresses into a more regular industry stuff. And so that's kind of, I see a lot of strong parallels with what we're doing now.

But the interesting part is that how that shifts from the community basis approach where it's all done by the community for the community. And if there's, you know, bigger losses than the community wears them. If there are not as many losses, then the community benefits, because, you know, that they get to share and what's left over. And so then what's happened over time and even if we kind of fast forward to earlier this century, you end up with these mutuals that start as communities, but then what happens is they get to a point.

and they get to a scaling point where they struggle to grow because they can't necessarily grow outside their community base because often you will need capital to come in to make it grow further. And so usually the community is not like deep-pocketed. And so they kind of have limited in their growth. And also, you know, conceptually, if you've got one community over here and they want to like share coverage and scale with a different community, they have to actually trust each other to pay on the claims, which can be a bit of an issue.

And so what tends to happen is these mutuals turn into shareholder-based companies. It doesn't happen all the time, but it's happened a lot. And what that means is they demutualise, they get shareholder equity-based capital, and the shareholders then go to capital markets and raise bigger capital for equity, and then they grow and can serve more people. but they've now introduced people into it that are kind of not necessarily there as part of the community there to help, you know, with aligned interests, they're the shareholders. And so that's generally how things have worked. And so I guess our premise here is that because we can coordinate people using token incentives, that's much more scalable.

And so you can coordinate people on a global basis to do this. stuff really efficiently and therefore you don't actually need to inject equity capital at any point you can scale a mutual really large and the members will be the ones that benefit and so it's really the community-owned cooperative type of approach to to insurance and so that that's kind of the history and the i guess our view one um how we think the blockchain can really kind of disrupt the insurance world Yeah, talk a little bit more about that friction between like a shareholder-based model and the average individual who's trying to get a pay out from, you know, their house burning down. Talk about that discrepancy. Yeah, I mean, by and large, it works fine. If you're in a development nation with a reliable legal system and a good regulator, then this all works fine. All of the kind of bat, there's always going to be quirks and stories around the edges and that's always happens. But by and large, it works fine. it only works fine because you have legal and regulatory barriers in place.

And that's costly and inefficient. So there's definitely that conflict of interest, but by and large, the customer is looked after because there are projections in place. And so I think that that's important. But what we're saying is we can do the same thing in a different way, in a much cheaper way, without that risk. And so if we get those token incentives right, that means we can attach.

achieve the same kind of protections, but on a global basis, and also for people that don't necessarily live in a jurisdiction where you have that reliable legal and regulatory framework. Hugh, you mentioned earlier that there's just a lot of inefficiencies in the current state of the insurance and mutual markets. Can you kind of elaborate on that as well? Yeah, sure. So I think probably the easiest way to explain this is if you pay $100 in premium, then you expect to get basically 60, 65, maybe 70% back in claims and the rest gets lost in expenses and profit and all the other costs in there. And so that's kind of the kind of tax in the system. So we're talking like 20 to 30% overheadish for the industry. So it's more like more like 30 to 40 but yeah. Wow.

So it's big chunky numbers. And I mean, you know, some of that, it's hard to get away from, but that's a big, that's a big, um, target to aim at. Um, and, you know, there are, there are obviously a whole bunch of reasons for it, but, um, but that's, it's not very efficient and lots of paper based and stuff like that. So I, I just want to, you know, maybe, uh, zoom out for a minute and, and talk, uh, about risk and insurance, right? So, um, I, I just started reading. Have you read this book here? It's called Against the Gods by Peter Bernstein. Um, no, I, I haven't actually. It's been on my list for a while. It is fascinating. So it is the story of some of

those ship merchants who basically created some mathematical models and kind of early probability and statistics and actuarial kind of tables to to, you know, kind of science the risk out of markets, right? So out of, you know, the first the shipping market and then others. And it talks about how getting risk, quantifying risk, and actually creating markets around risk essentially is a scalability technology. I was thinking about that with the context of defy, right? So defy can only grow so large, you know, before it's like essentially hindered by lack of insurance because there's plenty of people who just are going to be unwilling institutions, for example, other traditional banks. They're going to be unwilling to get into defy if it doesn't have an insurance, if the risks

cannot be assessed. Can you talk about that from a macro perspective? I mean, do you see basically insurance and the ability to measure risk and quantify that with some market price as a scalability limiter to defy? Yeah, definitely. The simple one is there are a whole bunch of institutions that have a check list about what they need, what needs to happen before they get involved. And, insurance is just one of them. At really high level, like, insurance is actually just fundamental financial infrastructure for economies.

And the economies with the highest GDP growth and stuff like that tend to be the ones with a meaningful or well-developed insurance industry. It's just, that's just how things work. Like, if you want to develop anything or do anything new or take your risks, then that happens much more often. when there's a reliable risk management tools in place and reliable insurance in place.

You know, if you want to build a railway, launch a rocket, whatever, like no one's going to let you launch a rocket unless you've got insurance in place. Like, you know, things go wrong. So, you know, this stuff, you know, it may be boring and sitting all in the background, but it's just has to be there to enable the growth of an economy. And so, you know, so our view is that Ethereum is creating this new parallel financial economy to start, but, you know, obviously, hopefully much, much more than that. And insurance should be a key part of it. Well, and just to kind of quantify that, it feels like the value locked in defy can't get beyond a certain amount without insurance. Like insurance is a necessary part of scaling the system. It's a necessary part of

of defy essentially growing up. So right now, I don't know how much we have locked in defy, like something like is it $8 billion or so? Yeah, $8 or $9 billion. And Nexus now has about $230 million in cover, right? And a year ago at this time, there was like no insurance for smart contracts, maybe a little bit. I don't know what you guys were working on, but it felt like there was almost nothing. But in order to get to 100, like we talked to Vance from Framework a couple episodes ago,

and he predicted possibly 500 billion locked in defy close to the end of this cycle. And we're just not going to get there unless we have insurance in the billions of dollars. It's just not going to come. So this is all defy growing up. And we've kind of seen a little bit on the crypto bank side. And we tend to refer to exchanges as kind of crypto banks because they're expanding their functionality beyond trading to other banking type features. some of the crypto banks have started to get some pretty robust traditional insurance for their

multi-sig custodial wallets and solutions. And it seems like that is the crypto banks growing up. Can you talk about that for just a minute? So how, where are the crypto banks going to get their insurance? You know, Gemini ruled something at Coinbase has had insurance for a number of years. Are they going to just the traditional brokers? And how are the traditional brokers kind of assessing the risk for, you know, multi-sigs and custodial wallets and vaults in crypto banks today? Yeah, they're mostly going to the, I mean, they're going to be a traditional brokers through Lloyds or through other providers,

etc. The traditional insurers are, you know, stepping their toes in in various places, mainly with, they're kind of like standard crime policy. that are actually just applied to essentially private keys of custodial assets. And so really, that's not too much of a stretch from a product point of view. They obviously have to do a bit more analysis and understand it a bit better, but that's kind of where they're going. In terms of the capacity that's currently offered,

I haven't caught up with the brokers I know recently, but it's always been a bit of a challenge. And for example, Lloyd's put a crack down on things recently, saying, you know, no more cryptocurrency risk in any of the end. syndicates. So there is some capacity, but it's not at the billions of scale. Why did they do that, by the way? Why does Alloys make a decision, you know, no more cover? We're not providing anymore. Is that just a risk management thing? Yeah, it's a risk management thing. I also know that some, there are some like, you know, if you wanted a hundred million line of custody cover, which is a

relatively small line in itself in the insurance world, then it's actually been broken like between 10 different providers and that's like just unheard of because usually people, any decent provider would go, oh yeah, happy 100 million. So, so, you know, that's just to give you a bit of a flavor for how and where they are thinking, but that they will come and eventually, but they need to understand better. And there's a long, there's a long kind of education gap there. And the market's not quite big enough for them to be interested right now, but, you know, that will change over time.

So they are, it sounds like, would you say, like they are miles away from doing anything with defy and smart contract insurance if they're just like barely comfortable insuring exchanges, right? Yeah, exactly. I mean, that's my view. I mean, they will get there eventually, but probably five years, maybe. And actually, I think they're more likely to enter with us. Like what you tend to do as a bigger capital provider. in the insurance well, it's like you find an expert in that particular thing and then you back them. They take the first levels of risk and you can help back it up and give them more capital to really scale. And so that's a potential option for us in the future. So do you think there maybe a couple years away from starting to do that? Or is it close to you think this cycle? Does it happen this cycle? Yeah, I'm not too sure. It's going to have to be the right partner and all the rest

of it. But, you know, and they're going to want a few years of claims experienced before they start backing stuff. So, you know, we've probably gone a little bit yet. So, Hugh, you said that, you know, one of the prerequisites for any, like, significant investment getting into an industry is if it has insurance or not. And do you think that people that think in that way, when they look at Nexus, do you think that Nexus counts? Like, because it's kind of inside of the industry that perhaps they were looking for somebody outside of the industry to insure. Do you think, do you think Nexus would check that box in their mind? I know it checks the box for some people. I know it doesn't trick the box for other people.

So, yeah, it depends on the point of view. We actually, I was talking to a few people recently. Obviously, there's a couple of Swiss foundations around that manage crypto assets for projects. And they have some criteria about investing and not taking risk with the funds. But a couple of them have got advice that if you put money in, say, compound or whatever,

and you also get cover with Nexus that puts it at an okay level from a risk point of view. But without the Nexus coverage, it wouldn't be. So, you know, that's just one specific example about how we can help get over some regulatory restrictions and stuff. Well, just to make that super tangible, right? So when you put your money and when any of us put our money in a bank, let's say a bank in the US, for example, under $250,000, there's something called FDIC insurance, which means the government is essentially backing up your savings account, right? So if the bank goes insolvent for whatever reason, if there's a run on the bank,

they run out of money. Again, fractional reserve system, of course, then the government will ensure that you get your money up to a certain amount. Defi, if you inject funds into compound, which is essentially a defy, a bankless savings account, if you will, you don't have FDIC insurance. natively, right? So if something happens to the compound smart contract, say there's a hack, you are out of luck. The government is not going to reach in and refund you. And that's why something like insurance helps defy scale. Because when you wrap Nexus as part of a compound

savings account, essentially, then you do have some insurance that it is protected against a smart contract hack that we've seen, you know, many times in this space. So like that just kind of makes it real. What you're adding is not just a savings account, but this nexus primitive adds, uh, insurance, almost like an FDIC type insurance to the protocols as well. Is that, is that kind of how you see it? Yeah, it's definitely how I see it. Um, on a conceptual basis, here's where I get my legal stuff on, but, um, like legally we aren't insurance. We provide discretionary cover, um, which means like the cover payouts are kind of at the discretion of the other members of the mutual via voting, etc.

But conceptually, that's the idea. That's what we're trying to do. You know, compounds a lot of bank. They act like a bank. We're not insurance company. And we act kind of like an insurance company, I guess. And so that's, but that's conceptually what we're trying to do. Ideally, you know, you hopefully have, we get to the point where you get like a badge

or a token that kind of, you know, represents, oh, he's your, he's your, Here's your agent role, and it's kind of, it's covered by Nexus, and that's kind of like, here's your bank account with an FDIC insurance, you know, that type of thing. And so just to talk about, you wrote an article for bankless, I think almost a year ago now, where you talked about kind of three categories of risk, right? And it's important to, I guess, remind folks that something like Nexus doesn't cover all three categories of risk. Can you talk about those categories of risk and what Nexus would cover and what it doesn't

doesn't cover. Yeah, so I can't, yeah, put them in three categories. Basically, technical risk of the smart contracts failing. That's what Nexus covers. So that's basically the salinity code. If there's a bug in it, you know, the code was designed to do something. It clearly does something different. Someone could drain the funds or freeze them or whatever.

That's basically what we cover. The, I guess the other two broader categories are basically anything outside the smart contracts. So things like like a governance attack or. or like an Oracle failure, stuff like that. That's not covered right now. And I guess the third category is like an economic incentive failure. So there might be a system that's relying on economic incentives to work so that the whole system works. Like, Maker-Dow could be an example.

Like the die peg may fail, not because the smart contracts fail, but because the economic incentive system around that doesn't quite hold it. And so we don't cover stuff outside the smart contracts or those economic incentive failures. right now. We basically launched something simple so that we could get it out there, test it out and all the rest of it. But we definitely have plans to kind of broaden the coverage and provide more complete cover. And the bulk of D5 failures so far, have they been more in the smart, in terms of total value lost amount? Have they been more in the, you know, smart contract technical hack camp or have they been in the other categories as well?

I think probably the one bigger one that was in the other category. They've mostly been in this might contract technical failure in my mind. So, but the other one that hasn't been, has been a bit outside, was the MakerDAO, like Black Thursday stuff, where the keepers didn't keep up with the auctioning process and vaults got liquidated below market value and stuff. So that one was a key example, but we haven't, I guess there's always a few times when someone just drains the funds

or exit scams and stuff. I guess that's kind of classified as a governance failure. So, yeah, I think majority has been smart contract technical risks, but there are other things to consider. All right, so we've been teasing the listeners with a bunch of things circling around the topic of Nexus Mutual itself and the NXM token. So let's go ahead and dive right in. Hugh, what was the first step towards building Nexus?

Ironically, legal and regulatory research. is it basically how do we do this in a way that just that you know doesn't piss off the regulators how do we do this without getting shut down day one okay basically you know um like i i i guess i was coming out from one point of view like you kind of have two options you either kind of um do okay from a do it fine from a regulatory point of view or you go full dark mode and just release it right and go fully centralized from day one. Yeah, anonymous founder, you are Satoshi, right? Yeah, yeah, exactly.

And I just knew from, like, immediately that this thing would require iteration and updating and you could never get it anywhere near perfect from day one. And that just wasn't going to be a possibility. So to me, I went the other direction. And so once we kind of sorted out a route to market, then it was all a kind of economic design and stuff like that before we started coding. And then, and where did this, when did nexus start to become built? When did, when did work actually start to, to happen?

We started, we started, like, putting together a proof of concept late 2017. Then we kind of raised the seed around early 2018 and then launched the protocol in the May 2019. So, so that's basically the roadmap. Were you affected by, like, the doldrums of the bear market, the brutal bear market in 2018, 2019, where everyone thought, you know, Ethereum is dead, D5 is nothing going, is not going to be much. And there was kind of just rampant Bitcoin maximalism. Did you fall prey to some of that? Definitely. So yeah, we went through some very tough times. We had to let go of half

the team, cut down the runway. It will cut down the cost space a lot, so we had more runway. and then basically crawl over the line. We were very, very close to shutting down. Going back to all of our initial seed investors saying, you know, can you provide a little bit extra, didn't quite go anywhere. Then a friend, I guess, an Ethereum OG decided to help us out and give us a little bit of extra money. And combined with a chunky loan for myself,

we managed to kind of get it over the line and get it to launch. And then, and then, you know, I guess cockroach our way out of it. And I guess, you know, things are looking pretty good now. We've got a protocol with lots of people using it and stuff. But I guess early 2019, yeah, there was pretty tough times going on. Oh, my God. So what kept you going? Well, I think I found out that I'm just super stubborn. It's a good time to find that out. The cockroach. Yeah. Yeah, I think I got to the point that I felt, I just felt we were so close and I'd just be

really disappointed if we didn't get to launch. Like, if we got to launch and it just didn't work, I'd be like, okay, I've given it a shot. Nobody wanted to use it. Didn't work as a product, whatever. But I'd just be so disappointed that we just didn't quite get there to give it a shot. And so, yeah, just managed to get over the line just, really. and we're here today still, so that's great.

Well, you are here. So, like, can you tell us about the 2020 experience? Because that's been a little bit different than 2019, hasn't it? Yeah, 2020 is like, I don't know, like five years condensed into five, five weeks or something. I don't know. Like, we were. Just give us some metrics. So in terms of contract cover, where did you start the year?

Actually, I have the up nexus tracker.io if folks want to see it. I've got the tracker. I don't know who built this, but okay. So end of 2019, you had 1.15 million in cover, right? So that's the amount that essentially of smart contracts that you're able to ensure through the Nexus protocol. And now here we are, I'm looking at it. And as of right now, there is $233 million. That is, you have more ETH locked in Nexus than the Ethereum Foundation, I think, or it's pretty close.

has eaten. And all of that has happened this year. That's like, you know, my God, that's all of it all of it's happened since July, basically. Wow. So yeah, it's, it's been a massive three months for us. Like, yeah, we've had like, um, in terms of our capital pool, we were sitting around five million for quite a while. Um, we're now up at roughly 80, I think, 70, 70, 70. It depends what ether's doing right now. Um, and, and so yeah, it's, um, yeah, we've had massive growth over the past little while. Basically, the big kickoff has been yield farming. It makes a lot of sense when you're earning ridiculous returns to just take out some cover of Nexus and reduce that return a bit, but be in a much better position from a risk or board point

of view. And so that's kind of really kick things off. And lately, the last few days have been safe mining, which is just another level of craziness. But But that's what's been going on recently. We're definitely going to get there. But let's actually talk about how Nexus is constructed. So what are the core primitives that power the Nexus mutual system? Yeah. So, I mean, if you think about it, yeah, really high level,

you've got one capital pool. It's basically a pool of ETH right now. And then you have the token NXM that kind of sits over the top as an incentive layer to make sure that people do the right things. We pay out the claims that are genuine, we decline the claims that are not. We do the right things from a governance point of view. We back the right risks with the right of pricing, etc. And so essentially what we have is this one pool that all of the cover prices go into

and all the claims go out of. And then people can actually contribute ether to the pool and get the token in return and do the reverse as well because you can then. burn the token to take Eath out. So there's basically like only a few like money in, money out type inputs here into the one capital pool. But then you've got the token which kind of allows you to do the different actions. And so the first one, I guess most obvious one is actually buying cover. So you actually kind of burn the token to buy cover. You actually don't see that in the background. You can just purchase directly with diary and then it just does the

conversion in the background for you. So that That's kind of in this case, one. And then there are three more main functions. The next major one is what we call risk assessment, where you kind of stake and accept tokens against risks that you think are good. So like you might want to back uniswop or compound or Rave or whatever. And then you earn a share of the cover price that gets purchased on that protocol. And so that's a key incentive mechanism there.

And then there's the claims assessment, which you stake some NXM again for voting power in the claims assessment to improve or deny claims. And then there's usual governance, update parameters, upgrade the system, et cetera, stuff as well. So those are kind of the four things that you can do. So the NXM token and how it comes into existence is interesting because it's very much unlike any of the other DFI protocols and their token, right? And so, you know, SNX is the collateral for synthetics. You know, the lend token is the future governance token over AVE with potential cash flows that we all kind of assume is baked in. But the NXM token is different because it has this much more codified relationship between the growth of Nexus Mutual and the demand for insurance and the value of the NXM token. And that comes from the bonding curve.

And so talk about the bonding curve and how. that incentivizes ether deposits and nxm creation and also how the shape of the bonding curve has changed over time yeah sure so i guess what the whole purpose of the bonding curve is is it's a way to manage capital and neutral so so what we want and what you kind of need is you basically need enough capital in the pool so that you've got enough money to pay claims but you don't want too much because that's inefficient. And so you kind of want to get capital in there to back the covers that you've got. And then when you write more and more business, you want more capital so that you can grow. But you don't want to be sitting on hundreds of millions of capital that you're not using

because that doesn't make any sense. And so the whole bonding curve is specifically designed around capital efficiency and making sure that you've got the right level of capital to back the covers that you've got. So say one of the main, there's kind of two main main, there's kind of two main elements to the bonding curve. The first is kind of what we call the MCR percentage or minimum capital ratio percentage. It's basically like a solvency margin. So it's more or less the funds that the mutual has divided by the funds that it needs to back the policies that it's got. And so when we've got excess funds, the price starts going quite high quite quickly. It's got an exponential factor on that. And when we need more funds, then the price comes down.

So, you know, if we have a few large claims, for example, our funds level will reduce, our MCR percentage will reduce and that will lower the token price. And so therefore encourage more people to recapitalize mutual. And correspondingly, you know, if we end up writing lots of business and that kind of, you know, leaves surplus in the pool and we've got too much surplus and too much capital, then the token price will rise until people cash out NXM for the east. So it kind of balances things. That's kind of like the one metric. The longer term metric, which is the second metric, is really just the amount of capital we need. And so basically this means that over time,

as the mutual grows, assume the funding level position is flat over time, the solvency ratio is flat, then the token price is basically driven by how much cover. the mutual rights. And therefore, it's really strongly linked to adoption. And the point here was really to link the token price and use it as a core function for a call. Sorry, it's something that the mutual needs to operate. And it needs the right capital, the right point in time. And that's entirely what the token is for. Okay. So it's issued along a bonding curve, but there's actually

two curves to be paying attention to, right? There is the curve of the amount of capital that is needed to fulfill all outstanding covers if everything in DFI blows up, like all at once. And Nexus Mutual has this curve that establishes like the minimum amount of capital that is required so that it can pay out every single claim ever. And then there is another curve that I believe is 30 percent, like tracks that same first initial curve, but it's 30 percent higher that is that 30% buffer. And A, is that correct? And then B, also, is it correct to call that the premium?

So I guess no one of a few counts. But so the minimum capital requirement, the whole point of insurance actually is to heavily under collateralize, like fractional reserve banking, to be honest. Because, so as you can see at the moment, we've written 230 million of cover, but we have 73 million of capital. So if everything claimed it once, we wouldn't be able to pay.

And that's actually the whole point of insurance, because you can't cover extreme events with relatively low cover costs or premiums efficiently with a fully collateralized model, so one for one, right? So we have this model, which is basically how insurance companies work in the real world and kind of goes, you've got these risks, they're diversified, they're not all going to blow up at once, but we've got to make sure that we've got enough that if quite a few of them blow up, you've got it covered. And so that's that's the model that we're operating under.

So the bonding curve is actually, I mean, it's three-dimensional, if you want to call it that way. There's the solvency ratio and then there's the other demand to it. So the other element to it, the longer term. But it's really just one curve, I don't know if you want to call a three-dimensional curve, one curve or a lot, but that's kind of how it works. So the reason why I think this is so elegant is because, well, A, I just love bonding curves. They're one of the coolest pieces of defy infrastructure.

But it's a dual purpose curve in the sense that, like, if you want to become a member of the mutual, right, like you purchase NXM by depositing ether into the curve, and then that increases the value of the NXM token, kind of in the same way that Uniswap works, right? Like if you purchase ether with your dye in the unoswap die pool, the price of ether goes up, right? And the NXM on the bonding curve does the same thing with more ether deposited into the pool. But then there's like a fork in the road as to like who you want to become. Do you want to be someone who backstops the Nexus mutual by adding capital to the pool? And then if you do, you keep the NXM token.

or you can therefore instead become a person that purchases cover and instead of receiving the nxm token you burn the nxm token and that burning event is the purchasing of cover right and so both participants put ether into the pool one keeps the nxm token one burns the nxm token and the one that is burning the nxm token is purchasing cover for some contract somewhere and the burning of the nxm token means that there's more ether in the quote unquote treasury, right? More in the curve. And there's less NXM tokens. And so the remaining NXM tokens for any of the individuals that just want to be a part of the mutual,

their NXM token has a claim on a greater share of the ether in the treasury, right? In the mutual. Is it all of that correct? Yeah, exactly correct. I have a question about so I think most bankless listeners are more familiar with bonding curves in something like an automated market maker, which we talked about many times before, see our episode with Haseep, we'll include in the show notes.

This is different right here. Like, you know, did you create your own custom bonding curve, or was this inspired by a Uniswap or some other automated market maker? Yeah, no, we created our own bonding curve. We actually, we were developing this stuff before Uniswap existed. but we just had to do a lot more testing because it's a bit more complicated than the uniswap curve. We designed it specifically for what we were doing. It's a specific use case.

Like it's not as generalizable as uniswap is, but you can use in a few different scenarios, etc. But the, yeah, I mean, it was really developed for a specific purpose. I mean, we did a lot of like simulation testing and stuff on this thing because I guess it was relatively new. And this means basically because there's a bonding curve present, it's not like if somebody wants to purchase NXM, I guess, you know, they can purchase it from the bonding curve itself. So they're not like purchasing it from Nexus Mutual, some entity or something else. Of course, they can also purchase it on the secondary market, but they can always buy and sell tokens directly to the bonding curve. Is that correct? Yeah, that's exactly right.

Yeah. The Uniswap bonding curve is just like a straight curve, right? just a, there's super uniform. It doesn't have any, any other, it's like one single curve. But the nexus mutual curve is different, right? It's more custom fit to your guys' use cases. And earlier you said that like as there's more and more capital in the curve, the curve goes exponential really, really fast. Why, why is there a disincentive to add more capital to the Nexus mutual pool? Well, we just want to make sure we've got enough capital, but not too much, basically. Why is too much bad? Wouldn't you want more? Well, it's kind of like, not necessarily

because what we do, perhaps there's a few softities to it, perhaps. So this concept of like, there is one capital pool, but if we kind of like segregated into two sections, and there's kind of like the reserves, which is what we call our minimum capital requirement, and then there's the buffer over the reserves. And so what we want to make sure is that we've got enough reserves and we only write cover up to our kind of reserve levels to make sure that like we'd never allow cover on any particular protocol to be more than 20% of our kind of reserves. So that if there is an issue, we're confident we can pay because basically if the if people start taking money out and they can't take money out below our reserve level, it's locked.

So that's kind of like there's a free buffer which you can buy in and out of as long as you're above the 100% level, but you can't do it at below the 100% level. And so what we want to make sure is you can you can do your buying and selling as much as you want, but we have to have enough money to pay those claims. And that happens over time. It doesn't happen just now. And so that's kind of what we're making sure. And so what we do is where we have excess capital, like for example, what we do right now is when there's, well, up until actually two days ago, but what we've been doing is when there's excess capital is in our solvency ratio is over 130%, we ratchet up the reserves a little bit.

So we just kind of arbitrarily shift some of the buffer into reserves. And that allows us to write more business on each protocol. And so one of the interesting problems we've been having recently, you know, good problems to have, I guess, is there's lots and lots of demand, but we have to be able to kind of scale our reserves up to meet that demand. And so it's, you know, we have to do that in a good way. Because if we did it too fast, then we just absolutely crash the token price. And that's obviously not what we want to do.

So we're going to do it on a gradual, steady basis, which is definitely challenging in the very fast moving defy space. So Hugh, you own an individual comes and they purchase an XM because they want to be a part of a mutual and they want to access the upside of people paying cover. Right. And so you express that interest. by purchasing NXM. But there's one more function,

which is that you can stake NXM to a particular contract. Can you talk about that? Yeah, sure. So what you can do is really take an enhanced risk reward position by staking on specific contracts. And so when you do this,

then you earn a specific amount of the cover price that gets paid when someone purchases cover on that. So for example, you might stake on, yeah, compound or uniswob or maker or whatever. And when someone purchases on compound or then you get a specific share of the cover price. There is obviously a downside to that in the fact that it's enhanced reward, but there's also an enhanced potential punishment.

If there is a claim, then your NXM can get slashed proportionally to the claim amount versus the stake that's there. So there's definitely more risk involved. And so this is really kind of using prediction market like techniques to price cover. So the mechanic here is basically, if there's more staking, there's lower price and more capacity on that particular protocol is provided. I mean capacity, I mean more people can buy cover. And so those with more stakers gives you better price and more capacity.

And that's kind of a, it's important. to kind of incentivize them backing the right protocols. Because, you know, we don't want to provide cover on some random new protocol that hasn't been audited that's potentially got a zero day bug, et cetera, that people have planted, for example. So we have to make sure that there's a way to select good risks. So this acts as almost like a kind of a skin in the game type function, right? So it almost acts as a risk assessment. So people who are staking to something like Maker, they might be willing to stake more

to Maker because. it's been formally verified, it's been in action for a while. It already houses billions of dollars. Lindy effect is going strong. Whereas some new protocol, people are going to be unwilling to stake to it and risk their portion. So does this essentially act as a whole kind of risk assessment framework for individual DFI protocol? and contracts. Yeah, exactly.

That's exactly what it does. So you can, you know, assuming we, you know, get more scale and keep growing and gets more kind of, you know, a bit more experience on this stuff, you should be able to use the price on Nexus as one indicator of the risk of a protocol failing. And that means as a staker, you have to know what you're doing. You can't just blindly just park your funds in one contract versus another without having some understanding of it. It almost makes you kind of an assessor.

risk assessor in some way. Is that sort of who you're looking for in terms of the community members? Yeah, exactly. It's an expert function. It's a knowledge-based staking function. You know, that's ideally we want, we want the experts doing this stuff because that's where we're going to get the most value out of it. So you said this is a prediction market type model. And one of the core features of a prediction market is that people with privileged information or just are better equipped to analyze something are going to sway the market using their own capital at stake to express a certain opinion about the future of something, right? And so people that have more privileged information about whether a contract is risky or not or at risk at all can stake

their NXM in an expression that this particular contract is safe. And the reward for that is they get an outsized share of the cover being paid to that particular contract. But also, some of that cover also goes back into the treasury to repay all of the NXM holders, their share, but it's the people that are staking on that particular contract that get that outsized return first, right? It's a nice little reward for that extra risk. I want to go into that extra risk just a little bit more. How does, you said that if that contract gets, you know, exploited or bugged or whatever,

and there is NXM staked to that contract, you said that gets slashed. How does that, maybe punish isn't the right word, but how does that cost the stakers before the rest of the mutual? So when a claim is paid, the actual claim payment gets paid out from the mutual fund. so like ether or die, depending on what the cover was purchased in. And so that's a direct negative on the treasury. In addition to that, the equal value of NXM that is staked on that contract is also burned. And that's proportionally shared amongst the staker.

So if there's a lot more XM than the claims pay, then it's a partial burn. If it's the other way around, then all the NXM would be burned. So it's kind of like an offset. So you definitely still pay the actual funds out. So we kind of have like hard capital, which is like ether and die used to pay the claims. And then we've got the incentive layer on top. So make sure you stake on the right stuff, which is the NXM. And so after a claim payment, the treasury has gone down and the number of NXM has also gone down.

Okay. So the treasury that you keep talking about here. So there is about 230 active cover, right? But the treasury is smaller than that. The treasury is about 73. That's just how 73 million or so, I think you said earlier, which is just how kind of insurance works, right? That's 73 million.

Would you call that float? And the reason I ask is because, you know, people like Warren Buffett, of course, have famously been an insurance business for decades. And that's kind of where they make their money, right? they take all of those insurance premiums, essentially that becomes the float, that becomes their treasury, and they go and they reinvest it. And Buffett famously reinvested that in Bull Run stock market for the past 40, 50 years or so. Is that treasury float for Nexus? And what do you do with

it? Do you make your money on float in any way? So yes, it's a float. And yes, we will use it, but we aren't currently. So that's going to be a big part of Nexus interview. each other's for sure. The we have to we have to kind of make a few enhancements of protocol to make that happen. They're on the roadmap. The other aspect that we have to be a bit careful of is if for example we put money in say compound and we're also covering compound and compound goes down then we lose assets and liability and have to pay claims at the same time. So you know we just have to be careful about the risk accumulation. One one thing that could be that we're

you know obviously very excited about is like ETH 2.0 launching and being able to earn some sort of return on the ETH we're holding by staking, because that could be potentially uncorrelated to the risks that we're riding. And so that could be a really good thing to put some of the float to work in. And that would flow back to the Treasury to all mutual members, and it just helps the mutual members directly. So you don't want to play hedge fund manager with that float, of course, right? But if you did put that 635,000 ETH in something like staking, for instance, we've, part of bank was we've kind of talked about that as being almost the risk-free rate of ETH in a way. Not to say there's no risk,

but to say it's almost kind of like like T-bills or treasuries in the U.S. government, where that interest rate that you receive as part of a T-bill is kind of the risk-free rate of capital for that market. Is that sort of? of how you see ETH with staking. Is that why it's kind of a safe, a relatively safe place to put some of that float to work? Yeah, exactly, right? We want to, we want to make sure that we have the funds available for paying claim. So you want to, you know, you can invest some of the float in more riskier stuff, but you don't want to invest the majority of any riskier stuff. So we need to work out what we do with that majority. And something like the ETHO staking is

perfect. And that float, the interest received. them at float, whether it's, you know, 3% or whether it's 8% or whatever it ends up being, that would flow back to the mutual holders. So holders of NXM, the asset, is that correct? Yeah, exactly right. So basically, as, you know, they've got that treasury pool and you've got money coming in for covers, money going out for claims, money coming in for people who put eth in and going out for the other way, you also have the float, the investment returns. and so to the extent that, to the extent you're in this stable environment where you're just writing business, same amount of business going on and off, then the surplus that's generated from the cover purchases plus the investment earnings on the float just accrue directly to the treasury. And then that starts pushing the token price up on the bonding curve because you've got your funds actually held over funds required just keeps ticking up because funds held goes up, but funds required stays as a same.

same. So that's basically how the model works. It all goes back to the members. So what's super interesting, I think, about Nexus is that all of the capital backing these claims is ETH-based. So it's all in essentially Ethereum's reserve asset, which is Eith. Why are you guys going? Nexus is an ETH maxi. Yeah, it's like a, it's an ETH, it's hungry for ETH. Like it's an ETH monster. It just consumes more ETH and the more ETH that it has, the more cover it can provide, essentially. Why, why Ether? And have you thought about other assets or what are the kind of the trade-offs, pros and cons of using non-Eather assets? Yeah, so we won't be all ether forever, that's for sure. We started off with Ether because we believe that, I mean, sorry, stepping back,

the key way to actually manage an insurance company here is to match your assets with your liabilities on a currency basis. So if you're writing claims, potential claims, or writing cover, denominated in ETH, you have to pay claims in ETH potentially, or you have to pay claims in U.S. dollars die, then you should theoretically hold the same assets in the same mix. So if you write 50% cover and ETH, 50% cover and die, you should probably hold 50% ETH and 50% die-based assets. So that way, if currency rates move, they move on both sides of the balance sheet and your funding position is state. You're not taking any, you know, FX risk for an like currency exchange risk in that way. Yeah, exactly. So, so we started with ETH only because we believe that most of the

cover purchases would be done in ETH and we were over-calatialized to start. And so it was, it was all, it was all kind of okay. We're getting to the point now where, um, well, we probably should start having more more in the value being held in diet to match things a bit better. But it's okay for now. But the, um, but we are a relative ETH maxi compared to other stuff, that's for sure. I guess what we need to do is when we kind of enable this investment earning stuff, we also need to balance the weights of what the assets are and make sure that the currency risk is not too much. So in theory, the makeup of the treasury and all the assets inside of it should generally match or track onto the demand for cover based in specific currencies. Is that right?

Yeah, exactly. So if we're writing, as I say, know, 50% eath cover and 50% die cover, then we probably want to hold 50% eth-based assets. And, you know, that could be staking or whatever. And correspondingly, you want to probably hold 50% US dollar-based investments in whatever shape or form that is. One of the things we've talked about a lot is how Hugh, you were able to put all of this essentially in smart contracts, right? And presumably the typical traditional insurance industry, it costs 30 to 40% in administrative costs. And your costs are much smaller relative to the amount of cover that you can provide.

So that's one efficiency gain in making all of this Ethereum native and smart contract based. But I'm also curious about this. Could this thing continue to operate if your team, sort of the management team and the developers of Nexus kind of went away. I guess how bankless is it? How decentralized is it today? And what are your goals there? Yeah.

So not right now. It wouldn't be able to. There are a few centralized elements that we're basically working to remove. The idea is to become a fully permission, the most decentralized protocol. That's the goal. We've got a few things to do to get there. couple of more complex calculations that we want to bring on chain and we're kind of in the process of doing that. But it's definitely on the progressive decentralization end of the spectrum.

I guess relative to something like a compound or something, we do have a lot more mechanics involved and a lot more things that we have to iterate on and test them. And we're going through that process and fine-tuning stuff and working it out. But we're on that process and we're working towards it. In terms of like the actual kind of underlying risk there, there's effectively a multi-seek behind this that we have governance that can get formalised on-chain governance that that does updates and stuff like that. But there is also a multi-seek of the five advisory board members that they could do potential harm to the protocol if they colluded. There is a protection there, the fact that they are actually legal directors of Nexus Mutual Limited, a company

in the UK. But, but, you know, that's the situation we are in right now to be blatantly out there and transparent about exactly what's happening. And, but we're, I guess, working to remove that over time. There's always the question we learned in 2008. Who insures the insurers, which I don't know if we have a good answer for right now for Nexus, but do you see any help on the who's going to ensure Nexus? Yeah, that's a good question. No one right now. We're covering open, but yeah, but no one for Nexus right now.

We have this treasury, and this treasury is funded by this bonding curve when you deposit capital into it. The capital is largely ETH right now, but it's going to diversify into a much more diversified basket of assets to mitigate risk. On the other side of that bonding curve is the NXM token, which is the token that can purchase cover, which gives you some amount of rights to the funds in the treasury if a particular contract goes under. And so this is the general core nexus mutual system. What we haven't covered yet is what happens when a contract blows up. And this is actually happens. So there are actually

real life instances of contracts blowing up. So Hugh, can you kind of walk us through the process of what happens when a contract that is insured by Nexus, quote unquote, blows up. Yeah. So basically the cover holder submits a claim in Ethereum transaction. And then that goes to creates essentially a workflow item for our claims assessors. And so anyone can be, any member of the mutual can be a claim successor by staking some an XM. And then it basically goes to a vote.

So these are humans interpreting stuff. So, you know, that has pros and cons. obviously. It means we're massively flexible in terms of what power we can provide in future, but it also means that there's people involved rather than programmatic rules. And so that's essentially a voting process, state-weighted, there must be a 70% or more consensus on things. And if that threshold's not reached or there's not enough staking, etc., then it escalates to a full member vote where any member of the mutual can vote without staking. And that's kind of a resolution mechanism or the dispute resolution mechanism, I guess.

And then depending on the vote, it either gets approved or denied. And so I guess we paid our first claims of the BZX hack back in February, it was, which was interesting. BZX got hacked again recently. So. Is it sure? No, it wasn't. So, well, there was actually. two covers purchased two hours after the attack. So I'm not quite sure what was going on there, but there were no covers that were out live before then. So I'm pretty sure we would have paid a claim as a result of that event, but there was no one with any cover. So there's no objectivity to insurance claims, right? There's no way to automate this in the payouts into a smart contract because when like for example if nexus mutual was around when the tao hack happened right we call

it the tao hack but it was more of a tao exploit and even even more objectively from the perspective of like a robot the tao hacker was really just using the Dow code as written right like he didn't change the code he didn't there wasn't a bug because that doesn't that doesn't happen in ethereum technically right like there aren't bugs. There are just, there's just code, and then there's people using the code. And so,

and so there's always going to be some sort of human subjectivity component to Nexus Mutual. And so how do you guys go around, how do you guys deal with the issue of, you know, technically there's nothing that's actually like an exploit or nothing that's actually a bug? And so how do you determine what should be paid out and what shouldn't be? Yeah. So I guess the first point here is if you,

if you could code, had codify a way of doing it, then you could ignore the, you could get rid of the bug in the first place. From a theoretical point, that's a fantastic point. So basically you can't do that really. The way we've done it is we've got essentially old school terms and conditions document. It's basically two pages long. It tells you what should be paid out and what shouldn't be paid out and people make a subjective interpretation of what that means. And it all comes down to what was the intention behind the code.

Like, you know, clearly, clearly the Tao, the people who go to the Dow did not intend for it to be able to be trained. Clearly, the people would go to Zedex didn't intend it to be able to be exploited the way it was. So, you know, those types of things, right? And so, you know, there's definitely human subjectivity in there. But I think that's, I think that's what people expect. And, you know, that's, I think we're going to be in a much better, but I believe we're going to be in a much better position with that type of stuff available. The one of the benefits that we've got here is that if we want to put out a new product,

we can just write a new set of terms and conditions in a document and essentially socially coordinate around those and offer cover on anything, whether that's something in Ethereum, whether that's something on a different blockchain, whether that's something in non-crypto-related. It doesn't really matter. We can use these same mechanisms that apply them to any risk. Well, I think we want to talk about some non-crypto, blockchain stuff later. But one question I had. So what about an options-based approach? So you mentioned the Open Protocol. They have O tokens, and they're able to provide some level of insurance through

basically people betting on options. That doesn't seem to require as much governance. Is that a more scalable approach or are there tradeoffs with that to you? Yeah, no, that's a fantastic approach. I love it. The thing that it does really well is works for tokenized networks. When you can like swap one token for another, for example, or you got this token that's supposed to be worth, one US dollar, and you can swap it for another token, etc. And so, you know, there's potentially ways to do that with Nexus as well that we're looking at. The one thing you can't do with that is if you can't tokenize it,

then you can't cover it in using that option-based approach. Another advantage of Nexus, of course, is because it's crypto-native, it's composable with all of these other money protocols. So we use that idea of dye, and you can literally have dye and wrap that inside of some kind of a Nexus protected token and have an insured die, almost like an FDIC type of die inside of your wallet. And it could be just as fungible as before. You could pay your bills with it, whatever. So that's something that's super cool. Can you talk about how Nexus's relationship with some of these other early DFI protocols and the money Lego aspect?

Maybe talk about YFI. So Wiifi, they've got this Y Insurance. Dot finance thing. What is that all about? Is that backed? Is that powered by Nexus? And how does it work? Yeah, it's basically white-labeled Nexus.

That's pretty much the one-line description. of it right now. I'm sure Rondre has different plans to do different things with it. So he just put a user interface on top of Nexus basically and integrated it into the rest of the wire and flow, I guess. Yeah, exactly. But I mean, it's a bit more complicated than that. It actually turns our cover into an NFT and allows it to be traded outside the Nexus platform. Which is got a protocol synch thesis metaphor in there somewhere. Yeah, definitely. Okay, so what does that I mean, turning it into an NFT. So our listeners know what NFTs are.

These are non-fungible tokens. So this would be essentially like a, you know, a claim document for some certain amount. What's the advantage of turning insurance into an NFT? Essentially, you can make it tradable, I guess. That's kind of one of the big advantages. But you can also, like, potentially split an NFT into lots of little bits and pieces. Like you create a token, which represents fractions of the NFT. And then you can like really do some tricky stuff with that on like stream cover and do some fancy stuff.

So that's that's kind of a really cool advantage that isn't done now, but it could quite easily be done in the future. And so those are the types of things that composability on Ethereum is just amazing. We're only doing the stuff we can kind of think right now about or it's a bit easy to comprehend, but there's going to be so much stuff that we haven't even thought of yet. So Nexus as an NFT, that would be like you could create an NFT for a $500 policy on compound or something. Yeah. Yeah. Yeah.

So it basically. Yeah. So three things. You know, the time of the how long it's for, like so it covers for a month. It's for this amount. It's on this protocol. Those kind of the three elements. And then you could then what you can do is like, so I'm going to buy a million on compound for a year.

And then I'm going to turn that into a million. compound dye and wrap it with C die. And so now I have a million C and then NXM die, whatever you want to call it, which is natively covered compound dye that earns interest. That's crazy. Like there could be entire apps and entire business is built around just taking the Nexus mutual primitive

and creating NFTs out of it and then selling that in some way, wrapping that in some way. What about another one? So recently I think this week, safe came out. So this is kind of like insurance mining. And there's a safe token. Can you tell us what that is? I haven't kept fully up to speed, but got a lot of questions about that. Yeah, I'm not absolutely fully up to speed on it, but I'll give you my best shot. So basically this takes the Wi-Fi stuff that Andre's built, the NFT, and you can stake that NFT to earn. So, so basically,

safe governance token. And I'm not quite sure exactly where the project is headed, was headed, all the rest of it, I'm not sure, but the whole point was to kind of like bootstrap a new governance token, so you can earn that. So it was basically just using Nexus effectively in the back end via Wi-Fi. And so we just had a massive boon in cover purchases as a result of this. So basically people were buying covers so that they could farm safe. token, not really knowing exactly what SafeToken was going to do in the future.

But, you know, that's what people are doing these days. So that's kind of roughly what it is. And obviously there was some stuff happened earlier today that haven't quite gone on top of, but that may not last for that much longer. The crazy thing about all of this is no one needs to ask your permission in order to build these things. Like, Safe Team didn't need to ask your permission in order to come up with this NFT nexus market. Neither did Andre and Wiron, right? They could just build it on top of these provatives.

Yeah, exactly. That's one of the amazing things, yeah. So right now, Nexus's core product is ensuring smart contracts because that's what Defi needs, right? That's what we need, especially right now, especially with yield farming and definitely into the future in order to be legitimate. But like, as Nexus grows and grows and grows, I would imagine its product offering can also expand.

And so is there a future world where I can purchase cover on my dog, my house, like my computer. Like, is something like this possible? How about some health care in the US? It'd be nice. You'd have to fix that? Yeah, yeah.

Health insurance? Yes, with some caveats, obviously, but that's not like what we've brought it, and we've built it to be able to do. I mean, our vision is kind of like a decentralized version of Lloyd's of London. Basically, come to the mutual with any type of risk. And if people want to back it, great, we'll offer some cover. There you go.

And so that's definitely the idea. We'll stay within crypto for a while yet to get some scale. But in terms of stuff outside crypto, it's probably more likely to be things where there's a reliable data source to assess claims. So health insurance is probably the last thing we're going to do because putting public personal information available for people to assess claims should there be an event is probably not the best thing to do. But we can do things like earthquake cover or hurricanes or stuff like that where there are kind of objective, reliable data sources to assess claims on a remote basis to start with. And then you can start developing the networks and distribution channels and stuff where you have like localized claims assessment teams and those types of things because they should be able to earn income from providing that work on the system. So that's definitely where we're headed. It's a long journey.

but we do have quite a bigger vision outside of crypto for this stuff. So if in theory that I, if I could convince the chain link oracles to somehow make an oracle about the health status of my dog, you could insure it with Nexus. Well, I mean, in theory, we could ensure it anyway. And like if you're a claims assessor, you could actually hook up your own assessment up to a chain link oracle. That's up to you. You could do that.

But I think what we need to do is. is make sure that there is a reliable way of assessing claims. And yeah, yeah, if that's bi-chain link, great. David, you seem super concerned about your dog. Is he doing okay? She's doing good plan, yeah. Oh, great. All right. I got worried for a minute.

So with the future world of, you know, ensuring real world items, real world phenomenon, there's also the relevant issue of like the nation state and KYC, right? And Nexus actually currently has KYC built into it in specific arenas, like not just purchasing cover for, you know, the typical contract like MakerDAO, but for more specific niche use cases. And that's just a function of an artifact of how you guys bootstrapped the protocol. How are your guys' plans to remove KYC and also to kind of remove dependence on a core key actors and become, become deeper in the protocol. thesis. Yeah, yeah, that's it's definitely on the on the on the plans and in the plans. So we do actually have to have K. Y.C to purchase cover as well. Any member of the mutual has to be K.Y.C.

Um, right now. Um, so the, um, I guess the key here is that we have a legal entity in this thing. So we're kind of like a hybrid, um, DFI protocol, but we have a legal wrapper. That gives us some benefits that you can't actually get within DFI. Like, have limited liability on a per member basis, which is not something to just throw away lightly, but there are obviously trade-ups with all of this stuff. So, yeah, so I think the key is decentralise on a gradual basis. My goal here is, like, remove the centralized aspects of the protocol, get them fully unchained, and then the rest of it. And then we have the option, as a membership group, to shed the legal entity if they were.

And once you've done that, then you can remove the KYC. So that's definitely an option. I think it's up to the members to decide at that point. But that's definitely the path we're working towards. And is there a timeline on that? Is that a small obstacle or a big obstacle? I think, look, it's probably going to take us over a year, maybe two. We'll see how we go.

The key here is that there are a few kind of more challenging incentive mechanisms to make sure we get right and we want to iterate on them. And you don't necessarily want to harden them into a protocol too early when you're not quite sure if they've worked. So that's kind of the approach we're taking, making sure we iterate, get things right. And then once we're happy with it, we'll end up with a hardened protocol that we can step away from. Love it.

Fantastic. So in terms of other developments and other part things on the roadmap, like what are the next steps? Like what are you working on today? and then once that's done, what are you working on tomorrow? Yeah, so it's been a bit reactionary recently, given the defy-stuff is just going crazy. So I guess one of the things we're working on

is shield mining concept where basically different projects can provide bonus rewards to nexus stakers that stake on their projects protocol to kind of bootstrap early cover for new protocols. So that's an interesting one that'll be coming out soon. Then we're going to be looking at things like enhancing the core features of the protocol, things like offering partial claims, also like potentially tokenized cover and things like that. Then I also mentioned the investment earnings one before, but that's going to be a key larger one on the roadmap as well.

So there are quite a few things. The priorities and stuff that does move around a bit with everything moving so fast. But we've got a lot of interesting stuff coming out. looking to integrate with more people and stuff as well is going to be key to our success. So if you had to make a guess and say it's two years from now or five years from now and Nexus Mutual didn't work. It blew up for some reason. If you could guess why that would happen, what would you guess? Yes, good question. I guess the I mean there's always a potential for a bugging ourselves.

That's kind of one thing. I think it probably would be the incentive mechanisms on the staking side of things if we can't get those right. I think they're pretty good now but they definitely need to be looked at again and we are looking at them right now. And so I think we need some more iteration there

if we have to make sure that those staking mechanics work because that's kind of like key to the whole thing. If you can't bootstrap cover and use stuff, then, you know, that doesn't quite work very well. So, and you have to be, have an engaged staking community that, um, that's really involved in this stuff. So, um, those are probably the, that's probably the one, one key thing or, but, you know, there's always a potential for us to get hacked as well, I guess.

Hugh, we started this whole conversation with the question is DFI safe yet? What's it going to take for DFI to be safe for my parents, for institutional investors, for mainstream? Yeah, it's a good question. I mean, I think you're going to have to have several protocols, key core ones that have stood the test of time for a while, and that they become reliable. You're going to have to have, unfortunately,

you're probably going to have some sort of insurance or the safety net of some description around these things to protect individuals. You know, you don't want, you know, moms and dads or whatever, putting in a chunk of their life savings and then they're just blowing up, right? It's a bit okay. It's more okay when people are just gambling under their own and they know what's going on. But I think we need to have those safety nets in place.

Insurance is probably one, but I'm sure there are other things that probably need to be involved as well. One of the conversations about the difficulty of spinning up, ETH, too, is that no one kind of wants to be the first through the door with when they deposit their ether into the deposit contract to get it over on ETH2 because it's a one way it's a one way bridge right and if it doesn't work it's not coming back is has nexus talked about ensuring the east two deposit contract um we can out of the box actually um on that one um so yeah that's definitely an option we can also cover the stakeholders um so for example if you use you delegate your ETH to a validator because it's one way.

You're actually taking on credit risk of the validator. So because, you know, if they stop validating for whatever reason, they can't run their infrastructure, then all of a sudden your ETH gets eaten up by penalties. And so, you know, there's definitely kind of coverable risk there that we can look at. Hugh, this has been exceptional. Thank you so much for spending time with the bankless nation today. I've got one concluding question. So Vance Spencer from Framework a few episodes ago made the bullish bold prediction that we would see

500 billion, billion with a B locked in defy this cycle. If we get to, let's cut that. Let's say we're not as bullish as Vance. Let's cut it to, I know David is. but, you know, I do this for the sake of others who haven't listened to all the bankless episodes and aren't as bullish as us, David. So let's say we hit $100 billion. What percentage of that is insured and what percentage of that is covered in Nexus?

Yeah, a good question. I'm covering about 2% now or something. So I hope we can get up to something like 10. It ends up being a pretty big number if you multiply both those growth rates to together. But, you know, that's, that's, that's, that's what the opportunity is right now. It's a pretty big exponentially growing market. And so, you know, hopefully we can be there to support it, and protect people as we do grow. All right. So. No pressure here. Yeah. So, but if total lock value is 500 billion, then we're talking 10, 10 billion in Nexus cover then. That would be

exceptional. And hopefully we can get that number higher so that defy can remain safe. Hugh, thanks so much for spending the time with us. You know what? I'm really glad that you continued building through the bear market, my friend. I'm glad he didn't quit because if you did, we wouldn't have had this conversation, but we also wouldn't have had this entire D5 primitive. So we appreciate it. This is all about the builders.

That's what the series has been about. Thank you. Cool. Thank you, both. Awesome. Bankless Nation, a few action items for you today. The first is this. You've got to read Hughes canonical bankless article where he talks about.

where he talked about the risk of lending to a smart contract. We'll include that in the show notes. Just get your head wrapped around the main risks when you're doing something in DFI. And once you do that, also read about how to protect against hacks with Nexus. We'll include that in the show notes as well. May make you interested in some smart contract cover for what you're doing in DFI. Finally, David, how are we doing on reviews, man? I think we're 150, maybe more.

What do listeners need to do? We're pretty happy about it. The bankless nation is strong, and we want it to become stronger. And the way that we do that is that we get the bankless podcast to the top of the iTunes charts. We are already in the top 100 in the finance and investing category on iTunes podcast, which is just fantastic. And as this bull market continues, we want to just pump those numbers up.

Our goal is to get into the top 10 of the investing and finance podcast charts. And the way that you can help us do that is by going to wherever you listen to podcasts and giving us those five-star reviews so that we can move up the ranks. There are some forgotten ICO podcasts that had a bunch of views during 2017. And for some reason, they're still sticky. And so I definitely think that the Bankless Nation deserves to be ahead of those. another fantastic resource that I highly recommend people who are looking to gain a further more intimate understanding of how Nexus works. Defi Dad made a fantastic video of how to buy insurance cover

with Nexus. That is one of the videos that I watched in order to prepare for this podcast. And so that issue, if you are looking to learn more about Nexus, I highly recommend that video. We will include that in the show notes as well. All right, guys, risks and disclaimers. ETH is risky. That's why we have insurance. Crypto is risky. Defy is risky. You could lose what you put in, but hopefully lefts if you insure it. We are headed west. This is the frontier. It's not for everyone, but we are glad you're with us on the bankless journey. Thanks a lot.