Epicenter - Learn about Crypto, Blockchain, Ethereum, Bitcoin and Distributed Technologies - Hugh Karp: Nexus Mutual – The Decentralized Insurance for Ethereum

Episode Date: June 23, 2020

Nexus Mutual provides an alternative decentralized insurance solution for Ethereum. The protocol is built on the public chain and operates under a discretionary mutual structure meaning it is owned wholly by its members. It allows anyone to become a member and buy cover, and the model encourages engagement as members receive incentives for participating in Risk Assessment, Claims Assessment and Governance. At present the product offered is cover to protect against hacks in smart contract code. When Nexus Mutual is alerted to a claim, members will also be asked to vote on whether to pay out on that claim or not. Hugh Karp, the CEO and Founder of Nexus Mutual, has combined his insurance industry knowledge with his passion for decentralized technology to build this platform which is replacing the traditional insurance setup. They are currently looking into expanding to offer more insurance products and we are excited to see where they go next.Topics covered in this episode:Hugh’s background in insurance and how he moved into the blockchain spaceWhat drove Hugh to build this decentralized platformMutual insurance and the regulations involvedThe scaling problem in mutual companiesThe benefits this type of insurance can bring to the DeFi worldThe claim assessment processThe native token, NXMHow Nexus tackle price discoveryHow does Nexus manage correlation risksHow much has been contributed to the pool so farMutual vs other models of insurance on the DeFi spaceThe legalities behind NexusWhere they are looking to expand and what the next 12 months look likeEpisode links: Nexus Mutual WebsiteThe White PaperNexus Mutual Use CasesNexus Mutual DiscordNexus Mutual TwitterHugh Karp TwitterThis episode is hosted by Brian Fabian Crain & Sunny Aggarwal. Show notes and listening options: epicenter.tv/345

This is episode or episode 345 of guest Hugh Carp from Nexus Mutual. This is Brian Crane. And this is Sanyagher-R-Wall. And today we're talking with Hugh Carp of Nexus Mutual. I guess you could say we have a little bit of a insurance theme going on right now because last week we just did an episode with Open. And today with Nexus Mutual, we explore sort of a different form of how to do insurance, maybe a model that's more familiar to most people in what they think of insurance,

which is this mutual concept where people sort of buy in and pay premiums, and then they can make claims. And unlike Open, it's much more sort of linked to the real world. They have a more complex Dow structure where it's connected to a real world company. And so, you know, it seems like a little bit more of a bringing the existing system, but recreating it into a decentralized manner. Yeah. So this was great fun.

I mean, I remember speaking with you, and I mentioned the start of the episode, around four years ago, I think when he was just starting to work on Nexus Mutual, and I thought, you know, this was interesting.

And it's amazing to see how far they've come. And, yeah, I thought this was really cool, especially the idea that, you know, we're going to speak about this example as well. as well, right, that you can go and compound and you can lend out, let's say, some, you know, fiat stable coin, and then you can buy insurance for it on Nexus Mutual, you know,

for the case that there's some bug and the contract loses its value. So this is really cool use case and, yeah, I'm impressed. I think this is like one of the coolest daps that I've covered in an episode. Cool. So yeah, hope you guys enjoy the episode. We're here today with Hugh Karp. He is the founder of Nexus Mutual and also a board member of it. So we're going to speak a bit about kind of the structure of Nexus Mutual. I'm really excited about this. I remember vaguely, you know, having spoken with you, I think around four years ago about Nexus Mutual. And it was like at the very, very beginning. It was really exciting today to catch up on all the amazing progress that has.

app and then just also kudos. The website and the documentation are just really well written and very, very clear. So well done. Thank you. We've been at it for a while, but yeah, it's great to be out there and actually providing news to people in the DFI space, especially right now. So yeah, really great to be here. So you have a long background in insurance. Tell us a bit about, like, what was your insurance work like and how did your interest in blockchain come about? I'm an actuary by training and I studied actual science at a university in in Australia and yeah I worked for qualified as an actuary and then went for 10 years in life companies in Australia doing various roles pricing and reserving and product development and a bunch of

different things and get more and more into the marketing side a bit later on when I was there including them and then switching to doing M&A deals and a bunch of different stuff 2012 I moved to London and joined Munich Re, which is, I guess, one of the largest re-insurance companies in the world, and ended up working in their life division in the UK and did a few different roles, but ended up being the CFO for their life operation. So kind of ran a team of about 30 people, actuaries, accountants, analysts and stuff like that, and did all manner of things, capital arbitrage, shifting money around balance sheets and doing all that stuff kind of really at the back end of the insurance value chain. So that was kind of really

interesting for a while. But I did get a little jaded at the end because it was kind of, it was a bit far away from like the real impact on people. And like actually it felt a bit too abstract to me sometimes. I guess that's kind of the insurancey stuff, a quick whiz through on that. But on the kind of blockchain piece, I, you know, stumbled across Bitcoin about 2010, I think. And, you know, just kind of went down the rabbit hole, started playing around. I do remember I had absolutely no idea what I was doing and, you know, it was kind of mining on a web-based miner. I'm doing some really, really basic stuff.

Storing private keys on public internet websites and stuff. It was just, I remember doing like all the things you shouldn't be doing. Played around with it for a while. I found it really fascinating that especially you could send money from one person to another without anyone else in the middle. That's just kind of really blew my mind a bit. And then I guess I didn't really know what to do with it because I guess payment wasn't really my thing.

I found the tech fascinating, but I didn't, yeah, didn't really know what I could personally do with it. So I put it down, and honestly, I didn't really come back to it. And for quite a while, I think it was kind of late 2015 or early 2016

that I kind of heard about Ethereum and kind of started getting back into things and investigating and stuff. And I think that's kind of when it really kind of clicked for me because, you know, if you can write an if-then statement, then you can write an insurance contract. I kind of, like really kind of started doing research.

and stuff then and that were kind of the early stages of, I guess, nexus and the idea formation and stuff. So, yeah, that's kind of the brief history. So back when you were at some of the, you know, legacy insurance companies, were they at all, like, interested in blockchain stuff or even if the company itself wasn't, were there like murmurings amongst individuals, were other people really interested in this or not really? I think it was, I mainly only talked about it when I was at Munich, Korea. So I can only really comment from that point of view. But it was definitely a topic of conversation.

You know, it's new tech. It's on the, you know, on the kind of roadmap of things to look into. And they always got their, you know, scanning stuff on the horizon and things so that they look into it. I guess blockchain was kind of always lower down the priority list than other things that were, that are more kind of specific insurance stuff. So like IOT or AI or machine learning type stuff is kind of always a bit higher up the list in terms of priorities. I think blockchain got put in the bucket of this is a potentially, useful tech, especially in the insurance world where things are very interconnected, but it was more in the bucket of this could save operational expenses. And there are a lot of potential technology

solutions that can do that. So it would be competing against a whole bunch of different things. So it never kind of really got the high level focus. There were a couple of us that were always talking about it because we were kind of deep in the rabbit hole, maybe a bit more on the crypto side. But it didn't tend to really get much traction within the in the companies. At the time, I was working with company Monax, which started doing kind of enterprise Ethereum. They started in 2014, but I was there like 15 and 16. And that was, you know, significant part of the interest was firm insurance company.

And, you know, there was like pilots and lots of conversations from insurance company, including Munich Re. There was a Marcus there who was later, there was also this insurance consortium spun up. We spent quite a lot of time back then, and there seemed to be many also doing various pilots and projects. Maybe from the outside, it looked like they were quite interested, maybe even more so than banks from our vantage point, but maybe from the inside it looked different. But I'm curious, how has this all progressed? Like, what has come of these things? Are any things here going, like live in production being used today, or has this kind of died off?

There are a few that are live today and working. I think it's fair to say that everyone was very interesting because it's a new tech and it can do something fundamentally new. So they all wanted to get in and make sure they could understand. And perhaps cynically it's so they can answer to their bosses when the question comes. And they'll want to run a pilot to really kind of get into the details. But I think then the step of taking it from the pilot to the next stage of actual implementation in a real case. There's a massive drop off there. I think there's a few that are actually live.

So B3I are doing a little live product now where they're essentially running this consortium amongst the different reinsurers and insurers where you place like excess of loss catastrophe insurance on chain. And I mean, it actually works quite well because you can coordinate the placement. There's like, you know, if you want to take a huge risk, you kind of slice it and dice it between different entities in the insurance world and coordinating all the paperwork and who's on for what risk is actually a large part of the problem. And so blockchain is quite good at kind of notarizing that stuff and making sure that the sign-offs are all done.

And, you know, you're not shipping paper around and all the time. So that's working quite well. I think there's also a MERSC one, which is kind of shipping supply chain type stuff, which is an interesting problem because when the ship moves into different waters and different jurisdictions, different people are on risk. And so you have to kind of know exactly where the ship is and like, you know, tags and stuff like that. So it's basically about data integrity in those types of things, which, amongst multiple parties. So, you know, blockchain works in that context. A lot of like what B3I and stuff is doing is sort of helping coordinate these like existing insurance companies and, you know, like you said, making their operational cost

lower. But then you took a sort of very different route where, you know, you went a very crypto-native, crypto-first, like rebuilding insurance from scratch. Maybe all of your colleagues who were also interested in crypto went down this very more private blockchains approach. What drove you to building like public decentralized on Ethereum? To me, it was always a very natural fit, I guess. Like, basically insurance is a coordination problem. And it's an intangible good.

It's like you can actually have it running on a blockchain very natively. And it works really well because essentially blockchains are good at coordinating people and especially incentive mechanisms. And because there's no physical, necessarily physical good, it's really kind of fits natively like a currency in some ways. So there was always this very natural fit. And I also saw that there was like massive inefficiencies in the current system about moving capital around and also just paper administration and stuff. And so I saw that there was a big opportunity there. And I guess the other thing was I also noticed that all insurance companies really do

custody money on half of people. So essentially you pay your premium and the insurance companies look after it and hand it back as claims. And at some point, and as long as they do that appropriately, then everything's okay. And so you've kind of got all of these rules of like regulation and capital standards and all this stuff to make sure that they've got enough money and they do the right things. I thought that that could be done in a programmatic fashion

using smart contracts. And then all of a sudden you don't need all of this surrounding stuff. Do the insurance companies not also do like sort of the risk analysis and all that stuff or is that sort of outsource to other entities? It's a combination. But yeah, they do do that risk analysis. and stuff as well. But I guess what I was saying is that you need certain inputs like that and you'll need them

in any way, shape, or form. But I just saw that there was massive inefficiencies and the kind of agency risk. I mean, that's the whole reason actually the regulations exist is so that you make sure the insurance company does the right thing with the money and it's got enough to pay claims when they come. That's basically where we're thinking that this could be a whole lot more efficient. And also, insurance is kind of historically has always kind of come from mutuals, like, which are kind of community or people owned insurance companies rather than necessarily

shareholder owned insurance companies. And so they kind of work for the, and it's a very natural fit. Like you've got a community that shares risk together. If things go well, that they should all kind of benefit and they step in when times are bad. And so it's a very community native solution. And so that's kind of one of the reasons we wanted to do it was to kind of make a scalable mutual that everyone could join and scale the capital up, which is kind of one of the problems that mutuals have.

But anyway, so it's kind of a. It's a very native blockchain use case, in my opinion. It's always been talked about, and it's hard to do. And I guess you wanted to give it a crack, given that we've got the expertise. You mentioned the mutual now some understanding is that there's different models of insurance and this mutual or mutual insurance is one of them. Can you explain what mutual insurance is and how it differs from maybe the more standard insurance model? Yeah, I mean, there's kind of two.

general models. One's the mutual and one's the shareholder owned. Essentially, it just depends who owns the profits that come out of it, really. So a mutual basically, if it makes a surplus or profit makes a surplus at the end of the period, end of the year, then it essentially gives the money back to the members in some ways they perform, whether that's through discounted premiums for next year or cash rebate or something like that. That's how they work. And so there's always this view that we're working for the members. And then obviously, shareholder companies, it goes to pay the shareholders dividends, etc. Which is more common in the real world today?

The shareholder companies largely dominate. There are a few big mutuals, but they tend to, mostly what happens is the mutuals tend to get swallowed up by the shareholder companies. And that's primarily because of capital efficiency. So mutuals can actually only raise money from their members. And if they're members of the community, then they're not actually, no, massively deep-pocketed capital markets. Like, that's kind of the reason you would shift to a shareholder-based company that you can access more flexible capital, essentially. That has meant that a lot of the mutuals kind of demutualized.

So what they do is they turn into a shareholder company and give the current members shares in the new shareholder company as kind of a proxy for their ownership. And that's kind of how it works. So mutuals always have this structure or problem scaling up to big sizes. And that's kind of one of their reasons. that design nexus the way we have trying to use token economics to assist in that scaling problem. And our theory and our goal is to kind of break that scaling issue that mutuals have and be able to get big.

I didn't totally understand why the scaling problem exists for a mutual company. Can you explain that a little bit more? Simple example. If you've got 10 people in a mutual and they each put $1,000 in, then you've got $10,000. dollars. And so the most cover that you can provide is really like up to about 10,000 or, you know, because you have to have enough money to pay claims. If you get 100 people all doing the same thing, that's fine. But to grow fast, you need to grow the actual, you need some money as capital to actually cover bigger and bigger policies to start with. And so one of the problems

that mutuals have is because they, their members are usually just regular people. They don't, they don't like have a hundred million sitting in the bank, then they have to essentially put limits and they can't grow as fast. So shareholder-based companies essentially what they do is they just sell equity and just get a massive capital injection to kind of kickstart the process. And then they can sell really large policies and ramp up quite quickly. And insurance is really a scale game. It's all about capital efficiency.

Usually it's all about it. It's a huge leverage play. So for example, you know, like banks are kind of leveraged insurance. companies are even more leveraged. So they sell like many, many, many, many more times cover than they actually have capital to pay. So like basically if everyone claimed it once, they would never have enough money. But the whole idea is that the likelihood of everyone claiming it once is so, so low that it's okay. For example, like AIG covers about 60 times more amount of risk than it does actually have capital on its books to pay. And so that's kind of a whole idea. And that ratio, that number becomes bigger and bigger,

the more diverse and bigger you are. And it's a big. scale game. And so what happens is the mutuals grow, they have a good community product and service and all the rest of it and they grow to a certain point and they need some extra money to grow bigger. And usually the easiest way of accessing that is get bought out by a shareholder owned insurance company or convert to a shareholder one themselves. It's kind of like the back end of the insurance capital markets really that's kind of driving this stuff. So given all of that, why is it Nexus mutual then if we recently? seem to see that mutuals have these sort of scaling problems. Why did you sort of design it in as a

mutual model? The whole idea is that mutuals have this scaling problem because they can't get in, like they don't have any equity to sell. So they can't get in equity. But what you can do is actually you can tokenize the rights of the mutual. And while that's not actually getting in equity, it's actually getting in a more flexible capital structure. So you can have access to the same flexibility of the capital. But, without going outside the constraints of what a mutual is. A mutual can only raise money from the members, but you can still have a member that provides funds to the mutual

and get tokens in return, but they're still kind of a member. And so you're kind of accessing the same type of capital or similar type of capital, but in a different way in a blockchain native solution can actually make that happen really easily. And so essentially we can use tokens to give us capital flexibility where mutuals don't have it right now. Are there like some sort of regulatory benefits to being a,

mutual and is that why like you kind of structured as a mutual with like elements of shareholder based? This kind of goes into the question as we do you run a fully decentralized defy protocol versus what we're doing, which is kind of is hybrid, which is effectively a Dow, but it's linked to a legal entity in the UK. The primary reason we did that was because it gave us regulatory clarity because insurance is like one of the most heavily regulated industries in the world. And so we wanted to be able to get some clarity on that side of things. And there's what's called a discretionary mutual structure in the UK. And that's specifically not regulated as insurance business.

And so people use this today to sell mutuals. They've got like regular mutuals that, you know, ex-servicemen's mutuals, retail shop owners mutuals. Like there's like, you know, real stuff. And so we're basically just using that structure and automating it, fire smart contract. That gives us regulatory clarity. I guess the other element is that we knew we couldn't build this in an absolutely fully decentralized way from day one. And so we couldn't like go the kind of full decentralized route. No regulatory, don't care about the regulations at all from day one.

So we decided to go with this hybrid model, which gave us the clarity. Let's talk a little bit about what's a big vision for Nexus Mutual? Where do you want to see this project a decade from now. And when you think of the benefits that you think Nexus Mutual or maybe insurance solutions based on blockchain can bring in general, what are the most, the biggest pros? I mean, what we're aiming for is guess a decentralized version of loads of London. Anyone should be able to bring any risk they want covered, all that quirky stuff from any region in the world, kind of in their permission on spaces, and they bring it to the Mutual. And if the Mutual wants to cover it, they can.

and then the person can buy cover. A kind of route to that is more kind of stay within crypto because it kind of fits with the niche. Like our early users are going to be, we need, we're providing products for early users, essentially early adopters, and then move outside that as we grow and scale. That'll be a longish journey, but that's the kind of goal.

Scale into a whole bunch of different things. And there are a whole bunch of underserved markets out there. Mutuals work really well where you've got, we're not going to work like with auto cover in the US. That's like a heavily saturated market, competitive and stuff like that. Mutuals work well where you've got an underserved market with a specific need that's either niche or they can't get access for some other reason. The price are too high or whatever it is. And so mutuals work really well in that situation and we think we can

access those types of benefits, give access to those types of communities really quite easily and efficiently. Talk about why is insurance so important, like especially in the defy world. I was starting with a friend once and he gave this like really great explanation to me about how insurance is trustlessness where like you could go to traditional company and say their systems are 99.9.9% secure. And we go pitch like blockchain to them and we're like, no, no, look, using our stuff, you're 99.999% secure. But they're like, well, in the centralized system, that 0.1% of the time we're insured. So for us, that's trust. unless your system is not. Do you think that's actually a fair representation of it? When it comes down to it, like every industry in the world has insurance for basically the reason that, well, there's two real reasons. One, you don't necessarily have the capital yourself if something goes wrong. So you could self-insure, right? So if something goes wrong and you've got the money sit in the bank, then to kind of get back to where you were, then you can decide to do that. That's fun.

But obviously, that doesn't work for the vast majority of people. Like, you can't just rebuild the house if they have a fire or whatever. So that's kind of a long. one reason. The other reason is like the marginal cost of getting from being 99% secure to 100% secure is really, really high. And so you're better offloading that risk to a insurance company. I guess like natively like the same conceptual thing applies in defy where everyone's really doing some really solid work on like smart contract security as an example. And you know, different teams can afford different audits and verification and all that top of stuff. But you're never going to be able to get to 100% because the marginal cost of going

from, I'm really confident this doesn't have bug to. I'm absolutely sure that it doesn't is like just so astronomically high. And so it's much cheaper to actually get essentially an insurance product for that. It's been really interesting to like understand a bit how important insurance has been historically. Like the same friend who was actually explaining to me how like a lot of maritime law was actually sort of devised by Lloyd to London. as a way of setting the rules to like protect its own you know anyone who wants to get insurance

from lloyds has to like abide by this the laws that it sets for the sea and eventually those got canonized as like the maritime law ships is a good example right like a lot of those ships like the merchants wouldn't put their goods on the ships unless it was insured and the people who are insuring it effectively said you have to meet these standards otherwise i'm not insuring it and so it's kind of this standards type thing and then once that happens though it actually just spurs massive economic activity because everyone's confident in things and they're protected with the downside. So, you know, you're much more willing to take risk if you know that the downside's protected. You know, like shooting a rocket into space. Like, that doesn't

happen without insurance. Like, no one's going to give you permission to launch a rocket unless you have an insurance policy in place. So, you know, it just applies into kind of every single industry. And so I guess our thesis is like, you know, if DFI is building a, and Ethereum's building this parallel the financial ecosystem, then we need some insurance to kind of make it work. Could you walk us through a little bit now about how does it work? Like what would be the process? Let's say I'm a user of a protocol, let's say MakerDAO, right? I have some CDPs and I want to insure against smart contract based on MakerDAO.

Can you walk us through what the user process would be? I mean, it's relatively simple. Basically, you go to our app and select MakerDAO. So select what you want cover against where it. maker a compound or uniswap or whatever and then you choose how much cover you want so for example if you've locked up 100 eighth in your cdp then you maybe want 100th worth of cover as something goes wrong and then you choose the time period so you want cover for three months or a year and then you get a quote it comes back if you're happy with it then you purchase it pay the premium you also have to sign up as a member

of the mutual which does involve a k yc process on our side because you join the legal company in the UK, but that's basically it. And then say an event happens, you know, there's a hack or whatever, then to submit a claim, you basically just submit the claim, one transaction. And then that triggers an item, essentially a workflow item for our claims assessors to vote against. So there's a, we specifically have a voting process here rather than a programmatic outcome. And the reason we kind of did that was it gives us heaps of flexibility in terms of what we can offer and what products we can offer. Essentially what that means is the claims assessor. In aggregate, they're the Oracle, they're bringing in the information. And they're making that assessment on average. And so assuming it

gets paid, then you automatically get paid your claim to your address. And that's kind of the complete user for it. So who's doing this voting? Is it just the members of the mutual? Members of the mutual. So any member of the mutual can decide if they want to optionally vote in the claims assessment. And to do that, they have to stake some of our native token to do that. that and that's kind of their voting weight. And it's also their potential. It's like a bond. So if they vote maliciously, they can lose some of their bond. That's kind of the general process of how it works. How does this native token work? Let's say I joined the mutual. Do I get sort of awarded a fixed amount? And is there a way to get more native token if you want to be a larger

mutual holder, larger members? It's basically we actually run a bonding curve. So we're actually one of the first live bonding curve projects out there, which is interesting. But the first step is you sign up as a member, pay a very small membership fee, and then you can decide to purchase NXM for Ether. So you put Ether into the mutual, and based on the bonding curve price at the time, then you get NXM. And you can always cash those NXM out for etho, if you wish. There's a few things you can do as kind of like an NXM holder, so you can vote in the claims assessment by staking the token against as your bond. And you can also get involved in

what we call risk assessment, which is like the pricing side of things. So you can, for example, stake on maker a compound. Basically, you can pick the protocols that you think are secure. And then you earn rewards when people buy cover and you can potentially get burned if there's a claim. So there's kind of a plus

and minus there. And you can also like voting governance actions as well. Those are kind of the three kind of expert level stuff that you can kind of come in. And so you can buy more tokens free through it as you wish. So one thing I found interesting here is that you have these actions. Like, you know, you mentioned the thing of like, okay, you can stake tokens on a particular

protocol to sell a smart contract to say like, oh, I think this is secure. And basically you're putting up some sort of collateral to back that. And you make money based on the amount of collateral. You know, but at the same time, right, you have like various investors. who are, you know, these VC funds who, like, they may be knowledgeable about, like, you know, crypto on a high level and stuff, but not about smart contract security. So, I mean, it seems like the natural thing here would be to have some sort of, you know, delegation function, right, where there are people who are like specialized on risk assessment,

others on some other function, others that have capital and there's some sort of, you know, basically deal between them similar to, you know, proof of stake. like validators and token holders. Is that something you're considering or does that make sense to you? No, I mean, it does make complete sense. And it is something we're considering. I think we're probably the first steps are going to be, we're actually releasing a new staking mechanism very soon. And the main aim of that is to make the process a bit simpler and also enhance the rewards for the staking. So kind of we're focused on that to start with. But then we're going to be looking at things like, like step one might be, you know, allowing you to easily follow someone else.

So just kind of copy someone else's staking process. But then also, you know, enhance the system so you can specifically delegate if you wish. So, yeah, I mean, that makes, it does make complete sense to do that. It's very easy to just like sort of copy what someone else is doing. Let's say I just see what, you know, you know, opens up and I just go ahead and just automatically copy whatever they do. do you think that it's like they might be getting sort of under rewarded for the amount of work that they're doing in the system like they're the ones sort of doing a lot of the action but i guess i'm i'm

putting a lot of capital risk but how do we make sure that they are sort of appropriately rewarded for the amount of contribution that they do yeah i mean you're always going to be able to follow someone else so like we can't actually prevent prevent that so i think the important point is is that especially like with people like open zeppelin and stuff like i mean if they want to get more involved they can earn more rewards you know they it's up to them to kind of decide how much money they want to put at risk if they're happy to happy to back themselves a lot um then they can get more but with the delegation maybe we can have like a you know a fee aspect to it as well that you know maybe the person who delegates keeps only 90% of the rewards and 10% go to the person they're delegating to

or something like that. So if you want to delegate to someone, they maybe have a fee on top or something. So there's definitely models around that that we can, that we're potentially looking at to make that process easier. So yeah, could you maybe talk a little bit about how does this whole price discovery part work? Because obviously this is one of the most complex things in any insurance system. And, you know, we had Open on last week.

And even for them, you know, how to do the initial price discovery is always one of the hardest parts. So we walked through a bit about how that works at Nexus Mutual. Yeah. So I guess another thing that's soon to be changing very soon. But essentially, if we boil it down, it's basically staking. So there's going to be a formula behind risk. And the more that's staked on that specific risk, the lower the price. So it's kind of like, conceptually it's like you're like, is you.

your prediction market, but it's a bit more structured. Incentially, you just kind of one measure and not very much stakes, obviously high price, and then it comes down in a bit of a curve. So the more and more stakes you get the lower the price with minimums and stuff. So what are stakers doing here?

They are staking on the security of particular contracts? Yep, that's correct. And so if, let's say, there is a bug in that contract, the stakers, they are, MXN gets sort of seized first before the claims are made out from the main pool. Is that sort of the main risk that the stakers are taking on? Yeah, basically.

So what happens is it's like, there's one capital pool where all of the funds live. Basically, anyone who wants to purchase Nixem for ether or anyone, whenever someone pays a cover amount and it goes into the common pool. And claims go out of that pool as well. And also investment earnings on the pool, just stay in the pool. kind of conceptually there's just one pool of funds and that's kind of how insurance entities like work they kind of aggregate the capital altogether so that's just kind of the first concept and then over the top of that is like the incentive layer which is the staking and the reward mechanisms and

so when a claim is paid the ether or die which you bought the cover in gets actually paid from the capital pool and concurrently the stakers would get burned up to the claim amount if there's enough stake. Sometimes there may not be enough stake, so it may not kind of be fully covered by stake, but the kind of mutual would be taking the risk by itself then. But essentially, if there is staking it, it gets paid fast. When you say burned,

I mean, you have this capital pool where the things kind of accumulate, and then, you know, out of this, let's say MXN is paid to cover a claim. So when you say, oh, the stakers now get burned, basically means there's not like literally tokens being burned, but that there is some part of the capital pool that was allocated to those stakers before and now it basically gets kind of appropriated.

So I think the whole idea is that you've got like one one token, a whole bunch of tokens sitting over the top of the capital pool and they kind of have shared ownership of the capital pool because they're like the members, they're membership rights, right? And so whenever someone puts money into the mutual, they get more membership rights. So it's gone on the bonding curve. So that's kind of step one.

And then what you can do after that is kind of the staking. So perhaps conceptually it's easier to kind of just stop there for the moment. And if you're just holding an example, for example, then you're a member of the mutual and to the extent that the mutual makes a surplus, like so essentially the cover prices exceed the claim payments and the investment earnings of the capital pool, then you get, you get your kind of part of that. So you get to kind of, I guess, share in that side of things. Then as an additional optional step, you can increase your risk reward position if you'd like to by staking. And if you stake, then when someone else purchases cover, you earn additional NXM tokens.

And if there's a potential claim, if there's a claim, then you can potentially get burned. I guess you can take different risk raw positions depending on what your appetite is and what type of member you'd like to be. Okay, that makes sense. I mean, one of the things when I was reading through your, you know, explanations on the website that stood out to me and I found a little bit strange, maybe you can explain it. So if I'm buying, I'm buying some insurance coverage, right? And let's say I'm paying 100 MXN for this insurance coverage. then the way it's said in the documentation is that 90 mxn of those get burned and 10 get kind of allocated for a future you know if I want to make a claim I have to put up a little bit of deposit at the same time you say there's 20% of the cover paid which gets paid out to the stakers so I mean it seems does does that mean you are like burning ms and then at the same time you're like minting.

Let's say in this case we have 100. So you're burning 90 and you're minting 20 to pay out of those stakers? Yeah, yeah. So I mean, rather than like kind of, it's easiest to kind of look through and look at the net result. Right. After after everything, right? And so the whole idea here is that basically from a user point of view, you actually buy cover in either ether or die. And then what happens is step one.

happens all in one transaction step one you buy so you put say you're buying cover in ether it converts it to nxm and then it burns 90% of that nxm because it buys it on the bonding curve yeah destroys it immediately right so it's kind of a side point so really the ether goes into this in the pool and then it and it will be like let's say i can say and i just want to buy mxn i don't want to cover so i'm putting ether in the pool and i'm getting mxn from this bonding curve whereas, you know, Sonny, he doesn't care about MXN. He just wants insurance cover. So he's putting Ether in the pool.

The same thing happens. MXN gets taken out, but then he doesn't get the MXN, but that gets burned. Or slash 70% gets burned. 20% Quazai gets to some stakers for that contract. And 10% he kind of keeps for, you know, to take future actions around his insurance. Yeah, that's right. Yeah. Cool.

Yeah. So, and so, I mean, I guess it's important. So, like, all of these kind of metrics and stuff, we're kind of, we're basing them on, like, insurance company economics. So that's kind of the whole idea being that we, um, we price the cover at the right levels, you know, obviously we don't know what the claims are going to be right now. We need to be a bit more experience and stuff like that. But the conceptually, the idea is to leave a little bit of surplus in the pool.

And also for that 10% for the cover purchases, that's kind of, ideally, it's kind of like the mutual, like you can cash that out at the end. if you'd like to or you can use it to buy discounted cover next time around. So it's kind of like your ongoing participation in mutual. So conceptually, that's, that's how mutuals work. So going back to that question about the sort of price discovery, so alongside the staking, there's like other things that are taken into account as well. I read about like, you know, sort of how long a contract has existed.

And can you talk about some of what are some of the other factors that also get sort of. Yeah. So, I mean, that's really interesting. So we've, it basically is kind of trying to proxy how battle test the contract is, how much it's been used, how much funds is it got, how long has it been on MainN, how many transactions does it have? And so that was, that's kind of that initial pricing algorithm was kind of our first attempt at kind of blending old insurance world with staking mechanisms and stuff. We've worked a lot on these pricing stuff over the past, I guess we've been on Mainnet in about a year now. So we got a little bit of experience or stuff. We haven't got many claims.

We paid out in the BZX1, but that's it so far. But what we've learned is that that algorithm doesn't work the best in the situations, in all situations. And so what we're going to do is actually simplify that down and just bring it back down to staking. And so what we're trying to do here is like bring the minimum amount of information on chain and allow people, like if someone's got like a really awesome model to assess smart contractorists, they can do that and they can run that off chain.

They can do whatever they want. And then they can essentially condense that information into whatever they want to stake. And then they just put that on chain. And so the idea being that we don't care what tools you use or how you actually come up with your view, but we just care how much money you put behind it. And so that's going to work for smart contract cover, but that pricing mechanism can actually work for anything. Because it doesn't actually reference anything about the particular risk, just references the state. So if you want to like offer earthquake cover or hurricane cover or like a hurricane cover or like,

anything, you can effectively do it using the same mechanism. And so that's kind of one of the real goals that we're trying to get to longer term. How do you account for correlation then here? Right now you don't cover Oracle risk, but let's, you know, let's say eventually you do. A lot of stuff does take, like, depend on, for example, the maker oracles particularly. And that's like this point of correlation. So does accounting for the higher, you know, maybe because of that correlation, you maybe need higher premiums for contracts that do have like maker that touch the maker oracles.

Is this something that would also be accounted for within the staking system or is there additional functionality that's needed to do that? No. So I mean, generally the best way of managing correlation risks through capacity constraints rather than through pricing, just in general with insurance. That's kind of how it works. You don't want to like basically, you know, if you take, you know, you're all supposed to like business insurance in New Orleans, like, you know, if a hurricane or like a whole

bunch of different insurance, like if a hurricane hits, they're all going to go at the same time. So you basically limit your total capacity to that type of event. That's the kind of best way of dealing with it rather than through specific granular pricing. So that's kind of the way we're headed as well. To be honest, we're still kind of working out the best ways of actually capping and managing those correlations. We've definitely got some few ideas, but that's definitely really kind of higher. level expert stuff that we're trying to work out the best and most efficient ways to get

information on chain but it's more likely to be managed by a hold on we're going to make sure that these five risks are grouped together and their total capacity is not greater than next so that you know they can they can move in between that but as long as we kind of cap the total so the mutual doesn't go bust if there's like one event that hits five things so we have some limits now that are a bit more crude but we're going to be looking to ways to manage that a bit better in the future And right now you do only the smart contract risk. What are sort of the plans to expand here? And what kind of happens when things get the lines sort of get blurred?

So, you know, oracles aren't a good example of it's sort of blurring the lines. Or I just read just last night that there was like some bug found in the Argent wallet. And Argent is sort of this like interesting thing where it's like half of the stuff is being done on using smart contracts. but then a lot of the stuff also comes from like, you know, their app and like, you know, would you also cover? Like, oftentimes clients need to be smart in order to know how to interact properly with smart contracts. And if the clients have a bug and just incorrectly with smart contracts, does that count as something that's covered by Nexus Mutual right now? Not right now.

So we definitely, we focus down onto the essentially solidity covers, probably a better actual description of what we're offering. So technical risk in the solidity contracts. So, you know, if you send the wrong information to the particular contract because the UI had a bug, then that's not covered kind of thing. And same, and I guess same with the articles right now. Having said that, we started there because we felt it was a kind of contained thing that we could like at least get some handle on. I mean, it's completely new risk anyway that no one else was writing. But we thought we'd start there. But the plan is definitely to expand because, you know, if you're interacting with defyre, you basically want comprehensive,

in case something goes wrong. And so we know that the customers and members want that. It's just about working at how we actually get there in a good way that we can actually define the terms of when a claim is valid and when it's not and how you price for that and stuff like that. So we've got some good ideas on that and essentially build on the architecture that we've got and we're looking to do them in the near future as well. So what are the volumes you have so far?

Like let's say if you take something like compound or like what are the most property insurance policies you have and how much insurance is so far been taking out? So we've written nearly up to nine million worth of cover so far. We've got about four and a half million outstanding right now. And the big ones are surprise, surprise, compound of a balance. Anything with yield farming right now is that. is a big um it's a big um it's a big one curve's also really popular and so it's basically the the really

solid use case for us right now is like you can earn yield in defy via whatever method and then you can pay a lower amount and get some cover and then you kind of project it against a large chunk of the risk so that's that's that's that's that's a big use case cool and and so like what's the amount you have to pay to get like let's say i mean i don't know on i guess on compound right most most rates are kind of low, but maybe die or something. Like, I think the tether, I think the stable coins are kind of high. So, like, let's say I would want to buy a year's worth insurance there, like how much would that cost?

Yeah, so right now the rates on compound and most of the other big ones are 1.3% per annum. So that works quite well when you're earning 5, 6, 7 or 10 or whatever. You know, obviously it depends. When the DSR went to zero and that's kind of the, if that's kind of the risk-free rate, or close to it, I don't know. then everything else kind of followed. We weren't selling as much cover over the last three to six months,

but recently with, you know, Tether being able to get, you know, 10% on compound and stuff. Everyone's really, really interested in this stuff again. So,

yeah, that's, we kind of, we kind of go along with the, with Defi for the ride. How do you deal with sort of, like, perverse incentive stuff that are,

like, you know, you don't cover Oracle, so there's no issue with that, but like, what about like, you know, let's say I'm an attacker and I found a bug in a smart contract. I can sort of double my payout by first taking out insurance and then doing an attack, right?

How do you, is this something you do need to cover or? There isn't right now. So you can essentially do it like a naked cover if you want to describe it like that. So it's kind of like a credit default swap or something. So, yeah, look, it does lead to potential issues. We started that way because it was simple to do. I think what we want to do is actually have some level of proving of loss, which effectively takes away most of that kind of attack type issue there.

However, I mean, the risk is still out there. And if there is a bug, there is a bug. I guess there's a soft control. We do have KYC. So right now, we don't want to kind of rely on that as a prevention against attacks. But it does. It's a soft one against hackers. So yeah, look, I think with all things insurance, you can never do this stuff 100%.

There's always going to be a way of potentially defrauding the system. And the way what you have to do as a kind of provider is get that down to a costly enough level or a small enough level so that it still works as a whole. Because obviously if it's too high, the whole system breaks down. Yeah, look, we're definitely still learning on that. front and we're adjusting economics incentives and those types of things to gain experience and things like that so yeah i'm not saying we've got this completely 100% solved right now um we're definitely iterating could you talk a little bit about how this sort of compares to other models of insurance on uh in the defy world so prediction markets which i get i in my opinion

this actually seems sort of very similar to prediction markets in many ways and then the other would be something more like Open, who we just had on the show last week, where they do more of a financialized approach to it. Yeah. So, I mean, this essentially comes down, like derivatives or prediction markets, I kind of put them in the same, a similar type of bucket. And insurance pools, like, there's always going to be overlap there, but they are actually distinct products in my mind. And it comes, actually comes back to the capital models and how it, how the capital set up. For example, Look, if on open and on prediction markets, they have to be fully collateralized. And on open, they have to be more than fully collateralized.

Which means if you sell $1,000 worth of cover, you have to have on open $1,300 or something. I can't quite remember what the collateralization ratio is. And on a prediction market, you have to have a thousand, like in the pot so that if the event happens, you've definitely got enough money to pay. You know, essentially the premium goes from the person who they wants cover to the capital provider. And if you're writing risks that are quite likely to happen, like, I don't know, 10 to 20% likely to happen, then that's a reasonable premium to go to a capital provider. If you're talking about extreme risks that are very unlikely to happen, so say like a 1% type event, if you're a capital provider backing a 1% event one to one, then the most you can earn is 1%. And so it's very hard to attract capital on a fully collectualized basis for that type of reason.

risk. So what happens is insurance pools effectively allow you to underclatulize. They allow you to gear up. So Nexus can at least gear six times right now and we're aiming to gear more. So we're currently writing at 120, 130 percent. So we're under collateralized right now, which sounds bad, but it's actually kind of the whole point of what we're doing. And so that means it's more capital efficient. So what insurance pools work really well for kind of extreme events, you need to diversify the risk across. That's the whole point. You've got one capital pool,

covering lots of different risks. Options and, like, prediction markets and stuff, they work better when you've got, like, more at the money type risks. So, like, Open and stuff are getting some really great success on, like, the F-put options and stuff,

because the likelihood of something happening is a lot higher than 1%. It's, you know, they're writing put options that close to the money or whatever. So that's basically what it comes down to. They're very related products, but it all comes back to that. capital efficiency point. So two months ago, two or three months ago, you guys did make out your first

actual payment from Texas Mutual. Could you walk us through the whole story of how it worked in practice? And, you know, there was this whole thing where like the, there was first some claims made and it was rejected and then later it was accepted. Could you walk us through why and what happened? There was a really interesting time for us. It was, I guess, really great that we ended up paying claims because that's kind of the whole point of what we're trying to do. But there, so the BZX hacks or events, whatever you want to call them, happened. There were two different events and there were two days apart.

So one was on a Friday and one was on a Sunday. And so what happened was essentially both of them were quite complex transactions involving a flash loan set up and then manipulating it on-chain price article and then profiting from it at the end. And so on Friday, the first event happened within 12 hours or something, someone submitted a claim. And based on the information available at the time, it looked like it was basically a clever arbitrage trade using an Oracle manipulation and stuff, which, and it appeared as though the contracts operated as intended and there was nothing wrong with them.

And so because of that, the mutual members declined the claim. There was no bug in the slidity code. However, then, I don't know, another, like within kind of 12, 24 or 36 hours after the event, the BZX team put out the details of their kind of post-mortem. And it highlighted that there was a smart contract trigger that they were, that they intended to actually prevent an under-collatualized loan resulting after all of this. But it didn't fire. And so effectively it was bypassed.

And then because of that, the claimant resubmitted so you can submit your claim twice. and because of this new information available, the claims assessors approved it. That's basically what happened. It was just really a timing issue based on the information available. When the events happened, one of the first things that we did

was basically say to everyone that has cover, please don't submit claims for another day or so so that, you know, we have some information and people have done some analysis on this type of stuff. So yeah, I mean, overall, we were really happy that kind of we tested all kinds of elements of the system. And I guess one other interesting aspect How quickly are claims decided upon?

Like, you know, were they sort of have to have been acted upon within 24 hours? Like, why couldn't be like wait a week before deciding whether or not to approve or reject the claim? Yeah, there's some time limits. And there's like a minimum of, at the time, we've made these longer now. But at the time, there was a minimum 12-hour voting and a maximum 48-hour voting. And basically, but once you get like a certain voting power, it just closes automatically after 12 hours. So that's kind of what happened. So yeah, we've extended those time periods to kind of handle this type of thing.

I guess the other other interesting aspect of, like, we've had like quite a few claims votes now, but all of them have been like over 99% of people voting in the one direction. Like so basically there's been like a very, very high level of consensus about what the, what the result was, even if the Discord channel is flooded by lots of people screaming at each other, which is interesting in the, of itself. Cool. This is really awesome and I'm super excited to see how this was going to play out. Now, maybe we can just spend, I don't know, two or three minutes on this topic, but I mean, I know you want to go beyond smart contract covers also to cover, you know, maybe real world risks.

What do you think are the most promising, you know, sort of types of insurance coverage that you can write? And what's going to be the biggest change you have to go through to go from, you know, like purely blockchain to, you know, this hybrid blockchain physical world scenario. Yeah, so I think one thing that's kind of critical to make stuff work right now, especially, is the fact that to assess claims you actually need some data source or information to assess them. And so that kind of naturally pulls you into risks, initially risks like earthquake or hurricane or something where you've got solid data coming from multiple data sources about where events happened, and stuff like that.

And crop insurance and because you've got satellite data and stuff like that. So those are the types of risks that are more likely to be the first non-blockchain native stuff. So the big things that have to happen for that to become a reality, one,

Fiat on off ramps and that are slick to kind of abstract away all of the blockchain stuff behind the scenes so that regular people can just use an app and click a few buttons and it's done. The whole idea of Nexus is that you get a distributor that creates an app for earthquake cover in Mexico or whatever,

and they own the distribution there, and then we, Nexus provides essentially the risk capital directly into the application. And so they're actually buying cover with Nexus, but Nexus isn't doing the distribution and customer-facing stuff. It's done by partners that are local and understand their products and the markets and stuff. That's where these types of solutions tend to work very well. So that's kind of kind of need that tech side. And I guess the other thing is you also need a few experts in the mutual that are interested in doing that type of stuff.

So right now we've got a whole bunch of crypto experts that are interested in crypto related risks. But to expand into different types of risks, you're also going to need some community members that actually have knowledge about those types of things. And so you kind of have to grow into those things slowly with your membership base. let's just touch on the last topic which is you have this hybrid thing of the legal entity and the DAO like what is the relationship between the two they're one and the same thing so the well the legal entity is operated by spite contracts running on Ethereum so that's kind of how how it works there are legal documents that kind of describe these are the rules and if there's any disagreement between how thing operates, just look at the spike contracts. That's the final determinant. And then when,

when you want to change things, like you have to go through a governance vote and all of that's kind of prescribed in the legal documents. There's the sync. They're kind of synced up. And basically, when there's a governance vote, that means the terms and conditions of the mutual error are essentially updated. And so it all kind of works in sync, which is kind of cool. And I mean, there are a few of these more coming out, but that's one of the early ones to do it as well. I guess one other interesting aspect is, which you mentioned right at the start, was that they're actually four or five board members of Nexus, and they are the legal directors of the company.

And they have some slightly high powers within the system. But there's that kind of link to the, to kind of the traditional world, I guess. Does this allow you to hold sort of assets outside of on chain? So could sort of the insurance pool also hold some, I don't know, Swiss francs in a bank account somewhere? Is that one of the benefits of this? It could do.

And I guess that is a benefit, but it wouldn't be referenced by the token price. So we're trying not to do that. One of the big benefits it has, I guess there's two real big benefits. One, it gives limited liability on a per member basis. So you're joining a legal company in the UK. If the doubt is something wrong,

you only limited, your liability is limited to one bound. That's kind of the structure. with a membership organization, rather than if you are joining a Dow without this legal wrapper, then you're potentially liable on a personal basis for anything the DAO does. I mean, that could be quite an extreme view, but,

you know, that's one of the benefits it gets. And going back to near close to the beginning, you mentioned that one of the things that insurance companies do is, like, you know, what regulation does is that it provides a lot of, like,

capital requirements and stuff. Is there something similar to FDIC, but for insurance? Like, essentially governments have deemed that bank account, are like a vital enough part of like the economy that you know they provide insurance. Does the government all, do governments also provide insurance like reinsurance to these insurance companies?

No, not specifically, but they do set, they do have like government sponsored pools for certain things that it's often hard to get coverage for. For example, there's like terrorism related pools or flood related pools or something like that where, you know, the insurance industry may not be happy to take it on. so you kind of nationalized part of it or provide some subsidies or something. But in general, like the government, there's also this concept of being a systemically important insurer,

which kind of means that you have to pay some extra fees to governments and stuff so that, you know, they recognize that if that insurance company does go down, it's going to cause massive economic impacts. So they do extra to prop it up, I guess. What's ahead? Like, if you look at the next 12 months, what are the main milestones you hope to achieve?

Yeah, I mean, there's a lot of work coming out, as I've kind of mentioned pretty soon, on like pooled staking and pricing and kind of incentive, tweaking and stuff like that. That's really important for us. And then the two kind of biggest things that we want to focus on, one scaling the mutual's capital pool and growing

so we can meet the demand that we've got because a lot of people want lots of cover. We can't quite get everyone covered right now. But that's kind of one thing. And then also working on, distribution and sales and integrations and things like that to make it easier to purchase cover. So yeah, rather than kind of coming to our site to buy cover, we want the vast majority of people to buy cover off our site wherever they're interacting with Defi, whether that's

through Argent or Xerion or whatever they're doing. So that's the type of thing that we're looking to focus on. And yeah, just kind of growing and growing along with Defi. That's our main plan. Cool. Well, thanks so much for joining us, Hugh. I mean, it's really impressive where you've come. I think this is really super cool. This is live and functional and I'm thrilled to see where you're going to take it in the next few years. Cool. Yeah. Thank you very much.

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