How does decentralized insurance Nexus Mutual operate, and why are there two tokens, WNXM and NXM?

After Binance exchange announced the listing of the decentralized insurance Nexus Mutual's wrapped token WNXM on August 26, there have been increasing questions about this project. Do you know how decentralized insurance works? Do you understand the relationship between WNXM and NXM tokens? This article will help answer all your questions about Nexus Mutual.

Decentralized Insurance

In the current DeFi (Decentralized Finance) trend, which is considered a killer application of blockchain technology, people are flocking to DeFi platforms to enjoy the services of decentralized finance and passive income from liquidity mining. However, as Ethereum founder Vitalik Buterin mentioned in an interview on July 28th:

"The biggest problem is that many people underestimate the risks of smart contracts."

While DeFi offers interest rates several times higher than traditional bank accounts, it also means that the risks associated with DeFi products are higher. There is a much greater possibility of "platform bankruptcy" (caused by contract vulnerabilities). Even audited platforms and protocols cannot guarantee that the expected percentage profit will not be compromised within the specified time frame.

To allow the public to enjoy the revolutionary breakthrough of decentralized finance with peace of mind, without worrying about potential asset losses due to smart contract vulnerabilities, decentralized insurance provider Nexus Mutual has introduced a solution that allows participants in the ecosystem to help each other, providing an additional layer of protection for assets on DeFi platforms.

Nexus Mutual

Founded in 2017, Nexus Mutual is a decentralized insurance protocol designed by a UK-based mutual insurance company based on the structure of "mutual insurance." However, it is important to note that although Nexus Mutual claims to be "decentralized insurance," in reality, all functions of the platform require users to go through KYC and whitelist procedures to become community members before use. Due to compliance and regulatory reasons, users from 17 countries are currently unable to become members.

According to officialdata, since its launch, the platform has received a total of 26 insurance claims (requiring a deposit to file a claim), but only 3 have been approved. The highest claim paid was $30,420 for the incident involving BZRX at the end of last year. It is also important to emphasize that Nexus Mutual currently only covers smart contract vulnerabilities, and losses caused by other reasons such as lost private keys, hacks on centralized exchanges, or losses due to flash loans and arbitrage using composite tools are not covered.

Ecosystem Composition

Specifically, the Nexus Mutual ecosystem consists of three main roles: "Cover Buyers," "Cover Providers," and "Claims Assessors," all of which are open to any whitelisted community members to participate.

Users who wish to purchase insurance, known as "Cover Buyers," simply need to visit the Nexus Mutual platform, select the desired contract to cover (i.e., the DeFi platform to be insured), coverage amount, and duration. The system will automatically calculate the required premium in NXM, the native token of Nexus Mutual, but payment can be made directly in ETH or DAI. The platform also displays the maximum coverage available; for example, at the time of writing, Compound V2's contract can only cover a maximum of 14,473 ETH and 5,453,340 DAI, with these values fluctuating based on the conditions of the Cover Buyers and Cover Providers.

"Cover Providers" are those who provide funds for claims. Any NXM token holder can become a Cover Provider by staking tokens. NXM token holders can select DeFi platforms they believe are unlikely to have contract vulnerabilities, stake NXM on the platform, and provide coverage. The benefit of taking on risk is that Cover Providers receive 50% of the premium as a return.

The DeFi platforms with the highest token collateralization include Compound V2, Curve All Pools, Synthetix, Aave, and Uniswap, each with over 300 participants and over 200,000 NXM tokens collateralized. Calculated at current market prices, the coverage pools for these platforms exceed $10 million. This can serve as a reference for users when choosing a platform, as more Cover Providers indicate fewer smart contract vulnerabilities and increased security on the DeFi platform.

"Claims Assessors" play a role similar to the claims department of an insurance company, responsible for reviewing and evaluating claim eligibility and amounts. Claims Assessors, composed of NXM token holders who stake tokens, operate similarly to a PoS consensus mechanism. They must make correct judgments to maintain system operation, as incorrect judgments may result in punitive burning of staked tokens.

These three roles form the complete Nexus Mutual ecosystem.

Token Economic Model

Understanding how Nexus Mutual operates, let's take a look at the unique token economic model of NXM.

Recently, Binance announced the listing of Nexus Mutual tokens. However, if you noticed, you might have seen that the exchangelisting announcement stated "WNXM" instead of "NXM." This is because NXM, unlike typical ERC20 tokens, can only be transferred between whitelisted users (wallet addresses), meaning wallets not whitelisted cannot purchase, hold, or use NXM tokens. WNXM (Wrapped NXM) is a community-issued 1:1 mapping token designed to enhance token liquidity. Currently, all exchanges list and trade WNXM tokens, not the official NXM tokens.

So, how can one obtain official NXM tokens? To acquire NXM tokens, one does not need to be a miner or engage in over-the-counter (OTC) trading. Simply become a community member through KYC and then exchange ETH for NXM tokens on the official platform.

The operation is similar to a liquidity provider like Uniswap, with the distinction that NXM transactions do not involve liquidity providers; instead, smart contracts issue new tokens directly to users. Since NXM has no total supply limit, it can handle any demand regardless of quantity.

NXM Pricing Model

Now, how is the price determined when purchasing (selling) tokens from the project? Is it based on arbitrary pricing by the project team? Certainly not; this is where the interesting aspect of NXM tokens lies:

"The price of NXM tokens is not determined by the trading market or the project team but by the calculation result of a formula."

In the pricing formula of NXM tokens, the two most important parameters are MCR (in ETH) and MCR%. MCR stands for Minimum Capital Requirement, which is the "minimum reserve capital size" required by the insurance pool to be able to pay 99.5% of claims within one year if all insurance policies on the platform need to be claimed. MCR% represents the ratio of "all funds in the pool / MCR," indicating the pool's claim capacity. As seen in the formula, the larger these two parameters, the higher the NXM token value (with MCR% having a greater impact on short-term prices and MCR on long-term token prices). In simple terms:

"More assets injected into the pool -> Higher MCR and MCR% -> Higher NXM token price"

This design flawlessly captures the value of the Nexus Mutual platform in the NXM token price, significantly reducing speculations and tying token price to platform development.

This also means that investors should not rush to buy or sell based on the fluctuation of WNXM prices on exchanges but should first check the current pricing of NXM tokens on the Nexus Mutual platform to determine whether WNXM token prices are overvalued or undervalued. However, it is important to note that the NXM token price is determined not by the trading market but by the "formula."

Highly Linked to the DeFi Space

With the continuous rise in DeFi popularity, Nexus Mutual's pool of funds has explosively grown since July this year, soaring from $4 million to currently stabilizing at $60 million. Nexus Mutual can be considered a leader in the decentralized insurance concept, with significant room for development.

However, the success of the Nexus Mutual platform is closely related to the development of the DeFi space. If DeFi platforms face a bubble period due to overheating in the future, resulting in a significant decrease in adoption rates, it will inevitably affect the demand for insurance, leading to an unavoidable decline in NXM token price. Investors should be vigilant.