How Do Decentralized Insurance Protocols for Impermanent Loss Work?
Decentralized insurance protocols for impermanent loss typically operate by having users pay a premium to cover their liquidity positions. These premiums are pooled into a reserve fund.
If a liquidity provider experiences impermanent loss that exceeds a certain threshold, they can file a claim against the protocol. The protocol's smart contracts then verify the loss using price oracles and pay out the claim from the reserve fund.
The coverage terms, premiums, and payout calculations are all governed by the protocol's code and community-driven governance.
Glossar
Insurance Protocols
Mitigation ⎊ Insurance protocols within cryptocurrency, options trading, and financial derivatives represent mechanisms designed to curtail systemic risk and counterparty exposure, functioning as a layer of financial security beyond traditional collateralization.
Impermanent Loss Insurance
Framework ⎊ Impermanent Loss Insurance (ILI) within decentralized finance (DeFi) represents a nascent risk mitigation strategy addressing the potential for value erosion experienced by liquidity providers (LPs) in automated market makers (AMMs).
Impermanent Loss
Exposure ⎊ Impermanent loss, a risk inherent in automated market maker (AMM) protocols and liquidity provision, arises from price divergence between assets deposited and their subsequent value upon withdrawal.
Decentralized Insurance Protocols
Protocol ⎊ Decentralized insurance protocols represent a paradigm shift in risk mitigation, leveraging blockchain technology to automate claims processing and enhance transparency within the cryptocurrency and derivatives ecosystem.