P2P Coverage with Fungible Tokens
With yield farming becoming more popular in the DeFi ecosystem, coverage for smart contracts is now in high demand. Currently, the challenge is that providers have limited capacity or prices are exorbitant which means that most participants cannot get cover.
This is where Cover Protocol comes into play. Cover provides peer-to-peer coverage with fungible tokens (not non-fungible tokens) while letting the market set coverage prices. Unlike a bonding curve, it lets the market set coverage prices.
How it works
When market makers (MMs) deposit collateral to cover a product the process is set into motion. In exchange for their deposit, MMs receive two types of fungible cover tokens and MMs have the ability to either sell the fungible token(s) in order to earn a premium, or provide liquidity in DEX pools with the fungible token(s) so that they can earn fees. This then means that those seeking coverage are able to purchase the coverage they need.
Essentially, Cover Protocol offers DeFi users protection against smart contract risk. By facilitating trust between protocols and the protocol users, Cover provides some stability to the tumultuous DeFi space. Cover Protocol hopes to bridge the gap between DeFi and legacy finance and make decentralised finance more accessible and attractive to a broader spectrum of investors. According to the Cover team, their vision is to enable anyone to purchase coverage on anything by staking collateral without the need for KYC.
Cover Protocol is pioneering the concept of protocols providing coverage directly to their users. This is done by either providing liquidity for coverage, or by selling coverage on the market, thereby making it cheaper for their users to acquire some form of security. To better understand how Cover works, read this breakdown by DeFi architect Andre Cronje well-known in the crypto space for his contributions to Yearn.Finance and Curve Finance. Recently, it was reported that Yearn Finance is ending merger with Cover Protocol but no reason was given for this action.
Cover is the governance token for Cover protocol. It also plays a vital role in the claim management process. The COVER token has a max supply of 70,200 tokens.
- ~85% (~59,400) will be allocated to COVER community members.
- ~15% (10,800) will be reserved for the team, vested through the year.
What are Fungible Cover Tokens (covTokens)?
Fungible cover tokens are at the cover of Cover Protocol. So how are these fungible cover tokens created? Well, the answer is simple – when a user deposits collateral into a Cover smart contract. According to Cover, each Cover contract specifies the protocol to be covered (e.g. Curve), the preferred collateral (e.g. DAI), the amount to deposit, and then the expiration date of coverage.
The fungible cover tokens are maintained on a 1:1 basis with their collateral. For each DAI deposited, the user receives 2 tokens, a CLAIM token and a NOCLAIM token. The NOCLAIM token represents rights to receive the deposited collateral in the event that a claim payout is NOT awarded during the designated coverage period. The CLAIM token represents a right to receive the deposited collateral (or a fraction thereof) in the event that a claim payout is awarded by the claims management process.
According to Cover Protocols own documents, the claims management process goes as follows:
- File a claim. The fees will be refunded to the filer if the claim is accepted.
- Anyone can file a claim against a protected product by paying the claim file fee. The filing fees for each protocol will be increased by a multiplier each time a claim is filed, preventing spam attacks.
- Anyone can file a FORCED claim against a project by paying the force claim file fee. Step 2 is skipped if a claim is FORCE filed.
- Decide a claim by voting. Once a claim is filed, a snapshot voting page is created for the claim. COVER token holders can participate in voting whether it is a valid or invalid claim. If the voting rejects the claim, the claim is decided and rejected (if anyone disagrees with the community voting result, file a FORCED claim is the option). If the voting accepts the claim, the claim will be passed to the auditors in the next step.
- Final Decision by the Claim Validity Committee. The Claim Validity Committee will review the filed claim and make a decision whether the claim meets the requirements to be accepted and what the payout % should be. Each claim will be assigned to 5 or more auditors. To decide a claim, more than 50% of the auditors must agree on the validity of the claim and payout percentage (up to 100%) if the claim is accepted. The claim that the auditors accept will have the claim fee refunded to the filer. Every other filed claim on the same protocol will be denied and the fees will be sent to the treasury.
- Once a claim is accepted in the above step, the CLAIM token holders will be able to start to redeem their payout after a delay period.
Credit Default Swaps
According to Investopedia, a credit default swap (CDS) is a financial derivative or contract that allows an investor to “swap” or offset his or her credit risk with that of another investor. For example, if a lender is worried that a borrower is going to default on a loan, the lender could use a CDS to offset or swap that risk. To swap the risk of default, the lender buys a CDS from another investor who agrees to reimburse the lender in the case the borrower defaults.
Cover Protocol will make it possible to purchase protection for lending products. These products may have whitelisted addresses, delegated credit or simply higher risk collateral types, where lenders may not receive enough payments to cover their initial investments. According to Cover, Ruler Protocol will be one of the first beneficiaries of this service with the introduction of a credit default swap market for its lenders. Lenders on Ruler will now have the option of hedging the default risk from the borrower side. As a result, insolvency risk will be minimized even in the absence of liquidations. In order to attract liquidity to the pools offering this coverage, Ruler will incentivize these Cover pools using RULER tokens.
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