3F Mutual employs a rainy day fund like mechanism that allows for one to hedge against MakerDAO collapse risk. It exists as neither an option nor a short position of ETH/DAI/MKR. The 3F Mutual rainy day fund-like design means it acts more like collective insurance.
Opyn, the so-called DeFi “insurance”, is an option like hedging tool for “guaranteed acquisitions” of specific assets. For example, if you want to hedge against the risk of holding ETH, you can buy an oToken that “exchanges 1 ETH for 150 DAI” for a period of time. Or hedging the risk of Compound loan, purchase oToken of “acquisition of cDAI at the original price”. Pay a little insurance premium and get compensation when an accident occurs.
However, this type of insurance uses a default swap model. The compensation is received from the full mortgage of the counterparty who provides the right to sell. You must have someone in the market willing to use the money to bet against you (VAM) to buy insurance. Because there is no reasonable market-making mechanism, liquidity costs have to be taken into account. The places that can be undertaken are very limited, and the insurance premium is ridiculously high as well.
Third Floor Mutual (3FM) is an insurance system for major accidents. The mechanism adopted is more similar to mutual aid associations, and also similar to deposit insurance in traditional finance. By using risk models designed by experts, stakeholders (developers, depositors, traders) are encouraged to pay little insurance premiums and accumulate security funds to make up for losses in the event of a major crisis in the industry.
Like Uniswap to EtherDelta, in a decentralized world, transactions do not always have to match specific “orders”. The automated market-making mechanism (AMM) trading model is becoming increasingly popular. Smart contracts automatically quote based on reserves, and any buy/sell orders can always be fulfilled.
3F Mutual has taken market mechanisms into consideration at the beginning of its design. Insurance is undertaken by the fund pool in the smart contract, allowing anyone to purchase any amount of insurance at any time. The only difference is that the rate of premiums and claims will fluctuate in connection to market supply and demand.
3F Mutual’s insurance subject is MakerDAO’s stable coin system. The rules are simple, MKR holders could initiate Emergency Shutdown when the market is subject to severe market fluctuations, program vulnerabilities, and system failures. Which is equivalent to declaring DAI bankruptcy, directly clearing the remaining value in the system, and returning it to DAI holders in proportion. 3F Mutual uses Emergency Shutdown as an indicator. If it happens, it will be compensated. It's that simple.
For those who purchase insurance, the premium is determined based on X: the number of units purchased × Y: the number of insurance days. If the DAI closes unexpectedly Y days after buying insurance, you will be able to claim. The amount of claims depends on the total amount in the fund pool and the number of insurance units that are currently valid (not expired).
At the same time, the premium is the source of the fund pool. So before the Emergency Shutdown is triggered, the pool of funds will only continue to increase over time when more people are buying insurance. Which will provide a larger amount of insurance capacity, and then further increase revenue. Forming a positive cycle.
Although this model (funded by the insurance pool) is capable of self-growth and self-reinforcement, there is still an obvious problem that it’s very difficult to begin. For early users, there is no money in the fund pool, and when the first person bought insurance, their premium would be the first income of the fund pool. If a claim is settled at this time, the first user will only get its principal back, and nothing if it expires. In general, there is no hedging effect, and the expectation is negative.
To resolve the issue of imbalanced economic incentives, 3F Mutual designed a long-term benefit mechanism. When someone purchases insurance, no matter how many days they purchase, they will get as many “shares” as the number of insurance units purchased. Unlike insurance, this share will never expire. When someone buys insurance in the future, 15% of their premium will be distributed to all those who previously hold shares. The same amount of money, which has bought the protection for a period of time, has been converted into an insurance contractor after the expiration and continues to require interest.
I believe many people should be familiar with the idea of “My money is shared with to the people in front of me”, “I am entitled to share the money of people behind me”. Is this not the original Fomo3D gameplay? Taking advantage of the idea that everyone wants to seize the front entrance, which perfectly compensates the difficulty of 3F Mutual startup.
Let the early players and the late players form a mutual association, each taking what they need from the counter-party. For example, the early player will deposit an amount of money, in exchange for long-term passive income; The late player is expecting a rather solid insurance coverage with a lower amount of premium.
Expectations for excess returns will push the initial buying momentum of 3F Mutual until the rate of expansion starts to slow down. In the long run, unlike Fomo3D, the insurance unit in 3F Mutual will expire. This means the claim rate of insurance will sky-rise if no one is purchasing a new insurance unit. Therefore attracting new buyers. If the market expects that the probability of a MakerDAO Emergency Shutdown is 0.5% per day, then the daily income of 3F Mutual will be approximately 0.5% of the pool amount, which increases exponentially.
Those who understand the rules of the game may find it easy to notice that the best strategy of 3F Mutual is: 1. Purchase a large amount of short-term insurance in the early stage, pile up your shares to make a profit; 2. Purchase insurance at the final stage when MakerDAO is about to trigger Emergency Shutdown.
Although, no one knows when Emergency Shutdown will happen, but isn’t this what insurance is all about? Storing funds for the moment when an accident occurs.