Decentralized Finance risk transfer and smart contract-based insurance

This paper presents a model in which risk-averse individuals can purchase insurance via traditional indemnity contracts or Decentralized Finance (DeFi) smart contract-based instruments. The model incorporates key features of DeFi insurance, including parametric payouts, basis risk arising from imperfect loss verification and pooled collateralization involving the risk of liquidity shortfalls. We characterize optimal insurance choices as a function of pricing, payout correlation and risk preferences. Numerical results show that DeFi insurance can complement or replace traditional coverage, improving welfare when basis and default risks are moderate or pricing advantages are substantial. The analysis reveals how DeFi-specific frictions shape insurance demand and provides insight into how DeFi instruments may shift market structure and expand the set of attainable risk transfer outcomes.