Tokenomics Expert Course

Course Description
Become a Nexus Mutant expert and level up your knowledge of Nexus' tokenomics.
Get to grips with cash flows, the NXM token, the bonding curve, what MCR is, as well
as wNXM and how it relates to NXM.
Learn through a combination of written materials, videos and diagrams that are
designed to bring you up to speed in no time.

Expected Time to Completion: Up to 2 hours

Assumed Knowledge
Prerequisite(s): You understand the basics of the products Nexus Mutual offers and
the different roles users can take in the system; e.g., Cover Buyers, Risk Assessors,
Claims Assessors, NXM holders.
 Topics
#1 Cash Flows
Before diving into NXM, we need to understand the core cash flows underlying
Nexus Mutual. These are the foundations on which Nexus Mutual is built.
Conceptually, it is easiest to think of the cash flows as the foundations, with NXM
sitting on top as an incentive layer. We will return to NXM and how the incentives
work in the next topic.
Underlying the Nexus Mutual system are 5 primary cash flows, these are the
foundations on which members share risk with each other. All cash flows either flow
into, or out of, the shared Nexus Mutual capital pool.
The Capital Pool is jointly owned by all Members of the mutual, and there is no fee
or other external cash flow involved.
1. Cover Costs - All cover costs are paid into the capital pool in full. Cover can be
purchased in either DAI or ETH terms with the DAI or ETH flowing directly into
the pool.
Cover costs can be tracked here: https://nexustracker.io/ see the premiums
charts.

2. Claims - All claims are paid from the capital pool in either DAI or ETH terms, as
per the covers purchased.
Claims can be tracked here: https://nexustracker.io/claims
Note: that the relatively large number of declined claims are because most of
them are for testing purposes, or members submitting speculative claims to see
how the system works.

3. Buy NXM - Members can contribute ETH directly to the mutual to generate new
NXM. All the ETH goes into the capital pool. Members can contribute ETH at any
time.

4. Sell NXM - Members can redeem NXM for ETH directly from the mutual, but
only when the MCR% is above 100% (further details in a later section). MCR
means Minimum Capital Requirement and the "MCR lock" makes sure the
mutual has enough funds to pay valid claims.
5. Investment Earnings - The mutual intends to invest the capital pool of funds in
order to generate a return, this is also called earning money on the "float" in
insurance terms. All the investment earnings accumulate in the capital pool. The
mutual started off by just holding ETH and DAI, but has started making
investments (as of Aug 2021).
The capital pool status can be tracked here: https://nexustracker.io/capital_pool Or
also on Zapper
https://zapper.fi/account/0xcafea35ce5a2fc4ced4464da4349f81a122fd12b

If you'd like to understand more about the cash flows and reporting then
you can jump to topic #6 Financial Reporting.

#2 NXM
NXM is the tool which Nexus Mutual members use to share risk with each other. It
creates the right incentives to reward good behaviour and punish bad behaviour.

NXM is Asset Backed

One of the most important aspects of NXM, especially when compared to other DeFi
tokens, is that it's asset backed. Members of the mutual, NXM holders, own the
capital pool and the capital pool has real assets. This contrasts to most other DeFi
tokens where the liquidity in the protocol is owned by Liquidity Providers (LP's) and
the token holders have governance rights and potentially some smaller share of the
fees.

With NXM, LP's and governance token holders are actually the same
group, there is no distinction.

NXM the Incentive Layer

NXM is best described as an incentive layer that sits above the capital pool.
Members of Nexus Mutual have a pool of funds and they need to manage it well to
achieve the objectives of the mutual. NXM provides the incentives to encourage
good behaviour and discourage bad behaviour.
Good behaviour is rewarded with additional NXM and bad behaviour is generally
punished with burning NXM (or locking it). Overall, these mechanisms shift value
from bad actors to good actors by shifting their respective ownership proportions of
the capital pool.

Reward levels have been carefully set so they do not overly inflate the NXM
supply and are sustainable on a long term basis. Many other DeFi protocols
offer unsustainable reward levels in the short term to bootstrap liquidity
and the overall network. While this can make sense, Nexus Mutual hasn't
engaged in these activities and has successfully bootstrapped a meaningful
capital pool that it can use to back cover. Longer term this is expected to be
provide a material benefit to members as while the NXM supply is expected
to grow when business growth occurs, the NXM rate of supply growth will
be much lower.

Risk Assessment and Pricing

Risk Assessment is the primary staking function within Nexus Mutual. Reward and
punishment functions are designed to encourage members to back good risks, and
price effectively.
Rewards are received (extra NXM) when cover is purchased on a particular risk, and
punishments are made (burned NXM) when claims are made on a particular risk.
For details on the mechanics see here:
https://nexusmutual.gitbook.io/docs/users/understanding-nexus-
mutual/riskassessment
Claims Assessment
Claims Assessment also involves staking NXM but as claim events are relatively rare,
assessors usually stake on an as needs basis.
Rewards are generally calibrated to provide income for work input, as stakes are not
really at risk. While not generally at risk, stakes can be burned by the Advisory Board
if there is deemed to be fraudulent voting. This measure is primarily used as a
disincentive to prevent voting attacks trying to approve illegitimate claims.
For details on the mechanics see here:
https://nexusmutual.gitbook.io/docs/users/understanding-nexus-
mutual/claimsassessment
Governance
Small rewards are also paid for participation in governance votes. This is to
encourage broader participation, and as an offset for gas costs involved. As with
other mechanics it creates a small shift in value from passive network participants to
active network participants.
Cover Purchases
All mutual's solely exist for the benefit of their members. One of the primary ways
Nexus Mutual directly gives back to cover buyers is through the 10% NXM reward.
Every cover purchase results in 10% of the cover price being kept by the cover
purchaser. This NXM can later be used to either cash out, or as a discount on the
members next cover purchase. To the extent the mutual generates surplus (cover
costs less claims) then NXM will appreciate and the cover buyers will directly benefit
from the surplus they helped generate.
Capital
Another of NXM's core functions is capital efficiency, which is making sure the
mutual has enough capital to reliably pay all claims but not too much that it's sitting
on excess capital. These mechanisms are delivered via the bonding curve formula
and the Minimum Capital Requirement (MCR), the titles of our next two topics.

#3 Token Price Formula and the Bonding Curve

NXM is different from a lot of other tokens because it has a formula underlying the
price, this is also called the bonding curve. In this topic we'll explore why the
bonding curve exists and how it operates.

Why is a Bonding Curve used?

The primary purpose of the bonding curve is to ensure the mutual uses its capital
efficiently. Capital efficiency is extremely important in insurance as ultimately
insurance entities live or die based on their capital efficiency.
Capital efficiency in insurance means:
1. Making sure the mutual has enough money to confidently pay all claims, and
2. Not sitting on excess capital that is not required.
Balancing these two objectives are why the bonding curve exists.
 Bonding Curve Formula

The NXM Price (in ETH terms) is defined by the above formula. We'll step through
each component now.
A = 0.01028
A fixed constant that was set at launch and represents the starting NXM price in ETH
terms. It was set so that the price of NXM with zero money in the capital pool was
roughly 20-25% below the price of NXM at 100% MCR (see below).
C = 5,800,000
Another fixed constant that was chosen at launch, this determines the shape of the
curve. The goal is to calibrate the curve to common valuation metrics (eg Book
Value) at certain MCR% values. We will address Book Value further in later sections.
MCR(eth) or Minimum Capital Requirement in ETH
Further explored in topic 4, this is the amount of money the mutual needs to hold to
be confident in paying all claims. It's measured in ETH terms.
MCR% or Minimum Capital Requirement Ratio
See topic 4 for more details, this is the ratio of funds actually held in the mutual
divided by the MCR(eth). It can also be described as funds held vs funds required,
and is therefore like a solvency ratio.

Short Term vs Long Term Price Drivers

In the short term the MCR(eth) value is fixed, this means that short term NXM price
movements are driven entirely by how much capital is in the capital pool. More
capital means higher MCR%, which leads to a higher NXM price.
The capital pool increases when the mutual generates surplus (premiums less
claims), investment earnings grow and/or members contribute more funds to the
mutual.
In the long term, if we assume the MCR% stabilises around a certain level, then price
will be driven by MCR(eth) which as we shall see in the next section is driven by
active cover, or adoption.
So the bonding curve price reflects the two fundamental business drivers, funds in
the capital pool and cover sales.

#4 Minimum Capital Requirement (MCR)

One of the most important concepts of the mutual is the Minimum Capital
Requirement. It can be thought of as the amount of money the mutual needs to be
confident in paying all claims.
The mutual needs to make sure it always has funds close to the MCR value, as it's
primary objective is to pay claims when needed. This can lead to what is commonly
referred to as the "MCR lock" where funds cannot be taken out of the mutual if the
funds held in the mutual are at the MCR value or below.
The MCR is actually the greater of two values:
1. Fixed MCR Floor value which is currently 162,424.73 ETH, and
2. A multiple of current active cover, currently active cover / 4.8

MCR = Max (MCR Floor , Active Cover / 4.8)

For further details and history of the MCR Floor value, see here:
https://nexusmutual.gitbook.io/docs/users/understanding-nexus-
mutual/minimumcapital-requirement

MCR% or the Minimum Capital Requirement Ratio

The MCR% is the ratio of the funds the mutual actually holds (in ETH), divided by the
MCR (in ETH). It is a measure of solvency.
If MCR% is materially below 100% then the mutual needs to attract more capital to
be confident in paying claims. This may occur if a few large claims happen with the
token price then decreasing to encourage capital contributions.
If the MCR% is above 100% then the token price rises very quickly due to the
exponential curve, this encourages members to withdraw excess funds from the
mutual.
 Sell Spread
The bonding curve contains a 2.5% sell spread, which means the Sell NXM function
on the bonding curve is executed at 2.5% below the token price as per the formula.
This is to discourage heavy buy/sell activity on the bonding curve and also provides
some protection against potential attack vectors that require manipulating the
bonding curve price.
The sell spread effectively remains in the pool and therefore benefits all NXM
holders.

Growing the MCR

As mentioned above, the MCR is linked to cover purchases through the gearing
factor of 4.8. For the vast majority of time since launch the MCR has been driven by
the floor value but when cover grows it will start being driven by active cover.

When cover reaches 779,638.70 ETH = MCR Floor x 4.8, then the MCR will
start growing with cover purchases.

At this point, there will be slight downward pressure on the token price, as MCR%
will decrease, which will help encourage more capital to be added to the capital pool
to fund cover growth.
Conversely, if cover was to decrease after this point then the MCR would decrease
and MCR% would increase causing upward pressure on the token price as the
mutual starts releasing capital reserves.

#5 wNXM and NXM

Another interesting aspect about NXM is that it can only be held by members of the
mutual. Individual ETH addresses are flagged on chain when members go through
the sign-up process and the smart contracts enforce that only members can hold
NXM. This means that NXM is not tradeable outside the membership base and
therefore can't be traded on DEX's etc.
To bypass this constraint some of our community created a new token, wNXM, which
is a fully tradeable version of NXM that can't be used with the Nexus Mutual system.
wNXM is 1 to 1 backed with genuine NXM and members of the mutual can generate
or redeem wNXM at any time. wNXM Price Differential
When the MCR% is above 100% there is a two way arbitrage available between
wNXM and NXM which means any price differential is likely to be very short lived.
For example, if wNXM is above NXM then traders will be able to mint NXM from the
bonding curve, convert to wNXM and then sell at higher prices. Conversely, if wNXM
is below NXM traders can purchase wNXM convert to NXM and sell on the bonding
curve.
When the MCR% is at 100% or below a sustained price differential can occur with
wNXM being lower than NXM. Having wNXM is actually a benefit to Nexus Mutual
members in this case as there is now an option to exit liquidity even when the "MCR
lock" is in effect. The price differential can be thought of as a liquidity discount.

Any liquidity discount is primarily market sentiment driven, so can remain for
sometime until the market views on the NXM token change.

Restoring the wNXM to NXM price link

While wNXM is trading below NXM then any surplus or investment earnings that the
mutual generates will push the MCR% above 100%. At this point, a trader, usually a
bot, completes the wNXM to NXM arb and makes a small profit, reducing the MCR%
back down to 100% in the process. The net impact from the mutual's perspective is
NXM is being burned and the total NXM supply is reduced.

As the mutual grows its fundamentals, and surplus and investment earnings
keep rolling in, NXM will keep burning and the mutual is effectively applying
buy pressure to the wNXM markets.

Docs: https://nexusmutual.gitbook.io/docs/nexus-mutant-
community/wnxmcommunity-run-dapp
Coingecko: https://www.coingecko.com/en/coins/wrapped-nxm

#7 Book Value
Book Value and Price to Book ratio are important metrics in insurance. They are
more common than the usual Price to Earnings ratios that are used more broadly
across other sectors.

The primary reason for valuing the insurance sector with the P/B ratio in lieu of
the P/E ratio has to do with the fact that insurance companies have a lot of
assets on their balance sheet. The assets suit as underlying equity to back up
their insurance contracts. Similar to an option trader that has a margin
requirement, an insurance company needs to have skin in the game in order to
underwrite insurance contracts. Value Walk

Nexus Mutual's Price to Book

The book value for Nexus Mutual is simply the assets held in the capital pool. This
can be obtained in real time here or from the tracker.
We'll now run through an example calculation of Price to Book:

• For the sake of argument lets assume the current capital pool has $500m of
assets. This is the Book Value.
We then need to work out the market capitalisation, which is slightly complicated
due to the existence of wNXM. wNXM is the freely trading version of NXM, so it's
the best asset to use to determine price. From here we need a supply figure to get
to market capitalisation, and in this case we actually have to use the total supply of
NXM (rather than wNXM). This is because all wNXM is backed 1 to 1 with NXM, and
the total NXM supply is the true supply metric that matters.
Continuing with the example, let's assume:

• wNXM price = $65

• NXM supply = 7,000,000

In this case the market capitalisation is $455m = $65 x 7,000,000.
We can then take the ratio of market cap to book value to work out the price to
book ratio:

• In the example P/B = $455m / $500m = 91% = 0.91

Book Value Reference Points

Price to Book values in the Property & Casualty sector do vary, but large established
insurance companies tend to have lower P/B due to the lower growth expectations.
Smaller start-up insurers tend to have higher P/B due to their higher growth
expectations.
Some approximate reference points:

• Established insurer with low growth expectations 0.8 - 1.2

• Average insurer 1.3 - 1.8

• Higher growth insurer 1.9 - 5.0

Please be aware there are many other financial ratios that are important,
book value is just one metric, albeit a key one.

#6 Financial Reporting
As part of a community grant one of our members has built a slimmed down
financial statement for Nexus Mutual. We will walk through the key items here.
 Revenue Statement
The revenue statement details the revenue, claims and other cash flow items that
have occurred during the period. It also makes an adjustment for claims reserves.

Example revenue statement.

Membership fees and Cover Costs are the main revenue items and these are offset
by any claim payments. The resulting figure is Cash Surplus, which is what we have
been referring to as Surplus throughout this course.
The next item, Increase in Reserves, is an insurance focused metric. It is designed to
ensure that Surplus is reported in line with how it is earned. As risk is realised over
time we should only realise Surplus after the risk has passed, so new covers will
increase reserves, and expiring covers will release (or reduce) reserves. The net
impact is captured via Increase in Reserves.
Surplus is the smoothed version of Cash Surplus which recognises revenue only as it
is earned.
The next two items relate to the remaining 3 cash flows we covered under topic #1.
Net NXM/ETH Contributions is the net impact of Buy NXM and Sell NXM. If it is
positive there have been more NXM buys over the period, if negative there have
been more sells.
Investment earnings is a balancing item which as well as including true investment
earnings captures currency exchange rate movements, so it can fluctuate somewhat
depending on the time period used.
 Balance Sheet
The balance sheet is a snapshot of the Mutual's assets, and liabilities, at a particular
point in time.

Example Balance Sheet

The balance sheet is relatively simple, as the Capital Pool is represented by the TVL
(total value locked) line. There is a small addition for the Membership Fees which are
collected, and this brings us to Total Assets.
Reserves are as described in the Revenue Statement, in that context they are a
smoothing item for Surplus generation. On the Balance Sheet they represent the
amount of claims that are expected to occur but haven't been paid yet.