As an emerging decentralized finance platform, the unique first loss protection mechanism of the Huma protocol provides investors with a comprehensive risk mitigation solution worth exploring in depth.
Diversified Protection System Builds a Safety Line
The fund pool of the Huma protocol is primarily supported by income or accounts receivable. However, considering the risk of uncollectible accounts receivable, the platform has designed a first loss protection mechanism to address potential default losses. The core idea of this mechanism is to cover losses through multi-layered protection before they are passed on to the lenders.
Each fund pool can set up to 16 different forms of first loss protection, mainly including three types. First, additional collateral provided by borrowers adds a layer of safety to the borrowing process. Second, the insurance mechanism, although the market for comprehensive liquidity insurance is not yet fully mature, leaves room for future development. Lastly, a reserve fund provided jointly by the fund pool owners and evaluation agents forms a pattern of shared risk.
Strict fund management ensures sufficient protection
Before the fund pool is activated, the first loss protection providers must deposit sufficient funds into their corresponding protection layers. This sufficiency standard is strictly defined by the minimum liquidity parameters in the pool configuration, ensuring that the protection mechanism truly functions.
The operation of fund withdrawals is strictly controlled, only allowed when the withdrawal readiness flag is set to true. Typically, this flag is only activated after the fund pool is closed, effectively preventing the improper loss of protection funds.
Scientific Loss Coverage and Recovery Mechanism
When a default event occurs, the coverage amount of the first loss protection is calculated using a scientific formula: the smaller value between the upper limit of the first loss protection and the product of the default amount multiplied by the coverage rate. Loss coverage follows a clear priority order, first using the borrower's additional collateral, then insurance, and finally accessing the reserve fund.
It is noteworthy that if the loss is later fully or partially recovered, fund distribution will be conducted in the reverse order of loss coverage: senior shares will be repaid first, followed by subordinate shares, and finally the first loss protection. This design reflects fair treatment of different risk bearers.
Dynamic Growth Mechanism Optimizes Capital Efficiency
Considering that the first loss protection funds have not participated in lending and are classified as non-productive capital, the platform maintains a typical coverage rate between 2% and 10%. Additionally, based on the low early default rate of the fund pool, the Huma protocol has designed a dynamic growth mechanism for coverage.
The fund pool can only be activated after all first loss protections meet the minimum coverage requirements. Subsequently, the protocol requires that the income generated from the first loss protection be reinvested into the protection. More importantly, before the coverage reaches its maximum value, all fees earned by the management will automatically be deposited into the first loss protection, cleverly tying the interests of the management to the successful operation of the fund pool.
Innovation Mechanisms Leading Industry Development
The first loss protection mechanism of the Huma protocol embodies innovative thinking in the decentralized finance field, providing investors with a safer and more reliable investment environment through a multi-level and dynamic risk control system. This mechanism not only protects investor interests but also promotes the sustainable development of the platform, setting a new benchmark for the entire industry.
For investors seeking safe and stable investment opportunities, the first loss protection mechanism of the Huma protocol undoubtedly provides a choice worth considering. Its comprehensive risk control system and innovative incentive mechanisms are laying a solid foundation for the future development of decentralized finance.
