TL:DR

• Solace v2 will have its testnet in July 2023, followed by the launch in late August 2023.

• This blogpost follows the Solace DAO's 2 years-long journey of exploring hypotheses and product-market fit variations, leading to the introduction of Solace v2 and highlighting its strategic pillars.

• Solace v2 harnesses the power of the Ajna and Pendle protocols, utilizing the composability of DeFi. It goes beyond being a conventional insurance protocol, tackling the challenge of an unfavorable risk/reward ratio in DeFi. Through its thoughtfully designed approach, Solace v2 unlocks a coverage strategy with deterministic outcomes among its array of available strategies.

PROLOGUE

In survival, evolution, and organizational development, sharing experiences is vital for success. Similarly, in the evolving world of decentralized finance, sharing knowledge and lessons learned is crucial for industry progress, innovation, and resilience.

In our upcoming blog post, we'll share an exciting story. We'll take you through the journey of the Solace team over the past year, exploring hypotheses and testing product-market fit variations. In the next blog post, we will introduce our latest protocol version, showcasing how this journey directly influenced its development.

To keep things concise, we'll briefly outline three iterations of the product-market fit without going into the specifics of demand validation. Feel free to ask questions or seek clarifications on Discord or Twitter.

CHAPTER 1: Solace Portfolio Insurance 

Launched in February '22, Solace Portfolio Insurance (SPI) was developed based on the hypothesis that insurance in DeFi is excessively complex and inefficient. Its objective was to offer a technologically advanced and user-friendly solution for securing DeFi portfolios. Users could insure their portfolios through the Solace protocol with a simple three-click process. The system would rapidly analyze their portfolios and generate an insurance coverage offer based on the chosen limit.

By providing a single insurance policy that covered all positions in a portfolio, SPI offered several advantages at an architectural level. Unlike other insurance protocols that required separate insurance for each position, Solace's streamlined approach enabled more efficient utilization of capital and enhanced cost-effectiveness. 

This version of the protocol, unfortunately, did not validate the hypothesis that complexity and inefficiency are the primary barriers preventing users from adopting DeFi insurance. However, it became apparent that there were two crucial challenges that required prioritized solutions:

1. Inadequate underwriter rewards compared to other opportunities in the DeFi space.

2. The challenge of centralized risk management and monitoring, which erodes user confidence in insurance due to uncertainty regarding the level of protection offered.

CHAPTER 2: Solace Native

Introduced in September '22, Solace Native emerged as a solution to the core challenges of DeFi safety. It was also referred to as Dapp-level insurance or Native Crypto FDIC. The concept of Native revolved around protocols offering unconditional insurance to their users against technical risks and exploits. In return, these protocols gained a competitive advantage and security support mechanisms, with payments made in native tokens instead of stablecoins.

In simplified terms, Native was implemented by creating an index pool consisting of tokens from participating protocols. This index pool aimed to generate returns, and could be utilized for valid insurance claims. Additionally, participants of Native were provided with security guidelines and received audit proposals from partners, strengthening the overall security of the ecosystem.

Unfortunately, this version of the protocol did not gain traction as anticipated, despite our initial collaboration efforts with various industry players. The combination of market risks at a smaller scale and challenging market conditions ultimately hindered its success.

CHAPTER 3: Solace Underwriting Market 

The Underwriting Market (UM) was under development in Q1 2023. The core concept behind the UM was to establish a platform that provided ecosystem participants with the autonomy to negotiate the allocation of underwriting capital and associated rewards. This approach aimed to tackle a fundamental challenge in DeFi insurance - attracting underwriting capital - by leveraging market forces.

One of the primary goals of the system was to provide an effective and efficient way for underwriters to allocate their capital across different risk pools, allowing them to leverage their assets and generate yield. By leveraging DeFi's composability and tokenization, underwriters had control over their asset exposures and could tailor their risk according to their strategy.

The underwriting market was intended to become a key primitive in DeFi for managing liabilities and financial risks. It aimed to enable participants to easily find underwriters and trade various types of risks on an open market. The customization of parameters for each risk market allowed for the consideration of unique characteristics and individual treatment of each type of risk. 

The implementation of the Underwriting Market (UM) concept faced challenges due to heavy implementation requirements, limited stakeholder involvement, and the need for scalability and stable market conditions. As a result, alternative solutions were sought to retain core benefits while leveraging existing permissionless building blocks within the ecosystem. One key takeaway is the importance of prioritizing direct and immediate value for stakeholders to foster active participation, especially during challenging bear market conditions, for those relying heavily on third-party involvement.

Epilogue: Reinventing DeFi insurance

In July 2023, our team is gearing up for the upcoming launch of Solace V2 in the coming weeks. This milestone represents the culmination of our journey, characterized by experimentation and hypothesis testing. As we approach this exciting moment, let's take a closer look at the five strategic pillars on which Solace V2 is built.

1. Solace V2 has been specifically designed to tackle the fundamental challenge of an unfavorable risk/reward ratio. It recognizes that underwriting returns may not be able to compete with other opportunities in DeFi, especially when considering the additional risks associated with the underwriting process.

2. Another important consideration in attracting underwriting capital is recognizing that one potential solution to overcome this barrier may involve increasing underwriters' returns through leverage. However, implementing such an approach would require extensive intelligence and data to construct probabilistic models and establish robust risk diversification strategies. Unfortunately, these essential components are not yet available within the DeFi ecosystem.

3. Building upon the first two points, Solace V2 has been designed to explore adjacent use cases that can significantly enhance liquidity and efficiency. By establishing virtual relationships between underwriters and coverholders through utility, we aim to effectively address the existing challenges and unlock additional efficiency gains.

4. Although centralized risk management continues to present significant challenges, Solace V2 has been specifically designed to address this issue by incorporating coverage strategy with deterministic outcomes. This approach includes a claims process-free mechanism and the assurance of programmatically guaranteed payouts.

5. In the dynamic world of DeFi, a lightweight implementation is crucial for a successful system, particularly in bear markets. Solace V2 harnesses the power of the Ajna and Pendle protocols, utilizing the composability of DeFi. This dual approach enhances its capabilities while streamlining scalability, making it a robust solution.