The insurance reserve will be funded by collecting 5% of the total Net Interest Income on the protocol. This fund will be used to mitigate potential losses in the USDC pool.
When an NFT becomes undercollateralized which is when the amount owed is greater than the value of the asset there is no longer an incentive to claim the NFT by repaying the loan balance. To prevent the platform from having a complete loss of that asset, the insurance fund will pay off part of the interest rate, which brings the digital asset to below market value.
This opens up the opportunity for investors and traders to buy this undercollateralized asset at a discounted rate compared to other markets to own or trade elsewhere.