Understanding Crypto Insurance: How to Mitigate Risks

A shifting cryptocurrency landscape represents fertile ground for many traders looking to make high returns on their investments. However, these promises of riches aren’t without certain drawbacks. There are many risks and uncertainties one faces when navigating the crypto sphere, some of which can be mitigated by crypto insurance.

At its core, insurance is all about paying a small fee to protect yourself from large and unforeseen losses. But how does that work in a transparent and blockchain-secured digital environment based on self-custody?

Whether you’re a seasoned veteran with substantial holdings or an entry-level crypto enthusiast looking to create a solid foundation of knowledge, you can significantly benefit from learning how to protect yourself. Join us as we unwrap the advantages and drawbacks of crypto insurance to help you decide if it will be helpful for you. Let’s get started!

What Is Crypto Insurance & How Does It Work?

Crypto insurance is a specialized form of financial insurance designed to protect individuals and entities from risks associated with the unique nature of blockchain. The term can also be used to describe instances where traditional insurance companies leverage blockchain technology to provide specific services to their customers.

Essentially, crypto insurance works similarly to traditional insurance, where the goal is to mitigate the impact of unforeseen damages or losses by leveraging the idea of risk pooling. It is a fundamental insurance concept where multiple parties take on small amounts of risk (often in the form of monthly payments) to cover rare instances of significant catastrophes.

However, unlike traditional insurance, such as those related to health or property, cryptocurrency insurance covers risks associated with blockchain assets and activities. This includes risks like:

• Attacks by malicious parties, such as hacking, fraud, theft, and more
• Technical malfunctions, such as smart contract bugs and protocol failures
• Centralized exchange (CEX) vulnerabilities, like third-party attacks, inside scams, operational errors, and more
• Asset loss due to stablecoin depeg

The key benefits of decentralized finance (DeFi), such as transparency, immutability, and self-governance, are also some of its most significant drawbacks when it comes to asset management.

Cryptocurrencies aren’t government-insured like fiat. Moreover, the permanent nature of blockchain makes every confirmed transaction irreversible. As a result, if you don’t have your funds insured, there’s nothing to protect you should anyone gain access to them. That makes crypto insurance a vital tool, albeit there’s still much to do in that field.

Types of Crypto Insurance

There are many different types of crypto insurance to accommodate the fact that it’s a vast field with technology and financial instruments that constantly evolve. While there’s no one-size-fits-all crypto insurance policy, users can choose between several types, such as:

• Crime insurance. The decentralized, immutable, and peer-to-peer nature of cryptocurrencies resulted in crime being rampant in the field. Asset loss can happen due to hacking, data breaches, scams, fraud, cyber threats, and more. Insuring your funds against crime can help you mitigate damages when you are a victim of an attack.
• Custody insurance. Self-custody is one of the core DeFi concepts. However, that also means there’s nothing to protect you if you mismanage and lose your assets. It’s estimated that around 30% of Bitcoin’s total supply is permanently lost. Custody insurance offers peace of mind should you forget your seed phrase or password.
• DeFi insurance. Decentralized finance is mostly made possible through blockchain technology, smart contracts, and dApps. While created by professionals, these programs and platforms can be prone to hacks and exploits. They can even have hidden vulnerabilities built in by developers who later plan to exploit them.
• Business insurance. Crypto insurance isn’t exclusive to retail investors. More and more businesses and professional entities enter the space looking to secure their holdings. Crypto companies and organizations (e.g., centralized exchanges) also utilize insurance to protect both themselves and their investors.

5 Benefits of Getting Your Crypto Insured

Crypto insurance offers many benefits similar to traditional insurance, including some that are specific to the DeFi space. Here are some of the key advantages to having your crypto assets insured:

1. Theft protection. The main upside to insuring your crypto is mitigating risks associated with the theft of digital assets. This includes losses due to scams, fraud, hacking, and various other malicious activities by third parties. Crypto insurance can also include physical theft of hardware wallets.
2. Peace of mind. The cryptocurrency landscape can look daunting, especially to new investors. Having their assets insured can help them navigate the space better without being overwhelmed by all the security risks and vulnerability concerns.
3. Enhanced governance. Self-governance is one of the biggest selling points of DeFi and the main reason many investors enter the ecosystem. However, it can be a challenging endeavor for many individuals, particularly those who are less tech-savvy. Crypto insurance protocols and companies can help alleviate these issues.
4. Trust, transparency, and efficiency. Many crypto insurance funds and projects leverage the power of blockchain to operate. All activity is recorded on these immutable ledgers and displayed for everyone to see. Moreover, by using smart contracts in place of traditional procedures, these protocols can vastly cut time and resource costs.
5. Regulatory compliance. As businesses enter the crypto space and make cryptocurrencies part of their portfolio, products, or services, they might be required to insure it. Having safeguards in place might prove necessary for the long-term success of these enterprises, especially as the regulatory landscape continues to evolve.

Crypto Insurance Companies

Let’s examine some of the biggest and most prominent crypto insurance companies.

#1. NexusMutual

NexusMutual is one of the most popular DeFi insurance companies that offers a variety of products. It’s a community-governed protocol where a decentralized autonomous organization (DAO) helped pay more than $18 million in claims.

Its most popular product is “Protocol Cover,” which protects participants from EVM-related risks, such as smart contract bugs, oracle manipulation, liquidation failures, etc. Users buy covers with crypto, while smart contracts calculate quotes based on the amount of assets protected and the protection period.

#2. Etherisc

Etherisc is a crypto insurance company that leverages blockchain technology to provide protection against both cryptocurrency and traditional risks. One of their biggest products is USDC depeg protection. By purchasing this option, users can protect anywhere from 2,000 to 100,000 USDC in case this stablecoin’s value depegs.

On the other hand, this decentralized insurance protocol can help mitigate damages due to travel delays. They offer automated and almost instant payouts. Another useful product is crop protection, which allows participants to recover in cases of drought or flood. The protocol is heavily driven by the community, and the roadmap features many upcoming additions.

#3. Insurace

Insurace is a multi-functional crypto insurance platform. On the one hand, it offers asset protection against various DeFi-related risks, such as smart contract vulnerabilities and stablecoin depegs. On the other hand, the platform allows participants to provide capital and stake crypto, earning passive income in return.

Some of Insurace’s key features include flexibility and inclusivity since there’s no KYC required. They also cover 20 different chains, providing protection to a wide assortment of cryptocurrencies. Users can also bundle different covers together and get up to 60% savings on payments.

Challenges with Crypto Insurance

Crypto insurance is a relatively new concept, so it’s not without challenges. Some of the core ideas behind insurance clash with the basic features of cryptocurrencies, creating obstacles for insurance providers and users alike.

Here are some of the biggest disadvantages of crypto insurance:

• Lack of insurer clarity. One cryptocurrency owner might use several platforms and services to purchase and manage their assets. They can purchase and store coins and tokens on a centralized exchange while using a hardware wallet for enhanced security. When a cyber attack occurs, it can be difficult to determine who is at risk and who is at fault or to establish clear ownership of assets. The situation becomes even more ambiguous when there are multiple parties controlling a single fund or wallet.
• Historical data inconsistency. Traditional insurance projects and companies function by taking into account past experiences. They use that to calculate fees and premiums and to develop products and covers that benefit insurers while keeping the insurance businesses operational. Considering crypto insurance has existed for just a couple of years, there’s a substantial lack of historical data. That can lead to unexpectedly high crypto insurance costs or unsustainable business models.
• Currency obscurity. The crypto space is highly volatile, and even the most stable coins, such as Bitcoin, can experience steep price rises and drops. A user might insure 1 BTC when its price is $30,000, but its value can go to $15,000 or $45,000 in the span of a few days. This volatility puts insurance companies and DeFi protocols at risk of not having funds to pay out their customers. This risk is particularly prominent if regulation prevents these companies from holding crypto assets, so they must conduct business in fiat.

Can Centralized Crypto Exchanges Be Insured?

Centralized crypto exchanges can be insured, but not like traditional market platforms. For example, the Federal Deposit Insurance Corporation (FDIC) protects up to $250,000 worth of customers’ deposits in case of bank failures.

CEXs don’t enjoy that protection from the government or federal agencies. Still, many of them have private insurance funds used to compensate holders in events of attacks or other unforeseen circumstances.

Binance, the world’s biggest centralized exchange, features an insurance fund as a safety net for investors. That’s how the company managed to compensate all victims in the 2022 attack when more than $500 million in crypto was stolen. This fund also protects traders from liquidated counterparties, ensuring they are always paid out in full.

We can find a similar example in the CEX exchange. Apart from having strong safeguards in place, such as military-grade encryption, physical segregation of hardware wallets, and multiple points of control, the exchange also features a self-regulated reserve fund. Essentially, they set a portion of revenue aside to cover customer losses in cases of unfortunate events.

Most of these exchanges provide private insurance at no cost to the user. In a competitive market, that can give centralized exchanges that offer it an edge over those that don’t, thus promoting an industry-wide trend that can only benefit the investor.

Future of Crypto Insurance

In the future, we might see crypto insurance evolve to keep up with the rapid changes in the DeFi space. One of the key trends could be the expansion of coverage options. As the market grows, introducing more assets and earning options, so will the need for different types of insurance to cover all possibilities.

Another trend to keep an eye on is the integration of crypto and traditional insurance. We already have crypto protocols offering traditional coverage, as well as traditional companies offering crypto protection. Still, this development is at its beginning, and going forward, better interconnectivity can benefit both insurance companies and their customers.

Finally, there’s plenty of work to be done when it comes to technological and regulatory advancements. As blockchain and smart contracts become more sophisticated, so do cyber-attacks, making it essential to secure one’s investments. On the other hand, as more companies join the insurance space, we are likely to see regulatory pressure.

Key Takeaways

While many crypto enthusiasts participate in the space almost exclusively for its independence and self-custody, others look for protection and a more hands-off approach to their investments. In these cases, crypto insurance can bring much-needed security, easing the minds of risk-averse holders.

On the other hand, even dedicated DeFi supporters might take advantage of DAO-governed decentralized platforms that offer asset insurance. While the technology is still in its inception, the benefits far outweigh the drawbacks. Crypto insurance might just become a vital tool necessary to facilitate broader adoption and the evolution of the space!