The cryptocurrency market has been maturing over recent years. This means that there is more demand for crypto insurance solutions as more experienced players get into the emerging ecosystem.
Investopedia reports cryptocurrency insurance as a “big chance,” with a spokesperson from Allianz, one of the largest insurers in the world, saying that they have explored product and coverage options for the space.
Although the cryptocurrency ecosystem is considered volatile and dangerous, funds aren’t always completely safe even on top-rated exchanges. Although some platforms like Coinbase have publicly stated that they have hot wallet coverage through specific insurers, many don’t make it clear if assets deposited there have been insured.
Insurers face unique challenges in this industry. One, premiums are often determined using historical data. This is a problem in the cryptocurrency industry, where it is very limited and not available in newer areas, such as nonfungible tokens (NFTs).
There is still a demand for insurance in this space. Crypto exchange Crypto.com has increased its insurance program to $750 million by 2021. Decentralized solutions based upon decentralized autonomous organisations (DAOs), such as Nexus Mutual, have been created.
Tony Lees, chief products officer at Wirex digital payment platform, stated that one of the main obstacles to mainstream adoption in the past few years has been the belief that cryptocurrency is “untrustworthy” and “insecure.”
Lees stated that most users believe that crypto assets are more risky than traditional stocks and that investing in them is unsafe. Lees said that platforms have been able to show how safe their funds are by using industry-standard compliance and other regulations. Lees said:
Wirex has been able to show that corporate-level insurance coverage, with custodial platforms like Fireblocks, allows them to show that reliable systems and controls exist in order to provide the user with peace of mind.
Michael Vogel, founder of Canadian crypto-exchange Netcoins and CEO of Coinstream, shared Lees’ thoughts. He told Cointelegraph that crypto presents a “very different risk paradigm than what investors are used too.” Because no consumer ever worries about their Tesla shares going missing from their online brokerage accounts, “Cointelegraph” is not the only one to hear.
Vogel stated that many users are not comfortable taking on the responsibility for protecting their coins. Accordingly, many users aren’t comfortable with the responsibility of handling their coins themselves. The market has developed “custody-type” solutions where trusted companies act as crypto banks.
He said that insurance companies could give clear guidelines to custodians to help them qualify for insurance. Investors in the space could benefit from this move. Lees stated that most people are familiar with the Financial Services Compensation Scheme, which is equivalent to 85,000 British Pounds in the United Kingdom, and the Federal Deposit Insurance Corporation, which covers up to $100,000 in the United States.
Lees stated that these schemes help investors feel more comfortable leaving their money in banks. Crypto insurance that covers users’ holdings on a central platform would offer “that familiar, traditional protection against hacks and cyber-attacks.”
The idea of familiarity would be further supported by centralized entities such as Allianz, which could enter the space. Johnny Lyu, CEO at KuCoin cryptocurrency exchange, stated that although the crypto ecosystem does require insurance, most of its participation will be from centralized institutions in its early stages of development.
Lyu stated that the decentralized options are improving as the industry evolves. He said that whether these platforms can truly be decentralized will depend on the improvement and development of the crypto environment. For now, both central and decentralized entities face challenges.
Contract for fire insurance in 1796.
These challenges can be overcome to give investors more confidence in investing in cryptocurrency and increase exposure to this emerging asset class.
Vogel says that fraud is a significant problem for cryptocurrency-based insurers. Vogel used house insurance to illustrate the point. He said that insurance has a tangible benefit in that a house can be rebuilt if it is damaged.
However, fraud could be facilitated by obfuscation of the blockchain. Vogel said:
“A crypto-insurance fraudster might double dip, hide, or obfuscate his coins and receive an insurance payout.”
Lees believes that the greatest challenge facing the cryptocurrency industry is “providing traditional service to a new unknown sector,” especially in regards to the technology. Lees also stated that the difficulty of tracking funds on the blockchain has “created a nervousness among insurance companies.”
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He said that in recent years, strong Know Your Customer (KYC), checks have been “paramount for crypto providers,” whose work has been with blockchain forensics firms such as Chainalysis and Elliptic has made it easier to track transactions between crypto addresses.
Lees expects that the industry’s overall risk will be further reduced. This will make it easier for insurers and consumers to understand and underwrite.
This level of confidence would initially come from the central players in the insurance industry. Decentralized solutions aren’t yet widespread and may need to be improved before becoming mainstream.
Smart contract risks
Over the past few months, decentralized insurance solutions were active. Nexus Mutual, a popular decentralized insurance provider, currently covers more than $400 million in Ether across a variety of projects. InsurAce, meanwhile, claims to have covered more than $340 million.
Cointelegraph spoke with Lior Lamesh CEO and cofounder of GK8, a blockchain security firm. He stated that the crypto ecosystem requires insurance for end-users and decentralized protocols. Wile Lamesh pointed out that “automatic and decentralized insurance tools could indeed be in handy,” but he suggested they could also need insurance.
Decentralized insurance tools, which are part of the protocol layer, rely on smart contracts and could fail over human error. This could leave them vulnerable to hackers.
Lamesh suggested that a flaw in the protocol could be in its ability to cover itself for failures after users suffer losses. He said:
“Hypothetically we could still end-up in a loop smart contracts insuring smart contracts. But I would expect that central insurers would get involved at some point.”
The crypto CEO believes that more central insurers will enter the market because they are better equipped to grasp blockchain technology and stay in the lead, “while decentralized solutions will likely take some effort to develop and find the best approach for the industry.”
He said that hacks in decentralized finance (DeFi), are occurring “every week if not every other day”. This makes it difficult for decentralized insurance protocols, which can be lucrative targets for hackers.
He said that decentralized insurance will “take off” once the industry matures.
Over time, the cryptocurrency insurance industry has grown. Lamesh says the current challenge is to get experts “wrapped around” the technology involved, as blockchain can be confusing enough even for people who don’t have a degree in computer science.
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DeFi protocols are required for crypto insurance transactions. Lamesh said that there may be a bright future for the industry.
“The future is bright, as blockchain enters mainstream insurance and decentralized protocols tap AI-driven data Oracles to offer us customized insurance plans and packages for everything we need.”
Lees stated that the crypto insurance market has “become more established in the last 12-18 month,” with traditional firms entering this space and offering coverage for “certain digital assets based upon how they are stored, and the compliance levels at wallet providers.”
Lees said that as the overall crypto industry expands, Lees can only see the crypto-insurance sector following suit. Given the volume of new crypto wallets opening every month, Lees believes the standards crypto firms will meet will have a traditional feel which will give insurers the assurance that they can underwrite holdings.
Crypto insurers may face significant revenue challenges as central providers might offer products that exclude certain types of risks, such as hacks and smart contract failures.
These risks are what most users want, but the security of a central platform that offers them insurance they can trust may be enough for them to consider entering the crypto market.
Eileen Wilson –Technology and Energy