Cryptocurrency Insurance – Does It Exist and Is it Worth It?
With the crypto space still growing out of its infancy and largely unregulated, investors need protection for their investments. This is where cryptocurrency insurance enters the picture.
What is cryptocurrency insurance?
Investors in the United States and most first-world countries, who entrust their assets to a bank, can rely on government protection and insurance. In the U.S., the Federal Deposit Insurance Corporation (FDIC) provides standard insurance for depositors per insured bank of $250,000. In the E.U., depositors’ savings are insured for up to €100,000. Should a bank fail, for whatever reason, depositors are guaranteed to receive back their funds up to the insured amount.
However, since cryptocurrencies are not yet legal tender in most countries, and crypto exchanges and custodians are largely unregulated, there is neither governmental protection nor insurance for crypto deposits. Should a crypto exchange fail or theft occur, then there is no guarantee that investors will receive back any of their funds. This is where crypto insurance steps in and offers holders of cryptocurrencies some protection.
Note: In the earliest days of banking, before private and governmental insurance for bank deposits was introduced, investors’ only protection against bank failures was to withdraw their assets and hold them in self-custody in the form of precious metals, paper securities, and central bank notes.
Today, with cryptocurrencies, investors have the option to withdraw their funds from crypto exchanges and custodians to their personal crypto wallets as well. This way, their funds are fully under their control and responsibility. For reasons of convenience or to generate extra returns, many investors waive the possibility of self-custody and leave their funds with a third party. This increases the demand for crypto insurance.
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Why crypto insurance is needed
The success of Bitcoin, Ethereum, and many other cryptocurrencies have attracted high levels of criminal energy. Technically skilled actors saw the endless potential to steal vast amounts of money from uninformed and careless crypto investors, projects, and protocols.
The first known crypto hack happened as early as 2011. The largest Bitcoin exchange at the time, Mt. Gox, was hacked and 25,000 Bitcoins (U.S. $400,000 at the time) were stolen from over 400 users. And this hack was just the beginning. Since then, countless thefts, hacks, scams, and rug pulls have shaken the crypto world, with the amounts stolen getting higher year after year.
Today, large crypto exchanges and custodians are facing several challenges. First, they have the honey pot problem. Due to the large amounts of cryptocurrencies they hold, they become attractive targets for hackers and thieves. Second, multiple large exchanges such as BitFinex or KuCoin got hacked even though they took security measures and promised safety to their customers. The lesson here is that there is always a small probability that a hack could occur, no matter how tight the security measures are. Third, should users lose trust, they will immediately transfer their funds to different exchanges or their personal wallets — given they still can.
To mitigate these threats, exchanges and custodians are pressured to signal to their clients that they have ramped up the security measures to keep the entrusted assets safe. As promises are cheap and actual security measures hard to check for outsiders, crypto insurance proves to be a great way to signal to customers that their funds are protected.
How does crypto insurance work?
There are two basic types of crypto insurance. The first type is for crypto exchanges and custodians, while the second is for individual investors. As of today, the largest section of the crypto insurance market is held by crypto exchanges and custodians, with individuals only accounting for a tiny fraction of total revenue.
Crypto Exchanges and Custodians
To prepare for the event of a hack or theft, some crypto exchanges and custodians take out insurance policies with companies like Lloyd’s to insure parts of their assets. Should an incident happen, then the insurance company covers the damages up to the agreed amount. Examples are (numbers show insured amount):
Coinbase: $225 million
Nexo: $371 million
BlockFi: $200 million
Currently, there are not many insurance companies that are capable and willing to insure crypto exchanges, especially when it comes to hacks and thefts. The main problem is that assessing the inherent risks of such attacks is difficult. Due to the lack of adequate offerings by insurance companies, or the high premiums charged for such services, some crypto exchanges have started their own insurance and reimbursement funds to protect their customers against hacks and theft. Examples are:
Binance Secure Asset Fund for Users: >1 billion
Huobi User Protection Fund (20% of income) and Huobi Security Reserve (20,000 BTC)
For users, no extra costs occur for the insurance protection offered by the exchange. Thus, when opening an account with a crypto exchange, make sure it has some form of user insurance in place.
Individual crypto investors can also protect their cryptocurrencies held in online hot wallets against theft or malicious attacks. For example, Coincover has created an insurance product that protects crypto assets stored in a wallet from a value as low as $1,000.
For the price of roughly 1% of the assets stored in a wallet, Coincover insures investors “against attacks their tech is designed to prevent.” This suggests that their insurance only covers cases that their tech has actively been designed to prevent but not all other attacks. Whether or not such an insurance policy is worth the money is up to each individual user to decide.
Is crypto insurance here to stay?
Crypto insurance is still in its infancy. Currently, only a handful of insurers are offering some form of cryptocurrency coverage. But as the crypto market matures and the adoption of cryptocurrencies advances, the field of crypto insurance will attract many new players. It is seen as a promising opportunity for growth and a future revenue driver for insurance companies.
There are several important factors that influence the future of the crypto insurance space.
Government protection and insurance: Should Bitcoin and other cryptocurrencies become legal tender, then, in the future, crypto deposits could be covered by governmental protection and insurance as well, just as bank deposits are today.
Government protection and insurance would likely only be available for regulated financial institutions with the necessary licenses. Practically, this would mean that only some, not all crypto exchanges, would be eligible for government insurance.
New regulation: Lots of new regulation concerning crypto is expected to be put in place in the years to come. There is the possibility that crypto exchanges could be forced by law to insure their clients’ funds. This would present an opportunity for insurance companies to enter the crypto space and offer their own insurance products.
New technical development: During the past few years, centralized parties have offered many services in crypto. But lately, the crypto community has built similar services in a decentralized manner as well. For users, this reduces the dependence on centralized parties and allows for more trustless, on-chain interactions. On an individual level, this could shift the need for insurance coverage from protection against third-party risks to protection against smart contract risks.
And even insurance services themselves have been built in a decentralized manner on the blockchain. Protocols like Nexus Mutual and Etherisc offer on-chain insurance against smart contract failure, exchange hacks, flight delays, hurricanes, among other incidents.
Crypto insurance is a growing field
With more institutional investors entering the crypto space and the technical complexity increasing, the need for crypto insurance will most likely increase in the years to come. As large profits are generated with crypto investments and lots of money will keep on flowing into the space, insurance companies will be able to charge attractive premiums for their services. It, therefore, only seems a matter of time until the market around crypto insurance takes off.