Bybit Learn
Bybit Learn
Feb 7, 2022

Is Crypto Insurance the Next Big Thing?

The crypto market is growing in leaps and bounds. As it does so, it’s gaining more acceptance in the traditional financial system. Governments are exploring their options for incorporating cryptocurrencies into their central banks, while financial institutions are investigating new crypto-inspired products to offer their customers. The world of decentralized finance is an exciting one, offering consumers numerous worldwide options to access vibrant new financial products, applications and services. But crypto also brings new risks. Is crypto insurance, which promises the protection we seek, the next big thing?

What Is Crypto Insurance?

Crypto insurance is a type of insurance policy designed to protect against losses associated with cybersecurity breaches. Most major crypto exchanges carry at least some insurance to protect the digital assets in their custody against losses from theft and other security breaches. 

Because cryptocurrency isn’t legal tender, it’s not protected the same way other deposits might be by bank insurance. For example, in the United States, bank deposits are typically protected by the Federal Deposit Insurance Corporation (FDIC) or Securities Investor Protection Corporation.

On contrary, exchange insurance is designed to protect against losses incurred in covered security events. However, total losses may occasionally exceed insurance recoveries, leaving some investors unable to recover their entire investments. Additionally, policies don’t cover personal losses, such as those associated with lost credentials or personal data breaches — which means that there can be coverage gaps for some users.

Do Crypto Exchanges Insure Your Digital Assets?

The crypto insurance industry is still in its infancy, and many crypto assets simply aren’t protected by insurance. Most insurance policies are designed for businesses and corporations, not for private consumers.

Crypto wallets and exchanges purchase insurance policies with coverage, designed to protect against cyber theft and security threats. Other types of coverage are still in development and may feature additional protection, such as decentralized finance (DeFi) insurance, which could feature protection against the loss of funds associated with the shutdown of a service provider, lost private crypto keys, or similar catastrophes. However, these policies aren’t yet available for consumers to purchase.

In other words, the average consumer’s protection depends largely on the services they access and use. For the safest experience, the most basic level of security should include two-factor authentication (2FA) as a standard. Users are asked to provide additional information, such as a code, whenever they log in. Using a cold wallet for the majority of digital assets is also advisable. Hot wallets are more convenient, but they’re more easily accessible to hackers. Cold wallets are offline and are typically air-gapped, making them well-protected from those with ill intentions.

Most exchanges offer additional security measures, including crypto insurance programs. These aren’t backed by government-sponsored insurance plans the way conventional banks are, but if the exchanges are hacked, your funds will be protected and you’ll be compensated for your loss up to the amount specified in the insurance policy.

Do We Need Insurance in the Cryptocurrency Ecosystem?

In 2021 alone, numerous hacks have put crypto funds in peril. The Poly Network hack alone resulted in more than $600 million being stolen from Ethereum, Binance Smart Chain and Polygon wallets. Cream Finance lost nearly $150 million in Ether, Bitcoin and stablecoins in two separate hacks, and in December, hackers stole nearly $200 million from Ethereum and BSC wallets.

Investing in cryptocurrency brings the promise of major returns, but the risks can be very real with a volatile crypto marketplace. There’s a real need for crypto insurance policies, but insurance industry policies and premiums tend to be based on historical data. Because the crypto marketplace is still so new, historical data tends to be lacking, and market volatility can make the process even more difficult. 

When Bitcoin and other cryptocurrencies skyrocket in value, hot wallets and exchanges become especially attractive to hackers and thieves. For example, on Jan. 20, confirmed that it had been hacked with over 400 users being affected with unauthorized withdrawals on their accounts. Subsequently, Lloyd’s of London also reported using a variety of risk mitigation strategies, including cold storage, multi-signature wallets and server-side security.

Crypto insurance can fill the gaps, protecting against losses in a vulnerable, volatile system.

Regulatory Scrutiny

When Bitcoin was first unveiled, it was intended to serve as an alternative to the traditional financial markets. It would serve as a way for people to send and receive money via the internet without the need for an overseeing body or centralized authorities, but it would work much like any other currency.

Since its introduction, Bitcoin has grown in popularity and value, and numerous other cryptocurrencies have subsequently been introduced. The cryptocurrency markets have expanded rapidly, and crypto exchanges have had to move quickly to protect the integrity of their markets. The regulatory environment has evolved alongside the crypto markets, too. Regulators have gone from simply tolerating the existence of cryptocurrency to actively engaging with the markets.

From the Swiss Financial Market Supervisory Authority (FINMA) and Germany’s Federal Financial Supervisory Authority to the U.S. Securities and Exchange Commission (SEC), more countries’ regulatory bodies are taking proactive approaches when it comes to cryptocurrency.

Global organizations such as the Financial Action Task Force (FATF) and the Financial Stability Board (FSB) have issued guidance regarding cryptocurrency, as widespread adoption continues with market volatility a commonplace occurrence. The ultimate goal is to create a strong framework, or regulatory environment, to inhibit fraud and money laundering without quashing the free-thinking and innovation that encourage economic development and let crypto markets continue to thrive.

The Increased Adoption of Digital Assets

Since Bitcoin’s introduction in 2009, the cryptocurrency market has grown in fits and spurts. Still, the market was largely retail-driven until the mid-2010s, when the total market value was valued at around $100 million. At that time, the market entered what was known as a crypto winter, and prices cooled. Speculators fled the market, leaving only diehard crypto users who continued supporting the industry.

Their hard work paid off in the form of stronger infrastructure, new products and soaring demand. The long bitter crypto winter is now over, and institutions are ready to add crypto products to their investment portfolios. The demand for crypto products is hotter than ever, and the general public is clamoring for cryptocurrency and tailored products, financial services — and more regulated infrastructure.

The cryptocurrency market has also never been stronger or more viable for venture capital funds, banks and other institutional investors. Top banks investing in digital assets include Morgan Stanley, JPMorgan Chase, Citibank and BNY Mellon, with institutional investors beginning to significantly outweigh individual investors in the crypto marketplace. Retirement accounts are also increasingly turning to crypto investments.

There’s no better time than now to unveil a crypto insurance market.

Surge for Decentralized Finance (DeFi) Products

DeFi is still a relatively new concept in the crypto marketplace. Through the blockchain, users can complete hundreds or thousands of individual peer-to-peer transactions with complete security and privacy before settling them on the blockchain.

Decentralized finance refers to financial services that enable users to trade, borrow or lend via cryptocurrency on public blockchains. DeFi uses smart contracts to facilitate transactions without the need for a third-party regulator and facilitates peer-to-peer transactions through the use of DApps and/or exchanges.

Common DeFi services include:

  • Borrowing and lending cryptocurrencies to earn interest
  • Creating and exchanging derivatives of real-world assets
  • Purchasing stablecoins

The unregulated atmosphere surrounding the crypto marketplace and DeFi have allowed for some exciting and perhaps unexpected outcomes. In the traditional financial industry, regulations are intended to keep all parties safe and secure — but they can also have a dampening effect, preventing innovation and creativity that allow for stronger financial outcomes for both parties. In DeFi, transactions are built on the concept of “trustlessness.”

This doesn’t mean you cannot trust the transaction. Rather, it means that you do not need to put your trust in a third party or intermediary to complete the transaction. The process instead depends on smart contracts, a series of protocols that must be accomplished before the transaction can complete. This process protects both you and the other party in a transaction. Once the transaction is sent, it’s final. It cannot be reversed or altered in any way.

The growth potential for DeFi is enormous, which is why so many major players are looking to it, such as JPMorgan Chase and the Royal Bank of Canada.

Currently, the total value locked across DeFi stands at around $196 billion, compared to about $435 billion for this time last year. Comparatively, the value of the U.S. dollar is threatened by consumer inflation rates in the U.S.

This makes stablecoins and other cryptocurrencies with yields of 20 percent or greater even more attractive, for both individual and institutional investments. As the infrastructure has advanced, so has the access to and increased adoption of permissioned applications requiring KYC and Layer 1 blockchains, and Layer 2 scaling solutions for increased speed and improved asset management.

This has led to a new stage of evolution, with new cryptocurrencies, stablecoins and non-fungible tokens bringing new products and services — not just to more countries, but potentially to the entire world. This includes the estimated 1.7 billion currently unbanked people who could obtain simple mobile wallets, granting them instant access to the currency of their choice at a fraction of the cost of a traditional financial institution.

Surge in Bitcoin’s Value

Bitcoin was the first cryptocurrency in history, and its blockchain was initially slow to attract fans. The first BTC cost just a fraction of a penny. Over time, its value slowly and steadily increased until it was nearly a dime.

Although at first only intended as a way to opt-out of the traditional banking structure after the 2007 financial crisis, the Bitcoin blockchain has grown to so much more. Recently, its price has soared and is currently trading near $40,000.

Cryptocurrency is a volatile market, though, and prices can drop quickly, even within a few hours — which is why experts recommend keeping only a fraction of your portfolio in cryptocurrency investments. Crypto insurance isn’t necessarily designed to cover the devaluation of your crypto, but it can protect against certain types of losses, such as a misplaced or forgotten key, or hacking or theft.

Increasing Crypto Hacks and Cyber Infiltration

As more people opt into cryptocurrency for everything from day-to-day transactions to investing for retirement, they attract another type of attention: that of bad actors with ill intentions. Hackers, infiltrators and thieves find the large volumes of currency passing through exchanges to be irresistible, and they use every tool at their disposal to access it. Security has been a concern for Bitcoin since its inception.

Blockchain technology has always been secure and difficult to hack, but it’s not totally impenetrable. Security risks are almost inevitable at every stage of the transaction process. From hacking into hot wallets to outright scams, hackers will attempt to access digital funds any way they can.

They’ll also attempt to infiltrate security systems. Crypto exchanges hold private wallet keys on behalf of their users via a custodial structure. This allows for speedier transactions, improved service and protection against loss. However, it can also pose a grave cyber threat if the administrative key is compromised by a security breach. The “admin key” provides complete control over smart contracts. If user funds are lost through a breach, they can only be protected for the amount insured by any policy covering them.

Therefore, both leading-edge security and high-quality insurance coverage are essential for protecting your digital assets when using a crypto exchange.

Can You Buy Personal Crypto Insurance?

Generally, crypto insurance is designed to cover institutional losses. If a crypto exchange is affected by a security breach, its losses will be covered up to the amount covered in the policy. However, this emerging industry is beginning to recognize the need for individual crypto coverage as well. One insurer is now offering the service: Coincover. Coincover is partnering with Lloyd’s to create a crypto policy that covers losses beyond that which an exchange might typically include. The policies range in cost from $10 to $750, and cover account holders’ digital assets against hacking, phishing, malware, device theft, trojan software and brute force attacks. There are some exclusions, however, and certain types of losses aren’t covered, including price fluctuations, blockchain failures and hardware loss or damage.

Other insurers haven’t yet entered the crypto insurance market — but they likely will as the insurance industry continues to heat up.

Is Crypto Insurance the Future?

Crypto has gone mainstream, and as more people adopt and invest in digital assets, the industry will continue to expand. The potential for this virtually unregulated industry is nearly limitless — which is just what makes the risk-averse insurance market hesitate. That doesn’t mean that there aren’t plenty of opportunities for you, however. Proceed with caution, keep your wallet secure, and choose your investments wisely.