by Sam Ingalls
Since the days of Hammurabi – nearly four thousand years ago – insurance has been a system where two parties agreed to financial terms to protect an asset. Today, the next big prospect for financial protection could be the ever-volatile cryptocurrency space.
In modern society, nearly everything can be insured. Our livelihoods through life, disability, and health insurance. Our tangible assets, protected by insurance for the car, home, and family heirloom. In the scope of financial planning, insurance is the foundation that secures an individual or organization’s future by managing existing risk. But how do organizations and investors insure their newest digital assets?
For startups or organizations that went headfirst into cryptocurrency, insuring their financial stake hasn’t been easy. However, a growing market of financial products rooted in blockchain technology, as well as an increasing acceptance by private and public institutional stakeholders, means crypto assets could soon receive the same protections as traditional financial assets.
This article looks at how we got here and how one crypto segment is approaching insurance through decentralized finance.
The Road for Crypto Assets
Why Is It Taking So Long?
For years institutional advisors downplayed cryptocurrency, and can we blame them? The financial ecosystem has long strived to correlate investments in companies and assets with quantitative data to back up the purchase. Crypto was an exciting innovation, but an asset’s lack of understanding and legitimacy tabled further discourse. Add consistent volatility, and we’ve got a good argument for why it’s taken this long.
The Legitimization of Cryptocurrency
In 2009, Bitcoin launched as the world’s first successful decentralized exchange. Over a decade later, public financial institutions are now asking if cryptocurrencies are a feasible alternative to existing fiat currencies. With more investors, startups, and traditional institutions looking at cryptocurrency or already engaging somehow, the chances of broader market adoption grow.
A crucial ingredient to any financial market is investor participation. With tens of millions of crypto investors and more starting every day, institutions don’t want to miss out on what some perceive as the newest gold rush. Individual and institutional crypto investing only further legitimizes their value as assets. It’s a matter of time before every 401(k) portfolio contains a strategic portion of crypto assets.
Crypto Investing Opportunities Grow
In the realm of crypto investing, it seems new types of assets emerge every year. Cryptocurrency tokens like Bitcoin and Ethereum are the most familiar and popular. While just this last year, non-fungible tokens (NFTs) emerged as the next-generation medium for trading creative works, and blockchain-based insurance is a natural addition.
As a whole, crypto tokens are often broken down into types: utility tokens and security tokens.
Utility Tokens: Ticket to Ride
Utility tokens offer a right to a future service or product. Unlike crypto coins, which predominantly serve as an alternative to cash, utility tokens represent the value of the service or product. An online services vendor like a videogame developer can initiate an Initial Coin Offerings (ICO) to offer players tokens for use on the game platform. Like a voucher, utility tokens can be exchanged for their monetary value or used directly for their intent.
Security Tokens: Digitization of the Stock Market
In contrast, security tokens are digital contracts that represent an ownership stake in an asset. Through Security Token Offerings (STO), this new era offers tokenized forms of stocks that grant the owner the same rights as a stock owner. Bringing the traditional financial market and crypto space together, security tokens give investors the opportunity to buy fractions of assets, like stocks, backed by blockchain technology and regulated by traditional institutions like the SEC.
Decentralized finance (DeFi) uses cryptocurrency markets that employ smart contracts in place of traditional brokers, exchanges, and banks. Besides adopting one of the hottest new assets, DeFi protocols have shown far stronger yields than conventional bank accounts.
For those interested in securing their crypto trading, DeFi can offer protection against exchange hacks, smart contract vulnerabilities, and higher premiums. Existing DeFi insurance vendors include Nexus Mutual, Unslashed Finance, iTrust Finance, and Cover Protocol.
Nexus Mutual, run by its members, holds insurance claims accountable via a community-based system of governance. Having an NXM token doesn’t cover the risk of an exchange hack, personal key loss, or phishing attacks. Still, it can mitigate unintended uses of smart contracts due to code vulnerabilities.
Unslashed Finance is a pay-as-you-go insurance vendor covering stable coin pegs, validator hashing, smart contract vulnerabilities, and oracle failures. The London firm currently manages over $500m with 3,210 capital providers in their decentralized autonomous organization (DAO) that secures insurance contracts.
iTrust Finance focuses on building cover capacity for insurance protocols (like Nexus Mutual) to lower premiums and increase adoption. Vaults provided to clients manage the staking of tokens. In the future, iTrust looks to adopt ETH, BTC, and more for protocol options and expand to simple cross-insurer exposure.
Cover Protocol also seeks to address the insurance gap with peer-to-peer coverage via fungible tokens (not NFTs). These tokens serve as the collateral to cover a product and a source of liquidity when traded. Coverage demand and supply set the coverage premium, and clients don’t need a KYC to start.
The Need for Greater Protection
Though DeFi insurance is in its early stages, it’s encouraging to see organizations addressing the risks presented by crypto investing. Until underwriters become more available or willing to cover crypto assets, investors can continue to expect higher premiums. Factors like a lack of historical data, volatility in cryptocurrency tokens, and the extent of personal responsibility all play into why insuring the market at large isn’t currently feasible.
In the meantime, investors holding crypto assets must be vigilant and implement the best cybersecurity practices. These include:
Understanding crypto: how tokens, crypto exchanges, and blockchains work
Cold wallets: disconnected token storage to prevent cyber compromise
Wallet diversification: splitting assets between multiple wallets to reduce total risk
Robust access controls: including MFA to ensure authentic access
Understanding malware: avoid excessive sharing privileges and malicious links
Disclaimer: Investing in cryptocurrencies and crypto tokens remains a highly risky and speculative endeavor. This analysis is not a recommendation by the author or publishing website to invest in crypto assets, and interested parties should consult with a financial professional before investing.
About the Author: