20
Sep
2022

Crypto insurance market expands with decentralized and centralized options

Insurance is key for financially securing important assets. Yet, the cryptocurrency sector — which is predicted to reach a global market size of $4.94 billion by 2030 — may be lagging behind when it comes to insuring digital assets. 

For instance, it’s been noted that less than 1% of all crypto investments are currently insured. This statistic is alarming, considering the rapid growth and high-risk profile associated with today’s cryptocurrency market.

Ben Davis, team lead for digital assets at Superscript — a British startup and Lloyd’s of London-licensed insurance broker — told Cointelegraph that crypto has been marginalized when it comes to insurance solutions.

“Superscript has spent years focusing on insurance for emerging tech fields. I lead a team that focuses specifically on crypto and never in my career have I seen an industry more marginalized,” he said. Although the cryptocurrency sector is advancing, Davis believes that it continues to lack insurance solutions due to the industry’s strong financial focus. He said:

“Crypto is tackling something very fundamental, which is money. But, as a society, we tend to shy away from this topic. When a technology sector focuses on hard questions relating to value and exchanging money, insurance underwriters tend to move away from this conversation.”

Growing need for crypto insurance 

Although this may be, the need for insurance solutions within the crypto industry is becoming more important than ever before. In order to fill this gap, Davis explained that Superscript is taking a centralized approach to bridge the divide between traditional insurance providers and crypto companies. “We translate the risks associated with digital assets to the broader insurance community. Everyone on our team holds and interacts with crypto, so we speak the language,” he commented. 

As a Lloyd’s broker, Davis elaborated that the firm has experience getting customers in front of multiple insurance companies. As such, the firm has a centralized finance (CeFi) approach by presenting crypto companies to insurance providers suitable for their needs. “We work with many nonfungible token organizations, or crypto companies partnering with big names in entertainment, to help secure contracts with traditional insurance firms. We provide insurance for the full spectrum of digital asset businesses including tokenization platforms, miners, custodians, blockchain developers and more,” he shared.

Regarding the process involved, Davis explained that Superscript helps educate insurers about risk concerns related to cryptocurrency to ensure they can work with digital asset companies. Like most traditional insurance providers, Davis pointed out that insurers working with crypto will take premiums in fiat currency rather than in crypto. “We are currently looking at ways to innovate by making this process more seamless for our clients,” Davis added.

While Superscript aims to bridge the gap between traditional insurers and crypto companies, a number of decentralized finance (DeFi) insurance solutions have also come to fruition. Dan Thomson, chief marketing officer of InsurAce.io — a decentralized finance risk protection protocol — told Cointelegraph that although crypto insurance is broad, it fundamentally means that crypto users are protected against certain risks and catastrophic losses to their portfolios. “It is a financial insurance tool emerging in the wake of a multi-trillion dollar market,” he said.

Given this, Thomson explained that InsurAce aims to solve the intrinsic risks associated with DeFi protocols. In order to do so, Thomson mentioned that InsurAce works by allocating staked capital in its protocol as insurance capacity. DeFi users are then able to buy this capacity to cover their investments and staked assets in various protocols. “In the event of an exploit, for example, customers can claim via the InsurAce app. The decentralized organization, or DAO, will then vote on the legitimacy of these claims,” Thomson said.

Although this process differs from traditional insurance solutions, it has proven to be effective. According to Thomson, InsurAce’s largest payout occurred when the Terra ecosystem collapsed in May 2022.

Recent: Does the Ethereum Merge offer a new destination for institutional investors?

“We received 180 claims in total. InsurAce paid out $11.7 million to 155 affected TerraUSD Classic (USTC) victims,” he said. Some 8% of InsurAce’s USTC payout was made in stablecoins, while 60% consisted of layer-1 tokens, and the remaining 4% was paid in the platform’s INSUR token. According to Thomson, this process took one month to complete, which is typically faster than payouts processed by traditional insurance firms.

Given the decentralized nature of the crypto sector, it shouldn’t come as a surprise that other projects are focusing on DeFi insurance. Adam Hofmann, founder and CEO of decentrazlied insurance protocol Nimble, told Cointelegraph that digital assets must be backed by insurance in order for the crypto sector to advance. After spending 22 years in the traditional insurance sector, Hofmann founded his firm in June 2021 with the goal of creating a more democratized insurance process.

Hofmann explained that Nimble applies traditional insurance concepts to decentralized finance. For instance, the platform is built on the Algorand blockchain and works to insure DeFi projects powered by Algorand. But like traditional insurance providers, Hoffman explained that Nimble consists of underwriters, claim assessors and loss adjusters, all of which are pulled together to help facilitate “risk pools.”

“A risk pool is like a liquidity pool, but this involves retail and institutional investors allocating money to subsidize the risks on insurance. This creates a more democratized insurance process,” he remarked.

Hofmann added that Nimble works directly with customers to gather important information necessary for underwriting. This data is then released into the Nimble portal, allowing users to purchase insurance for certain DeFi platforms.

“If users stake an amount of crypto on a platform we support then they can purchase the insurance for a rate. This premium goes into the risk pool for that project and customers receive a nonfungible token in their crypto wallet representing that insurance policy,” he explained. In the event of a DeFi hack, Hofmann mentioned that customers will be notified immediately and receive payouts in crypto directly to their wallets upon community and smart contract approval.

Indeed, democratization seems to be a common theme among crypto insurance providers. For example, Nexus Mutual is a discretionary mutual currently covering millions of dollars in Ether (ETH) for various DeFi projects.

Hugh Karp, the firm’s founder, told Cointelegraph that the platform is an automated version of a very old structure where members share risks together. “The primary problem Nexus solves is the sharing of new and novel risks in the cryptocurrency space where coverage isn’t available in normal markets.” According to Karp, Nexus does this by allowing members to decide how risks should be priced, along with how claim payments should be made.

While this approach may be a good fit for the crypto industry, Karp noted that building trust with customers to ensure that genuine claims will be paid remains a challenge. “This can only be achieved with time and a track record. It’s also challenging to price risk appropriately, and we’ve seen some other crypto insurance platforms have trouble with this recently with the Terra collapse.”

Education is crucial for DeFi and CeFi insurance to take off

While some members of the cryptocurrency ecosystem view centralized approaches to insuring digital assets as harmful, it’s evident that both CeFi and DeFi solutions are needed. “Traditional CeFi insurers often get a bad rep, but this year alone I have seen more traditional insurers enter the crypto space than I have seen in the last five years of my career,” said Davis. 

This has become the case, especially as more institutional investors enter the digital asset sector. “Many of the companies we insure need to have financial backing from traditional insurance providers that are regulated,” Davis remarked. This notion is also starting to resonate with DeFi providers. For instance, Hofmann mentioned that Nimble is in the process of obtaining an insurance license through the Bermuda Monetary Authority in order to ensure both DeFi and traditional insurance capital protection. In the meantime, Hofmann believes it’s important that the Algorand Foundation is backing Nimble by providing a certification of the platform for users.

Even with certifications and credibility, insuring crypto assets remains a tricky business. For example, a number of cryptocurrency exchanges have been under fire recently for making false claims of being insured.

Last month the leading cryptocurrency exchange FTX received a letter from the Federal Deposit Insurance Corporation (FDIC) accusing the exchange of falsely implying that user funds were FDIC-insured.

Moreover, Celsius — the cryptocurrency lending platform that recently went bankrupt — is facing a lawsuit based on forged claims that users’ digital assets were insured. “The challenge of the insurance industry is that it can be confusing. People, along with organizations, sometimes don’t know what they are actually covered for,” said Davis. Due to this, Davis believes that trust within an organization or an entire industry can be easily eroded.

Recent: The Metaverse is becoming a platform to unite fashion communities

To ensure smooth development moving forward, industry experts agree that more education is needed. For Davis, this starts with educating traditional insurance brokers on how to handle crypto claims. DeFi-focused solutions, on the other hand, must focus on helping investors understand what is covered from the start. 

“For instance, market volatility can create confusion. InsurAce also doesn’t KYC customers, yet a protocol listed that their assets are insured through us on their website. When the Terra incident happened, customers were unclear about their coverage,” said Thomson. Given this complexity, Thomson believes that the vast majority of insurance coverage will be provided by crypto-native solutions.

“The risks are very novel and require deep specialist knowledge, which our members have. Some traditional providers have started dipping their toe in the space, but I suspect they will have a few false starts and progress will take quite some time.”