Many people all over the world have compared the cryptocurrency market to the wild West, largely because of the fact that there is little regulation. Crypto allows ordinary people and businesses to bypass traditional intermediaries, allowing people to make transactions in a cheap manner. So what does the future hold when there is such little regulation? Are assets likely to be safe and what can be done to protect assets? We look at crypto-insurance and what this will mean for the crypto world.
The current state of the crypto market
It is very easy for businesses and people to benefit from quick and simple payments. People can also remove any obstacles that put SMEs in a bad position, especially when major corporations are trying to compete with each other. Cryptocurrencies are great because banks are not needed for transactions to go ahead. The result is a reduction in processing fees which can cost people a lot of money.
A small or medium business’ sales opportunities can be expanded by cryptocurrency. This can be done by leveraging its acceptance as an international trade medium. Exchange rates between countries, buyer and seller may also fluctuate with traditional currency transactions because they can take many days to process, whereas cryptocurrency mitigate against this sort of risk. Funds are transferred quickly and cryptocurrencies have their own exchange rate, although this can also be an additional risk if the currency becomes prone to fluctuating value.
You can think of cryptocurrency as a bearer asset – this means that owning a bitcoin or some other unit of cryptocurrency establishes ownership, just like conventional cash does. The possessor is entitled to the value of their currency. However, when a bitcoin is stolen, this makes it very difficult to establish who owned it if authorities don’t know who actually possessed the bitcoin in the first place. Theft is a large risk for any currency like this. You can look at countless examples of crypto theft all over the media such as the following:
- Mr Gox Losing over $450 million in 2014
- Bitfinex losing 120,000 bitcoins in 2016
- Coincheck losing over $520 million which belong to their customers in 2018
- Hackers managed to steal over $1 billion of bitcoin in the first three quarters of 2018 alone
There are also other risks around, albeit slightly less nefarious. These can range from technical glitches to human errors and even price volatility can have disastrous consequences. Many investors in crypto have looked towards ways of protecting their assets. This is why many firms and consumers are looking towards crypto-insurance in order to protect from the damage of potential theft. It is unsurprising that a lot of insurance companies are now looking at charging premiums to cover potential losses of crypto assets. It is a market that is certainly going to rapidly evolve in the future.
The need to attract institutional investors
If more people are going to be investing in the crypto centre, insurance needs to be provided. You can look at a good example whereby the recent exchange of Gemini recently launched a captive insurance company. This company has worked to ensure the crypto exchange for losses of up to $200 million, which is the largest amount to date for any cryptocurrency custody service on the planet. Gemini’s institutional clients will be able to meet all of their regulatory requirements with ease. It’s no surprise that such large amounts are being insured for by the company. It is a company that prides themselves on putting security first while creating an environment that is compliant and friendly with customers.
In light of all of the risks and the fastly unregulated world of digital currency, the crypto sector is crying out for solutions and traditional insurance is one of them. It is this kind of insurance that protects far beyond thieves and hackers, for instance, many companies will provide insurance to account for risks with price volatility. This is a brilliant thing as it can protect firms from gyrations in the market, so for example when the price of bitcoin drop by ⅓ two years ago, there could be some compensation for this.
A company called Equilibrium have recently explained that the world’s crypto community needs to have reliable insurance solutions. They have spoken out in praise of such solutions because Black Swan events, unusual events and fluctuations need to be accounted for.
It is not as if an unusual event needs to be catastrophic. As an example, South Korea could decide to shop all of their exchanges down or United States regulators could suddenly decrease their hammer on bitcoin.
Equilibrium has been looking at matters slightly seriously. They have recently created stability funds which protect all of their users from strange and extraordinary market events. Those that use their stablecoin can now have added peace of mind when thinking about the protection of their assets.
The CEO of Equilibrium, Alex Melikhov, recently explained that users purchase their coin expecting the price to remain stable and not fluctuate. When extraordinary market events happen, this tends to affect the price of all cryptocurrencies, including theirs, so the price of bitcoin decreasing could as an example lead stablecoin to plummet. Users of this currency could find that in an instant their assets could become liquidated. Mr Melikhov believes that if something unusual were to happen such as a fluctuation that will cause the value of their currency to decrease any overall system collateral value to decrease below the value of stablecoin supply, their smart contract-based fund could step in in order to algorithmically ensure that all users of the currency will be able to maintain their value.
The protection of users
It isn’t only Equilibrium that is trying to implement self-capitalized funds to ensure the protection of their users. Other leading exchanges are trying to do it too. 2018 saw Binance announcing that 10% of all trading fees that they received would be put into an asset fund that would be stored in a separate cold wallet crypto system. This would then protect their uses and funds when extreme events occur. Almost a year later saw hackers stealing over 7k bitcoins with a value of over $41 million. Binance used emergency insurance to cover the costs relating to the incident.
Beware of dangers
With all the talk of protection and losses, traditional insurance companies are trying to outsource into the crypto sphere. The last two years have seen many insurance companies branching out and attempting to cover for crypto problems. It usually isn’t very cheap and affordable, yet is a way that you can protect your assets. The fact of the matter is that cryptocurrencies are very precarious and unsettled just by their very nature. There is also a distinct lack of historical loss data, so overall people really need to proceed with caution.
Many more custodians and crypto exchanges are turning towards using traditional insurers and brokers in order to gain some protection against thieves and hackers. When base revealing details of insurance coverage for its hot wallet crypto holdings exceeding over US$200 million. This was purchased through a broker working for Lloyd’s of London. Gemini, for their part, was assisted by various other brokers and their recent company launch.
If you look at last year’s scandal by firm Quadriga, another security firm who specialise in crypto security called Bitgo announced that they had purchased a US$100 million policy in order to cover any potential mishaps for their digital assets. Many insurance companies are at a much later stage of development and progression than others. There is a lot going on in the busy crypto community. Lots of companies are trying to tap in on insurance schemes in order to protect people’s assets, so the market is going to grow and grow much further in the future.
The vast majority of companies and organisations will have to sit down and educate all of the upper management levels about crypto. This is not something that is going to happen overnight, for instance, it could take many years. However, many more carries begin to create crypto policies today and we think that this as a trend that will continue to expand in the future.
How can capital best be used?
Crypto assets have to be handled with a lot of care these days. It is often the case that an exchange set aside some capital so that when mishaps occur, potential losses can be covered. However, there are a lot of problems that can exist with an approach like this. By setting coins aside, this means that you are sacrificing coins that could be potentially invested in. This sparks as not the best use of one’s capital. It is also the case that coverage terms and conditions are often very ambiguous because there is a lack of expertise.
Some companies are looking at forming captive insurance entities, whereby segregated funds are kept in audited and regulated vehicles. This kind of system could help an exchange get a lot more coverage from the reinsurance market. Many companies and people are optimistic about captive insurance options. However, there are some caveats to this. Every exchange is different, with different ways of being attacked and different kinds of security mechanisms to hold it in place. It will be quite difficult to come up with standardise industry pricing models without understanding the security methods of each exchange. Exchanges may also not want to share details with their competitors, therefore facilitating a further lack of understanding. Owning insurance may also discourage exchanges from investing in security to compensate for their costs of insurance.
The limits to insurance
It’s not possible to easily ensure everything, however. Not every insurance policy will guarantee total security, for instance no insurance company will fully cover an online site Book of Ra if it were to one day lose all of its money. One of the most difficult crypto holdings to insure are assets there are stored in hot wallets. It’s also not possible for an insurance company to provide measures in extreme cases, for instance, if bitcoin goes to 0 in value. For those users who are worried about their private keys being compromised, it’s important to look towards special vendors that will provide added protection. Every investor will want to research every vendor’s reputation and their balance sheet before thinking of entrusting crypto assets towards them.
Insurers require frameworks to price risk and this is something that is difficult in the crypto community. If you take an exchange, who is the insured’s regulator? Do firms have relationships with this person? What kind of financial position as the company in? Who exactly is on the management team and do they have experience? These are some of the questions that are difficult and time-consuming to answer. Companies that have been dealing in crypto have been rapidly evolving. Exchanges today look a whole lot different to those that started many years ago. However, there is usually an audited chief compliance officer employed to seek out any problems with regulators when issues occur. When compliance from the regulator is a priority, a business is going to find it easier to underwrite.
It is difficult to think about the safety of your crypto, especially when there is a lack of worldwide regulation. However, it’s unsurprising that insurance options are becoming available. All sorts of crypto firm insurance policies now exist and insurance is a hot trend in this financial world. It is without a doubt that the numbers of insurance policies will grow for many years to come in order to protect many people’s assets.
Are you an avid member of an online crypto community? We’d love to hear your thoughts on cryptocurrency exchanges and what needs to be done to improve them. Do you think insurance will help? Tell us about your thoughts and reflections in the comments section below.