The cryptocurrency industry is growing exponentially. As it growing rapidly, it is gaining increased acceptance in the traditional financial domain. Regulators are exploring their options for incorporating digital currencies into their central banks, while financial institutions are investigating new cryptocurrency-inspired products for their customers. The world of Decentralized Finance (DeFi) is an exciting one, offering consumers numerous options worldwide to access vibrant new financial products and services. But just as with new technology, cryptocurrency also brings new risks. Is Cryptocurrency Insurance, which promises the protection we seek, the next big thing in the cryptocurrency world?
Cryptocurrency insurance is a type of insurance where the policy is designed to protect against losses associated with cybersecurity breaches. Most of the major cryptocurrency exchanges carry some insurance to protect the digital currencies in their custody against losses from theft and other security breaches.
Since cryptocurrency is not a legal tender, it is not insured the way other deposits might be by bank insurance. For example, in the U.S., bank deposits are protected by the Federal Deposit Insurance Corporation (FDIC) or Securities Investor Protection Corporation.
On the other hand, Exchange Insurance is designed to protect against losses incurred in covered security events. However, occasionally total losses may exceed insurance recoveries, leaving some investors unable to recover their entire investments. Additionally, such policies don’t cover personal losses, such as those associated with personal data breaches or lost credentials — which means that there can be possible coverage gaps for some users.
The cryptocurrency insurance industry is still in its infancy, and multiple Cryptocurrency Assets simply are not protected by the insurance. Most insurance policies are designed for businesses and corporations but not for retail investors.
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Cryptocurrency 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 insurance against the loss of funds associated with the shutdown of a service provider, loss of private cryptocurrency keys, or similar catastrophes. However, these policies are not yet available for consumers to purchase.
In other words, consumer protection depends mainly on the services they access and use. For the most basic safest experience, security should include two-factor authentication (2FA) as a standard. Using a cold wallet for the majority of Digital Currencies is advisable, however, hot wallets are more convenient, but they are also easily accessible to hackers compared to the cold wallet. Cold wallets are offline and are typically air-gapped, making them well-protected from theft.
Most Cryptocurrency Exchanges offer additional security measures, including Cryptocurrency Insurance programs. These are not yet 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.
In 2021, numerous hacks put Cryptocurrency 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 marketplace. There is a real need for Cryptocurrency Insurance policies, but insurance industry policies and premiums tend to be based on historical data. Since the cryptocurrency marketplace is still so new, historical data tends to be skewed, and market volatility can make the process even more difficult.
When Bitcoin and other cryptocurrencies rise in value, Hot Wallets and Exchanges become attractive to hackers and thieves. For example, on January 20, Crypto.com confirmed that it had been hacked with over 400 consumers being affected with unauthorized withdrawals from their accounts. Subsequently, Lloyd’s of London also announced usage of variety of risk mitigation strategies, including cold storage, multi-signature wallets and server-side security.
When Bitcoin was first unveiled, it was intended to serve as an alternative to the traditional fiat currency. 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, and it would work much like any other currency.
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Since 2012, Bitcoin has grown in popularity and value, and numerous other Cryptocurrencies have subsequently been introduced in the marketplace. The cryptocurrency markets have expanded rapidly, and Cryptocurrency Exchanges have had to move quickly to protect the integrity of their markets. The regulatory environment has evolved alongside the cryptocurrency 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 regulatory bodies are taking proactive approaches when it comes to digital currency and assets.
Global organizations such as the Financial Action Task Force (FATF) and the Financial Stability Board (FSB) have issued multiple guidance regarding cryptocurrency, as increased adoption continues with high market volatility a regular occurrence. The mission is to create a strong regulatory environment, to inhibit fraud and money laundering without quashing the free-thinking and innovation to encourage financial market and economic development and let Cryptocurrency Markets to thrive.
DeFi is still a relatively new concept in the Cryptocurrency 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:
The unregulated atmosphere surrounding the cryptocurrency 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.
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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.
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. Cryptocurrency 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 cryptocurrencyexchange.
Generally, Cryptocurrency Insurance is designed to cover institutional losses. If a cryptocurrency 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 cryptocurrency coverage as well. One insurer is now offering the service: Coincover is partnering with Lloyd’s to create a cryptocurrency 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 Cryptocurrency Insurance Market — but they likely will as the insurance industry continues to heat up.
Cryptocurrency 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.
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