Crypto Lending Insurance

Who has it and why it's important. Learn about insurance products and practices within the crypto industry.

Mainstream adoption of crypto assets worldwide has led to incredible growth for many crypto projects. One of the leading beneficiaries of this growth has been the crypto lending industry.

In a report released in 2020 by Credmark, crypto loan originations totaled more than $7.8 billion in the final quarter of 2019. From 2019 onwards, the value of loan funds generated has gradually increased to more than $10 billion per annum.

Exponential growth within the crypto industry has prompted insurance firms to develop and offer insurance products for this industry.

The purpose of this article is to help you learn about insurance products and practices within the crypto industry. However, we will explain the role insurance companies play in a traditional lending company. We will also provide answers to questions like what is crypto lending insurance? How does a decentralized insurance platform operate? What are smart contracts?

What Are Insurance Corporations?

When unexpected events occur, insurance corporations provide financial coverage for traditional money platforms. Policyholders are, however, required to pay a fee, or "premium,” to enjoy the insurance policies issued by these corporations.

The Federal Deposit Insurance Corporation (FDIC) serves as the main insurance organization for traditional lending for banks located in the US. They also examine and monitor traditional financial institutions for safety and security. All money organizations under the FDIC are federally insured.

Another major function of the FDIC is to resolve likely issues for large and complex financial institutions. They are also tasked with managing receiverships and they offer investment advice to their policyholders.

The FDIC also monitors and insures many of the safest and most established platforms. Some of these platforms include Binance, Coinbase, Gemini, and eToro. Currently, the FDIC does not insure loan funds for cryptocurrency lending platforms. However, the FDIC has commenced work on the Crypto-Asset Policy Sprint. Currently, there is no set timeline for completing or implementing this policy.

What is crypto lending insurance?

There are two types of crypto lending companies: centralized lending platforms and decentralized finance lending protocols. Centralized lending platforms are controlled and owned by a central entity. Decentralized finance lending protocols are totally decentralized. These protocols make use of lines of code called smart contracts to coordinate lending activities.

Crypto lending insurance is an insurance policy obtained by crypto lenders and crypto investors to protect their digital assets from theft, hacks, or rugpulls.

Similar to FDIC operations, these organizations offer insurance policies to protect policyholders from losses resulting from theft, potential bugs, mishandling of private keys, or hacking-related incidents.

A long list of incidents has led to massive loss of funds for some crypto lending platforms. For example, a popular multi-chain lending protocol, Cream Finance, experienced a flash loan attack and lost over $130 million during the hack.

Also, On September 30, 2021, an error in the computer code of the decentralized finance lending protocol Compound caused a loss of over $90 million. In the past decade, consistent cybersecurity breaches and major hacks have led to the development of insurance products specifically designed to protect crypto investors and lenders.

Previously, crypto insurance policies were primarily available for exchanges, lending platforms, and crypto-wallets. However, with the development of decentralized insurance applications, crypto investors can now enjoy a wide range of insurance products.

Crypto lending insurance for centralized crypto platforms

Although relatively new within the crypto industry, there are several centralized crypto lending platforms that have insurance policies with top-rated insurance organizations. By taking these steps, the platforms are insuring their digital assets and protecting their users.

Nexo, a centralized crypto lending platform is regarded as the first lender to insure its custodial assets. A benefit of this insurance policy is that it covers up to $370 million in losses for users. This insurance policy is a result of Lloyd’s of London and BitGo’s partnership with Nexo. Currently, Nexo’s insurance coverage is worth over $370 million.

CoinLoan is another centralized lender with a comprehensive insurance policy for its digital assets. Due to its partnership with BitGo and Lloyd’s of London, this lender's crypto-backed loans have insurance coverage worth up to $100 million dollars.

There are a lot of insured centralized exchanges that offer insured crypto loans to their users. For example, Binance Holdings Ltd. has established an insurance fund worth over $1 billion for all financial products on its platform. This insurance applies to crypto loans offered by the platform.

What are smart contracts?

A centralized lending platform offers the same financial products as a traditional lending company. They also use similar insurance products to protect their assets from theft.

On the other hand, decentralized insurance is used to protect smart contracts that run and operate decentralized finance loan organizations. So what is a smart contract?

A smart contract is a set of programming codes stored on a blockchain to carry out specific tasks when certain predetermined conditions have been met. Their primary function is to automate the execution of already established agreements. In this capacity, smart contracts alert all participants to the eventual outcome of the agreement while eliminating the need for a third party.

All decentralized finance loan protocols use smart contracts to execute the financial products they offer. Due to their importance, smart contracts have become a target for security breaches. Successfully hacking a smart contract can lead to the loss of funds for users.

Advantages and disadvantages of smart contract code

There are many advantages attached to the use of a smart contract code by decentralized finance lending protocols. Their implementation adds transparency to the loan application process.

The codes also ensure customers enjoy fast transactions, saving them hours on various business processes. They also deliver accurate results based on the pre-existing terms of agreement by parties to the contract.

In terms of their limitations, smart contract codes are inflexible. In simpler terms, this means that they can not be easily altered after they are launched. Additionally, these contract codes require information from external sources to fulfill some of their terms of operation. Due to this factor, they are not completely decentralized.

What is a smart contract cover?

A smart contract cover is an insurance product designed by decentralized insurance companies to pay out claims made by crypto investors and lenders in case of a smart contract hack or a DAO hack.

Nexus Mutual is a crypto insurance platform that offers a comprehensive smart contract cover to its users. Nexus Mutual is a decentralized autonomous organization (DAO) that insures its members using a risk-sharing pool.

Although Etherisc does not offer smart contract cover like Nexus mutual. This is developing several decentralized insurance applications that will allow DeFi users to create their own insurance products. These finance products will include hurricane protection, lending collateral protection, and flight delay insurance.

How does a decentralized insurance platform operate?

Most decentralized finance insurance protocols use a DAO (Decentralized Autonomous Organization) structure. As a result, these insurance companies use a decentralized pool of coverage providers instead of offering insurance coverage from a single individual or traditional insurers.

Coverage providers are exposed to risks for adding their crypto assets to the decentralized pool. However, they earn interest on premiums paid by coverage buyers.

In spite of being part of a DAO, coverage providers must hold their insurance protocol token to enjoy voting rights. Users with full membership rights can vote on claims by insured parties.

Claim verification can sometimes be done automatically instead of by community vote. In many cases, this is done using oracles. Oracles are simply decentralized information mechanisms that verify and supply external information to a smart contract.

When applied by decentralized finance insurance websites, Oracles can help track the outcome of certain events and transmit the information to the DAO. Using this feature can lessen disputes over unpaid claims.

What Crypto Lending Insurance doesn't cover

The cryptocurrency lending insurance sector was created to cover the crypto assets of lenders and investors from theft, hacks, and rugpulls. Despite the impressive growth of this industry, it is still in its early days.

Consequently, this sector does not offer insurance coverage for all types of crypto thefts, hacks, or scams. This section of our guide will discuss some of the services that are not currently available within the crypto lending insurance industry.

The crypto insurance products of centralized platforms are not available to individual investors. Instead, these insurance policies are used primarily by exchanges, lending platforms, and crypto-wallets.

These insurance policies provide custodial insurance coverage and protect centralized lending platforms, exchanges, and crypto-wallets from hacks, thefts, and scams. BitGo and Ledger Vault provide this type of insurance policy to their users.

Unlike insurance policies for centralized crypto platforms, DeFi insurance is primarily designed to offer protection to each investor using a DeFi application. However, the insurance products on offer can also be used by DeFi protocols.

There is a long list of insurance products within the DeFi space; they include insurance policies for smart contract failure, Parity multi-sig wallet issues, DAO hacks, collateral protection for crypto-backed loans, and crypto wallet insurance. However, DeFi insurance is not available in cases of exchange hacks.

Conclusion

The growth of the crypto-insurance industry has resulted in the development of several centralized and decentralized finance insurance platforms. These platforms serve as insurers for lending platforms and crypto users. As part of their major functions, they provide custodial insurance coverage and collateral protection services.

They also provide investment opportunities for DeFi users due to the adoption of decentralized pools as a means to provide insurance coverage. Although relatively new, we expect to see more growth in the crypto-insurance sector over the coming years. As a general rule of thumb, we advise using crypto lending firms with insurance coverage against security breaches.