Crypto Staking Insurance
Learn how the concept of crypto staking insurance works and how it can help you.
Staking is a popular term associated with the crypto and blockchain industry. This expression describes any activity requiring cryptocurrency holders to lock up their assets to earn rewards.
The purpose of the locked assets could be to secure Proof-of-Stake(PoS) blockchain networks. Staking also helps to provide liquidity for DeFi protocols. Although crypto staking can be a lucrative way to earn extra income, it is also risky.
These risks often result in losses for crypto investors. As a result, investors often seek protection for their assets using staking insurance services. What is staking insurance? How does it work? How can you benefit from it? Follow along as this article reviews this unique concept.
What is Staking Insurance?
In general, insurance helps to protect individuals from potentially harmful situations. In a more conventional sense, it is an arrangement in which one entity, usually a corporation, compensates another for a specific loss. In exchange for its services, the corporation or insurer receives a premium.
While insurance products are standard in the traditional financial space, the concept is relatively new in the world of cryptocurrencies. However, it's already catching on due to the prevalent risks associated with decentralized finance protocols.
Staking insurance focuses on protecting stakers against the loss of their crypto assets. This insurance service delivers products tailored to cover losses resulting from thefts or hacks involving staked assets.
How Staking Insurance Works
The type of staking insurance available usually depends on the platform on which investors stake their assets.
Staking Insurance on Crypto Exchanges & Investment Platforms
It is not uncommon for crypto exchanges and investment platforms to insure users' deposits against thefts or hacks. For example, Coinbase has obtained a crime insurance policy to protect digital assets held in its storage systems against cybersecurity breaches or thefts resulting in a loss. However, this insurance policy does not apply if investors suffer losses after losing their login credentials.
Similarly, Binance has an emergency insurance fund called the Secure Asset Fund for Users (SAFU), currently valued at $1 billion. This insurance fund is set aside to cater to platform users who suffer significant losses due to hacks and thefts. These definitely include users who deposit their assets into the Binance staking program.
Some investment platforms in this space use cold wallet storage to store deposits from their platforms. Usually, the platforms that provide asset custodial services via cold wallet storage offer some form of third-party insurance coverage.
Crypto Staking Insurance for DeFi Staking
Crypto staking insurance also covers DeFi staking. With DeFi staking, crypto investors have the opportunity to purchase insurance products for their staked assets.
However, unlike centralized insurance organizations, DeFi insurance platforms like Nexus Mutual, Bridge Mutual, Bright Union, Opium Finance, and Etherisc don't provide insurance coverage to their users.
These decentralized insurance platforms only connect buyers to insurance pools. In this instance, the risk underwriters are individuals who pool their funds together to create a pool that offers insurance coverage for a specified event.
Capital providers are individuals or entities that provide liquidity for the insurance pool. Like regular investment funds, the individuals that provide capital expect to earn returns on their investments.
Those purchasing insurance must pay a premium to the pool to get coverage against any staking risks. Like regular insurance, staking insurance also has a scope of events it will cover. Examples of events that staking insurance may cover include exchange hacks, smart contract failures, exploits of protocols or bridges, stablecoin de-pegs, slashing, etc.
Since individual cryptocurrency holders commit their capital to coverage pools, one may wonder what the role of the insurance platform is. The insurance platform plays a crucial role in offering a common infrastructure that enables decentralized insurance to be possible through smart contracts on the protocol.
How to Purchase Staking Insurance
Staking insurance is not as common as traditional insurance. But more than enough insurance providers cater to the crypto space. So, it is easy for any staker to purchase insurance.
Insurance companies in the DeFi community operate in unique and different ways. Most of these protocols also have a Decentralized Autonomous Organization (DAO).
How Do Insurance Protocols Verify Claims?
Claims verification is an essential aspect of all insurance processes. In decentralized insurance, verifying claims doesn't work the same way it does in the traditional insurance industry.
There is no insurance company to submit claims to and no centralized structure to carry out the necessary due diligence for claims verification. There are generally two ways to verify any insurance claim in the crypto insurance system. They are:
Insurance companies sometimes create Decentralized Autonomous Organizations (DAO) for protocol participants to verify claims. In such a case, every person providing capital to the coverage pool is a member of the DAO and can vote on the claims.
Some insurance DAOs only rely on votes from their community members to verify claims. Others subject the claims to expert review before payment. The voting power in DAOs depends on each member's tokens. The allocation of tokens is typically determined by the amount of capital each member of the insurance pool provides.
Another way to verify claims is by using oracles. Some insurance protocols use oracles to verify claims automatically. Oracles can track the outcome of real-life events, and smart contracts automatically verify the insurance claim based on the information from those oracles.
Types of Crypto Staking Insurance
There are several risks, and it's essential to get insurance against the most likely ones. Standard staking insurance products include:
One of the major risks in staking is slashing. This usually applies to staking for consensus algorithms. Proof of Stake (PoS) blockchains will reward validators for participating in block creation and network security. Additionally, it also punishes inactivity or malicious behavior.
The penalty comes in the form of slashing the stake, which means a percentage of the tokens staked will be lost. In some cases, the network can destroy the staked deposits completely and remove the validator from the network permanently or temporarily.
Two common offenses lead to slashing. These are double-signature and downtime. Anyone staking can guard against these by using reputable validators. No matter how efficient a validator is, the risks remain. As a result, slashing insurance was created.
Several DeFi insurance providers offer slashing insurance. Unslashed, Blockdaemon, and Nexus Mutual offer this kind of insurance.
Smart Contract Cover
Nexus Mutual offers this kind of insurance. It provides coverage against smart contract failures. This insurance product is a risk-sharing pool in which the liquidity providers are staking on the security of the smart contracts.
If there is an attack, failure, or unintended code usage of the smart contract within the duration of the coverage, then the person who took the coverage can submit a claim.
Liquid Staking Insurance
Staking usually requires assets to be locked on a chain to ensure the network's security. This usually means that a user can't have instant liquidity. Liquid staking offers a way to stake assets and have derivative assets represent your staked positions. The derivative assets can be used for trading and other activities within the DeFi ecosystem.
Most liquid staking pools are decentralized and non-custodial. However, they still have insurance for depositors' funds. Since these pools distribute deposits to validators who do the staking, every depositor shares the risk and rewards. Thus, some pools get insurance to cover the risks associated with staking.
A good example is the biggest staking pool for ETH2.0, Lido. In February 2021, Lido partnered with Unslashed Finance to cover about $200 million worth of staked ETH at the time against up to 5% in slashing penalties.
Do You Need Insurance When Using a Crypto Exchange or Investment Platform?
There are several ways to stake, and one of the most common is to use staking operators. These are usually centralized exchanges and investment platforms that offer staking as a service. Using these platforms is very convenient for most users since they only have to deposit their tokens and earn rewards.
These staking operators are custodial, which means they control and maintain users' digital assets during the staking duration. So, you don't need to purchase insurance coverage when using their services. Most staking networks insure their customers' deposits. But it is crucial to research and confirm the operator's policy before depositing your funds.
Crypto Staking Regulation
Crypto staking is a relatively new concept, which means regulations on it are scanty. Like the rest of DeFi, regulators are still trying to understand it.
The lack of regulations comes with both advantages and disadvantages. The major advantage is the maximum flexibility DeFi protocols have when it comes to innovation. This has allowed the DeFi industry to develop at a fast pace within a few years.
But this lack of regulations also creates problems. It puts every participant at risk. For example, if a person loses their funds on a DeFi platform, their chances of recovery are low since there is no legal framework to pursue such action. It also complicates tax obligations for crypto investors. However, this might change in a few years as several regulators consider regulating this space.
Learn more about crypto staking regulations.
Crypto Staking Safety
Staking usually requires locking up the tokens. This means the holder will not be able to use their crypto assets for any other purpose during the staking period. In exchange, they get rewards if everything goes according to plan.
However, everything doesn't always go according to plan in the crypto world. There are a lot of risks. Some are inherent, like the impermanent loss when the value of staked assets drops due to market action. There could also be black swan events leading to the total loss of staked assets.
Generally, there are several risks to be aware of when staking. They include smart contract code failure, potential bugs, centralized exchange hacks, slashing, private key theft, and rug pulls.
Due to the various risks in the DeFi industry and the difficulty or near impossibility of recovering stolen funds, it's important to take precautions. Such precautions include understanding what staking on each protocol will entail.
Multiple protocols and blockchain networks have different types of staking. So, stakers need to understand what kind of staking they are getting into. It is not enough to just invest in any staking activity because of the promise of passive revenue.
Learn more about crypto staking safety before you start staking.
Crypto staking insurance offers investors a way to recover from losses due to thefts or hacks involving staked assets. Most crypto exchanges and investment platforms in this space provide some form of insurance coverage for all deposits on their platform.
Additionally, investors can purchase cover for assets staked on DeFi protocols run by smart contracts. Interested in staking your crypto assets on the best crypto staking platforms? Check out our article on the best staking platforms in the crypto market today.