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Staking is a popular term associated with the crypto and blockchain industries. This phrase refers to any activity that requires people who own cryptocurrency to lock up their assets in order 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 protect individuals from potentially harmful situations. In a more traditional sense, it is an agreement in which one entity, usually a corporation, pays another entity for a specific loss. In exchange for its services, the corporation or insurer receives a premium.
Insurance is a common thing in traditional finance, but it's still a fairly new idea in the world of cryptocurrencies. But it's already becoming popular because of the risks that come with decentralized financial protocols.
Staking insurance focuses on protecting stakeholders against the loss of their crypto assets. This insurance service has products that are made to cover losses from stolen or hacked assets.
How Staking Insurance Works
Most of the time, the type of staking insurance available depends on the platform where investors put their assets at risk.
Staking Insurance on Crypto Exchanges & Investment Platforms
Cryptocurrency exchanges and investment platforms often cover their users' deposits against theft or hacking. For example, Coinbase has gotten a crime insurance policy to protect the digital assets it stores from hacks or thefts that could cause them to be lost. But this insurance policy doesn't cover investors who lose their login information and lose money as a result.
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 store deposits from their platforms in cold wallets. Most platforms that offer asset custodial services through cold wallet storage also offer some kind of insurance from a third party.
Crypto Staking Insurance for DeFi Staking
Crypto staking insurance also covers DeFi staking. With DeFi staking, people who invest in cryptocurrencies can buy insurance 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 case, the risk underwriters are the people who pool their money to make a pool that offers insurance for a certain event.
Capital providers are individuals or entities that provide liquidity for the insurance pool. People who put money into investment funds expect to get money back, just like with regular investments.
Those who want insurance must pay a premium to the pool so that they are covered for any risks they take. 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 is very important because it provides a shared infrastructure that makes it possible for smart contracts on the protocol to make decentralized insurance possible.
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 stakeholder 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 file a claim with, and there is no central place where the necessary checks can be made to make sure the claim is valid. Most insurance claims in the crypto insurance system can be checked in one of two ways. They are:
Using DAOs
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. Most of the time, the amount of capital each member of the insurance pool puts in determines how many tokens they get.
Oracles
Another way to verify claims is by using oracles. Some insurance protocols use oracles to verify claims automatically. Oracles can keep track of what happens in real life, and smart contracts can automatically check an insurance claim based on what the oracles say.
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:
Slashing Insurance
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 situations, the network can completely wipe out the staked deposits and remove the validator from the network, either permanently or for a short time.
Two common offenses lead to slashing. These are examples of double signatures 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, insurance rates were reduced.
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 where the liquidity providers bet on the security of the smart contracts.
During the time of the coverage, if the smart contract is attacked, fails, or its code is accidentally used, the person who bought the coverage can file a claim.
Liquid Staking Insurance
To protect the security of the network, assets are usually locked on a chain when staking. This usually means that a user can't have instant liquidity. Liquid staking lets you bet on assets and have derivative assets stand in for your bets. Within the DeFi ecosystem, the derivative assets can be used to trade and do other things.
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 Ethereum 2.0, 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. Most people find it easy to use these platforms because all they have to do is deposit their tokens and get rewards.
These staking operators are custodial, which means that they keep users' digital assets safe while the staking is happening. So, you don't need to purchase insurance coverage when using their services. Most staking networks insure their customers' deposits. But it's important to find out what the operator's rules are before you deposit money.
Crypto Staking Regulation
Crypto staking is a relatively new concept, which means regulations on it are scant. Like the rest of DeFi, regulators are still trying to understand it.
The lack of regulations comes with both advantages and disadvantages. The biggest benefit is that DeFi protocols give you the most freedom when it comes to new ideas. This has made it possible for the DeFi industry to grow quickly in just 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 rewarded 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 built in, like the temporary loss when the value of staked assets goes down because of what's going on in the market. 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 mistakes in the code for smart contracts, bugs, hacking of centralized exchanges, slashing, stealing private keys, and "rug pulls."
Due to the many risks in the DeFi industry and the fact that it's hard or nearly impossible to get stolen money back, it's important to be careful. 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 stake 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.
Conclusion
Crypto staking insurance gives investors a way to get their money back if their staked assets are stolen or hacked and they lose money. Most crypto exchanges and investment platforms in this space provide some form of insurance coverage for all deposits made on their platforms.
Additionally, investors can purchase insurance for assets staked on smart contract-run DeFi protocols. Are you 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.
Disclosures
The content is only provided for informational purposes. It is not meant to be tax or financial advice, and it does not recommend any particular investment plan. Every investment has risk, including the possibility of a cash loss. Past performance does not guarantee future results.
Bitcompare does not guarantee good investment outcomes. The way a security or financial instrument did in the past does not show how it will do in the future. Before investing in options, clients should carefully assess their financial goals and risk tolerance. Due to the importance of taxes in all staking transactions, a customer who is thinking about staking should talk to a tax expert to find out how taxes affect the outcome of any staking strategy.
