Mainstream crypto adoption has led to incredible growth for many crypto projects. The crypto lending industry is one of the leading beneficiaries of this growth.
According to Forbes, the crypto lending industry had more than $10 billion in value in 2020. By 2021, the number of loan originations at Genesis Capital alone will total $131 billion.
This exponential growth has prompted the development of crypto-specific insurance firms.
This article will help you learn about insurance practices within the crypto industry. We will explain insurance companies’ role 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?
Insurance corporations provide financial coverage for traditional money platforms when unexpected events occur. Policyholders have to pay a fee, or “premium,” to enjoy this coverage.
The Federal Deposit Insurance Corporation (FDIC) is the main insurance body for US banks. It examines and monitors traditional financial institutions for safety and security. Federal insurance is available for all money organizations under the FDIC.
The FDIC also resolves likely issues for large and complex financial institutions. They manage receiverships too, 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. But it has commenced work on the crypto-asset policy sprint. There is no set timeline for completing or implementing this policy.
What is crypto lending insurance?
There are two types of crypto lending companies: CeFi and DeFi platforms. CeFi platforms operate under the control of a central entity. There isn't a single organization in charge of DeFi lending protocols. These protocols use lines of code called "smart contracts" to coordinate lending activities.
Cryptocurrency lending insurance is applicable to both the CeFi and DeFi platforms. Crypto lenders and investors use insurance to protect their assets from unexpected risks.
These organizations operate like the FDIC. They offer insurance policies to protect users from thefts, bugs, and other risks.
A long list of incidents has led to massive losses of funds for some crypto lending platforms. An example is Cream Finance, a popular multi-chain lending protocol. It once experienced a flash loan attack and lost over $130 million during the hack.
Also, a similar thing happened to the compound protocol on September 30, 2021. An error in its computer code caused a loss of over $90 million. These breaches and hacks have warranted insurance products made for crypto investors.
Before, crypto insurance policies were only available for exchanges and lending platforms. Now, with DeFi insurance, more crypto investors can enjoy insurance products.
Crypto lending insurance for centralized crypto platforms
It is true that crypto lending is still new within the crypto industry. Yet, several centralized lending platforms now have insurance policies with top-rated insurance organizations. The platforms insure their digital assets by taking these steps. They also protect their customers.
Nexo, a centralized crypto lending platform, is a stellar example here. Its insurance policy covers up to $775 million in losses for users. This insurance policy results from Lloyd’s of London and BitGo’s partnership with Nexo.
There are many insured centralized exchanges offering crypto loans to their users. For example, Binance Holdings Ltd. has 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 is like a traditional lending company. They use similar insurance products to protect their assets from theft.
On the other hand, decentralized insurance operates through smart contracts. So what is a smart contract?
A smart contract is a set of programming codes stored on a blockchain. It carries out specific tasks when certain predetermined conditions are met. Their primary function is to automate the execution of already established agreements. In this capacity, smart contracts eliminate the need for a third party. They do this by alerting all participants to the eventual outcome of the agreement.
All DeFi loan protocols use smart contracts to execute their financial products. Due to their importance, smart contracts have become a target for security breaches. So, hacking a smart contract can lead to the loss of funds for users.
Advantages and disadvantages of smart contract code
There are many advantages to using a smart contract code for DeFi lending protocols. Their implementation adds transparency to the loan application process.
The codes also ensure that customers enjoy fast transactions. This saves them hours on various business processes. They are also dependable because of their accuracy.
As for limitations, smart contract codes are inflexible. In simpler terms, one can not easily alter them after launching them. These codes also use external information to fulfill some of their operations. Thus, they may not be entirely decentralized.
What is a smart contract cover?
A smart contract cover is an example of a DeFi insurance product. When hacks occur, decentralized insurance companies design it to pay out claims.
Nexus Mutual is an example of a platform that offers smart contract insurance. It is a DAO that insures its members through a risk-sharing pool.
Etherisc is another. It does not offer smart contract coverage like Nexus Mutual. Instead, it helps DeFi users create personal insurance products using Dapps. These finance products include hurricane protection, lending collateral protection, and flight delay insurance.
How does a decentralized insurance platform operate?
Most decentralized insurance protocols use a DAO (Decentralized Autonomous Organization) structure. There are two main parties to a DeFi insurance platform. They are the insurance buyers and the coverage providers.
Insurance buyers are investors who buy premiums from the platform. This protects them against thefts, hacks, and other DeFi risks. They can make claims and leverage their insurance policies if the worst happens.
There are also coverage providers, also known as insurance providers. They add liquidity to insurance pools, thus exposing their assets to risks. As a reward, they get part of the premium that insurance buyers purchase.
Most platforms only allow coverage providers to vote if they hold the platform token. Users with full membership rights can vote on claims by insured parties.
Sometimes automatic claim verification can take the place of community vote. Most platforms process automatic claims with oracles. Oracles are mechanisms that verify and supply external information to a smart contract.
These oracles track the outcome of certain events and pass the information to the DAO. Using this feature can lessen disputes over unpaid claims.
What Crypto Lending Insurance doesn’t cover
The crypto lending insurance sector protects investors from theft, hacks, and rugpulls. Despite the impressive growth of this industry, it is still in its early days.
So, this sector does not offer insurance coverage for all types of crypto thefts, hacks, or scams. We will now discuss some of the services that this type of insurance does not cover.
The crypto insurance products of centralized platforms are not available to individual investors. Instead, these insurance policies work primarily on exchanges, lending platforms, and crypto-wallets.
They provide custodial insurance coverage and protect clients from hacks, thefts, and scams. BitGo and Ledger Vault provide this type of insurance policy to their users.
DeFi insurance does not work like that. It offers protection to each investor using a DeFi application. Yet, the insurance products on offer can also work for CeFi platforms.
There is a long list of insurance products in the DeFi space. Some examples include insurance policies for smart contract failure and parity multi-sig wallet issues. DAO hacks, collateral protection for crypto-backed loans, and crypto wallet insurance are others. But, DeFi insurance is not available in cases of exchange hacks.
Conclusion
The crypto insurance industry has grown to include several platforms. These platforms serve as insurers for lending platforms and crypto users. Most provide custodial insurance coverage and collateral protection services.
Insurance pools also allow DeFi users to invest and earn passive income. Although still new, we expect to see more growth in this sector over the coming years. As a general rule of thumb, we advise using insured crypto lending firms. This brings peace of mind even in the face of unexpected security breaches, which is what crypto is if we want to make crypto lending safe.
Disclosures
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