Insurance for Digital Assets Can Help to Protect Users in the Crypto Space

The cryptocurrency market is one of the most volatile financial markets for investors, with massive price swings and less regulation than traditional markets. Apart from the volatility, investors can lose money due to human error and social engineering phishing scams.

Due to the decentralized nature of the blockchain ecosystem where users are solely accountable for their holdings, it's not always easy for investors to get a bailout if something goes wrong. For example, if users send tokens to the wrong address, are targeted by a phishing scam, or lose money by trading with too much leverage it can lead to the liquidation of their entire account.

Only in specific cases, for example, when a centralized exchange is hacked, is it most likely that affected users can receive compensation for their losses. However, these exchanges need to have some sort of guarantee regarding the maximum amount they reimburse users in the case of a hacking incident. Insurance for cryptocurrencies may assist with both the compensation of lost cash and the supply of crypto market liquidity.

This is where cryptocurrency insurance comes in, it can provide a guarantee for reimbursement of funds lost as well as help with the provision of liquidity in the crypto market. Nayms is one protocol that uses smart contracts to provide cryptocurrency as collateral in the crypto market. The aim of the platform is to ensure that the capital used within the crypto market matches the risk by issuing the insurance on-chain.

The platform works by insurance brokers using smart contracts to provide insurance on the cryptocurrency market. For example, one user may want liability insurance coverage for a decentralized finance (Defi) application or stablecoin protocol, to protect against claims of negligence during a black swan event.

The collateral will be designated in a cryptocurrency like Ethereum for example and the funds will be taken from the crypto markets in ETH. The Maker Foundation (the team behind the Dai stablecoin) has partnered with Nayms to provide collateral for these smart contract-based insurance protocols. The Maker Foundation plans to provide collateral through their Dai stablecoin.

The aim of this partnership is to enable users to provide collateral in dollar-denominated form as well as traditional cryptocurrencies like BTC and ETH. Insurance brokers are incentivized to launch smart contracts via a marketplace, receiving future trading activity in return. By using smart contracts, the platform aims to replace long and drawn-out legal processes seen in the real world for brokers who plan to provide insurance.

Nayms CEO, Dan Roberts, said:

“It is very rewarding to see the hard work of the Nayms team pay-off as we reach this critical milestone. It has been a very positive experience working with the BMA, who have allowed Nayms to grow within a developed regulatory framework.

He continued to say:

We look forward to taking this relationship forward, and furthering the innovation Bermuda is providing by scaling the Nayms marketplace on island.”

Increasing regulation makes blockchain-based insurance a viable option for digital assets

Despite their youth, cryptocurrency and digital assets are not a new technology, having existed for over 10 years since the creation of Bitcoin in 2009. However, historically speaking, many well-established businesses, such as major financial institutions and governmental organizations, have been hesitant to accept digital assets.

Only in recent years have we started to see increased adoption of cryptocurrency by traditional companies, from Microsoft accepting Bitcoin in 2014 to Tesla accepting Dogecoin in 2022. However, regular cryptocurrencies are very volatile with most coins down over 70-80% at the time of writing.

Stablecoins on the other hand are less volatile being able to maintain their $1 price pegs most of the time and it seems like these coins are getting increased recognition by government authorities. The first federally chartered digital asset bank in the US was established in January 2021 when Anchorage Trust Company was allowed to transition into Anchorage Digital Bank by the OCC, enabling it to collaborate with other conventional financial institutions to provide customers with digital currencies.

This is important since it increases the chances of traditional insurance companies providing collateral for digital assets via established digital banks. The OCC released guidelines earlier that same month allowing national banks and federal savings organizations to take part in independent node verification networks and utilize stablecoins, a cryptocurrency backed by cash reserves and government bonds, for payment operations.

This follows the OCC's clarification in two different letters of advice published last year that national banks are permitted to provide cryptocurrency custody services to customers and keep deposits that act as a reserve against stablecoins backed by fiat money. The government highlighted how broker-dealers must conduct themselves while serving as custodians of digital asset securities in a statement released in December to prevent enforcement action.

Traditional financial institutions may now use digital currencies thanks to legislative advancements, which are anticipated to open the door for even more investment in the digital asset market. Other businesses that have been investigating the advantages of cryptocurrencies are probably going to start making investments in this sector now that the legal environment is becoming more secure. And many observers believe that the asset class's widespread acceptance is just a matter of time.

Traditional insurers should be more inclined to provide insurance capacity in this area with the support of a better-defined regulatory environment. But just now, further instruction is still required. It is crucial for businesses and their directors and officers to comprehend what, if any, risk transfer alternatives are available to assist limit possible exposure as the regulatory environment changes and the likelihood of regulatory intervention increases.

Conclusion

Cryptocurrency insurance can be instrumental in reducing the losses that come with engaging in the crypto market. Regulated solutions for insurance in the blockchain space could prove to be very helpful to users if this trend picks up.