Answered – top seven questions investors have about cryptocurrency insurance

“Given that roaring adoption, it’s no surprise that more cybercriminals are using cryptocurrency,” the firm wrote in its analysis of the research. “But the fact that the increase was just 79% — nearly an order of magnitude lower than overall adoption — might be the biggest surprise of all.”

The burgeoning sector of decentralized finance (DeFi) represented a huge portion of crimes involving cryptocurrencies, which were mostly due to stolen funds and scams, including a relatively new type of fraud called “rug pulls,” where developers build what appear to be legitimate cryptocurrency projects before running away with investors’ money. The scam accounted for more than $2.8 billion, or 37% of the total crypto crime revenue.

Crypto theft, however, grew even more, with about $3.2 billion worth of cryptocurrency stolen in 2021, a whopping 516% ascent compared to the year prior. Of these, roughly $2.2 billion were taken from DeFi protocols.

But despite the report’s findings that “crime is becoming a smaller and smaller part of the cryptocurrency ecosystem,” Chainalysis pointed out that “$14 billion worth of illicit activity represents a significant problem.”

“Criminal abuse of cryptocurrency creates huge impediments for continued adoption, heightens the likelihood of restrictions being imposed by governments, and worst of all victimizes innocent people around the world,” the firm wrote.

Read more: Crypto insurance – how the market is expanding

While cryptocurrency has the potential to create massive opportunities in the current financial system, it also brings in new risks. But as the cryptocurrency insurance segment is still in its nascent stage, there exists a huge coverage gap, especially for investors.

“Most insurance policies are designed for businesses and corporations, not for private consumers,” explained cryptocurrency exchange platform Bybit in a guide on its website. “Crypto wallets and exchanges purchase insurance policies with coverage, designed to protect against cyber theft and security threats. Other types of coverage are still in development and may feature additional protection… However, these policies aren’t yet available for consumers to purchase.”

But considering the unpredictability of the cryptocurrency ecosystem, having insurance plays a critical role in keeping digital assets protected. Here are some of the most common questions investors ask about crypto coverage, along with the answers from industry specialists.

Why is there a need for cryptocurrency insurance?

The value of cryptocurrencies has skyrocketed in recent years, leading to massive scams and thefts that cost investors billions of dollars in losses as reflected in Chainalysis’s report, which covered crypto crime activities in 2021.

But since hitting its November peak, crypto’s value has been on a tumble, with the market crash wiping off as much as 40% of most top-notch cryptocurrencies’ value – reportedly totaling more than $1 trillion – in a span of just a few weeks, demonstrating the sector’s volatility.  

“Fear is the biggest factor that drives a bearish sentiment in the crypto market,” noted market research firm Analytics Insight. “As Terra fell, crypto investors panicked and started selling other coins as well, eventually crashing the crypto market. There are few cryptocurrencies that are barely hanging at the edge and might fail to survive in this massive bear market. But now, the cryptocurrency market is showing some signs of recovery.”

Both instances show how important it is for cryptocurrency investors to have some form of protection.

Read more: Crypto in 401(k) plans: Why fiduciaries should be cautious

How does cryptocurrency insurance work?

According to Bybit, crypto insurance is a type of policy designed to protect against losses associated with cybersecurity breaches.

“Most major crypto exchanges carry at least some insurance to protect the digital assets in their custody against losses from theft and other security breaches,” the firm explained. “Exchange insurance is designed to protect against losses incurred in covered security events. However, total losses may occasionally exceed insurance recoveries, leaving some investors unable to recover their entire investments.”

Because they are not legal tender, unlike the US dollar, cryptocurrencies are not backed by the government, meaning they get no protection from loss of funds. In the US, the Federal Insurance Deposit Corporation (FDIC) generally provides up to $250,000 in coverage for each person per bank, covering checking, savings, and money market deposit accounts, and certificates of deposit.

Deposits at brokerage accounts for the purpose of purchasing securities, meanwhile, are covered by the Securities Investor Protection Corporation (SIPC).

What does crypto insurance cover?

Crypto wallets and exchanges purchase policies designed to protect them against theft and cybersecurity threats, according to Bybit. The firm added that other types of coverages are still in development and may feature additional protection. These include DeFi insurance, which could feature protection against “the loss of funds associated with the shutdown of a service provider, lost private crypto keys, or similar catastrophes.”

The firm noted, however, that these policies are not yet accessible to consumers.

Read more: Cryptocurrency market ‘underserved’ by insurance

What does crypto coverage exclude?

Crypto insurance policies do not typically cover losses resulting from fluctuations in the market or if investors fall victim to a Ponzi scheme, costing them part or their entire investment, according to the financial website Investopedia.

Insurance information website PolicyAdvice added that coverage may exclude “direct hardware loss and damage and transfer of cryptocurrency to a third party” and “disruption or failure of the blockchain underlying the asset.”

What are the challenges facing crypto insurance providers?

One of the biggest challenges preventing cryptocurrency insurance from going mainstream, according to experts, is regulatory uncertainty.

“While there’s been demand for cryptocurrency insurance to cover everything from deposits to theft, the primary concern is underwriting risks,” consumer electronics media outlet CNET explained. “Major insurance companies don’t feel they can accurately assess risk factors due to a lack of cohesive rules and regulation in the crypto insurance industry. Though newer insurers are diving in headfirst, others are merely dipping their toes to test the temperature.”

Investopedia added that the lack of historical data and market unpredictability is lessening the appetite for crypto insurance. 

“Bitcoin and cryptocurrencies present unique challenges for insurers,” the firm wrote. “Typically, insurance premiums are based on historical data. Such data is absent for cryptocurrencies. Volatility in valuations, where three-figure price swings are not uncommon, can also affect premiums because it reduces the total number of coins being insured.”

Can investors purchase personal cryptocurrency coverage?

According to CNET, Breach Insurance is currently the only carrier that offers direct-to-consumer policies, with the insurer’s Crypto Shield product being the first regulated insurance for crypto investors.

Breach has a license to provide crypto coverage for residents of 10 states, including its home state of Massachusetts, California, and New York, with plans to expand to more locations later this year. The policy covers 20 types of coins – including Bitcoin, Ethereum, and Dogecoin – within exchanges Coinbase, CoinList, Gemini, and Binance. It protects against theft and provides between $2,000 and $1 million worth of coverage, with 5%, 10% and 15% deductible options. 

Read more:  Breach places industry-first crypto insurance policy

How do cryptocurrency exchanges and wallets protect investors?

The level of protection the average consumer can access from crypto exchanges and wallets, depends largely on the services they avail, according to Bybit.

“For the safest experience, the most basic level of security should include two-factor authentication (2FA) as a standard,” the firm explained. “Using a cold wallet for the majority of digital assets is also advisable. Hot wallets are more convenient, but they’re more easily accessible to hackers. Cold wallets are offline and are typically air-gapped, making them well-protected from those with ill intentions.”

Bybit added that most exchanges offer crypto insurance programs that, while not backed by the government, protect funds and compensate for losses up to a specified amount if these exchanges are hacked.