Joel Frank
2022 was an ugly year for crypto. Not just because most major coins like Bitcoin and Ethereum experienced aggressive price drawdowns, wiping out trillions in crypto net worth.
2022 was also a year of catastrophe for centralized and decentralized finance protocols. The collapse of the Terra ecosystem after the algorithmic stablecoin at its core, UST, depegged to the US dollar wiped $60 billion in value from the crypto space nearly overnight.
The collapse of FTX, which in hindsight appears to have been run more like a Ponzi scheme than a legitimate crypto exchange, wiped out yet further billions in crypto investor wealth.
Meanwhile, 2022 was also a record year for crypto hacks. $3.1 billion was stolen from Decentralized Finance (DeFi) services last year, with well over half coming from exploits of cross-chain bridges.
Amid all the chaos, one pillar of investor protection far more common in the traditional finance space was conspicuously absent. That of crypto insurance.
The Crypto Insurance Sector Needs to Grow
Investors in centralized and decentralized finance protocols often have a tough time finding insurance policies to cover them in the case of some kind of black swan event, like a major hack, bankruptcy or protocol insolvency.
That’s not to say no one is providing such services. According to its website, the largest DeFi insurance protocol Nexus Mutual has underwritten over $4 billion in investments and, to date, paid out over $14 million in claims. Meanwhile, the protocol is backed by $243 million in capital.
But these numbers pale in comparison to the size of the broader cryptocurrency market, which as of Wednesday, had a market capitalization of $1.01 trillion. Total value locked (TVL) within DeFi protocols was last around $90 billion, according to DeFi Llama.
Case in point, according to a recent report from Bloomberg, Nexus Mutual has paid out roughly $5 million to claimants relating to the FTX collapse and expects to pay out a further $2 million. That represents a tiny fraction of the many billions that FTX depositors are expected to have lost.
2022 “highlighted the importance of insurance… but it seems a very difficult problem for DeFi to solve,” commented Kaiko research analyst Riyad Carey. It remains difficult to “properly protect a protocol or position,” he noted, before speculating that, moving forward, DeFi insurance protocols like Nexus Mutual will play a bigger role in backstopping the industry.
Kaiko added that new entrants to the DeFi insurance space could fulfill unmet demand. These could include legacy insurers, who have for now stayed clear of crypto.
One thing is for sure. Growth in the crypto insurance space would certainly be helpful in rebuilding confidence in the industry, which took a big knock in 2022 following a series of catastrophes.
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This article was written for Business 2 Community by Joel Frank.
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