FTX Collapse Exposes Insurance Gap that hinders Crypto Sector Growth

After experiencing network bridges and unprecedented bankruptcies, there is a considerable task ahead to restore trust in cryptocurrencies, which includes the significant obstacle of providing investors with protection against such incidents. This task will be a long and challenging road.

While stock brokerage accounts frequently offer protection against circumstances like bankruptcy, crypto exchange platforms typically provide little to no safeguarding measures, as evidenced by the collapse of the FTX exchange in November.

It is challenging for investors looking for insurance policies to protect against such risks. Traditional insurers are cautious about providing coverage, and DeFi-native solutions in decentralized finance make up only a small fragment of the 1.1 trillion-dollar crypto sector.

According to the DeFiLlama report, the total amount of funds locked in Decentralized Finance insurance networks is about three hundred million dollars, significantly less than the eighty billion dollars in total funds in DeFi services.

DeFi employs digital ledgers and self-executing software programs called smart contracts to provide services, eliminating the need for third parties.

Challenges

To secure a position or network adequately is a difficult task, said Riyad Carey, a research analyst at Kaiko, a cryptocurrency data provider. In the previous year, he underscored the significance of insurance. Still, it is a significant challenge for DeFi.

Nexus Mutual, a membership-based service, is the most extensive service provider of DeFi insurance, accounting for approximately seventy percent of funds held in crypto-native insurance networks. In addition, Nexus Mutual has disbursed approximately five million dollars in claims due to the bankruptcies of the crypto lending platform BlockFi and FTX.

The company anticipates paying out an additional two million dollars, but those amounts are small compared to the billions lost in FTX’s collapse alone.

Nexus Mutual founder Hugh Karp remarked that the correlation between custodians’ and centralized crypto lenders’ risk profiles need full appreciation. He explained that these entities experienced similar downturns simultaneously, indicating their interdependence.

Insurance Gap

Although Nexus Mutual’s risk experts declined to provide coverage for software bridges and algorithmic stablecoins that link various blockchains, these areas experienced significant losses in the previous year.

For instance, the TerraUSD stablecoin ecosystem experienced a wipeout of sixty billion dollars, and cross-chain bridge hacks accounted for sixty-four percent of the accumulated 3.1 billion dollars taken from DeFi services.

Due to the recent rise in bankruptcy-related activities, payouts surpassed premiums by a record 4.7 million dollars at the start of the year at Nexus Mutual. According to Karp, the insurance pool has enough funds to sustain this uptrend.

Karp asserts that DeFi insurance will have a more significant impact as the cryptocurrency sector develops. According to Carey of Kaiko, new participants, including traditional insurance companies, could meet many unfulfilled demands.

Following the collapse of FTX, Ether and Bitcoin reserves at centralized crypto exchanges have declined, indicating that numerous investors have chosen to hold their tokens offline for added security rather than on crypto exchange platforms.

On the other hand, John J. Ray III, the current CEO at FTX, has indicated that FTX will utilize all available means to maximize the recoveries of its creditors and users. The target is to unlock the assets that FTX believes are being restrained by Grayscale’s self-centered behavior and inappropriate redemption sanction.

The CEO also reported that FTX creditors and users, plus other investors in Grayscale Trust whom Grayscale’s actions have harmed, will profit from additional recoveries.