For many years, cryptocurrency has been referred to as the wild west of the finance world. In part, this moniker is due to cryptos unregulated status, but its not only that. Bitcoins famous volatility, the pioneering nature of the cyberpunk movement, and the high-stakes game of trading and investing in digital currencies are all somehow reminiscent of the American frontier.
The risk of losses through volatility is one thing, but there are other significant risks involved in cryptos wild west. Hackers and malicious actors hover around exchanges and smart contracts, looking for vulnerabilities. This year, the nascent decentralized finance space has been hit several times. Most recently, a hacker lifted over $450,000 from token pools on automated market-making protocol, Balancer.
Just as the wild west was eventually tamed, there are signs that the crypto sector is starting to advance in terms of offsetting some of these risks. One such area is mutual insurance. Over the last year or so, a few different types of mutual insurance have popped up in the crypto space, offering loss protection in various scenarios.
Mutual Insurance as a Hedge Against Price Volatility
With the notorious volatility of crypto, trading the spot markets can be risky enough. However, the last few years have seen an explosion in cryptocurrency derivatives, with open interest exceeding $5 billion in February this year, according to data aggregator Skew. Cryptocurrency futures exchanges typically offer the opportunity to trade at high leverage, usually around 100x. This magnifies the potential for gains, but the same applies to losses.
This year, Bybit launched its mutual insurance facility as a way for its users to hedge against the risk of losses in the event that the market moves against a traders position.
Insurance protection can be taken out against long or short positions, for periods ranging from 2 to 48 hours. Traders pay a premium to have their position covered by the insurance, with all premiums pooled into Bybits Mutual Insurance fund, which the company itself kickstarted with an initial payment of 200 BTC.
Premiums are priced in the same way as an options product, using the Black-Scholes model. The higher the ...