13 min read

Staking Insurance: Explained

Detailed Guide to Insurance for Staking

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Published on

25 Feb, 2024


With most major purchases, we often opt for insurance. There are multiple insurance companies catering to nearly every niche insurance need. So, it was only a matter of time before insurance policies were adopted into the staking world, to greatly improve the security and confidence in the sector.

To give you a quick rundown, staking is a crucial part of the entire proof of stake ecosystem.

With the rise in usage of blockchain networks and growing interest among investors for passive income opportunities, more funds are being staked on these blockchains than ever before.

While new investors join every single day, there is still much scepticism about fund safety. Staking, due to its highly technical and complex nature, often warrants the use of a staking company which sets up validators, stakes the funds, and returns the rewards in exchange for a small commission.

This, however, also involves the staking provider taking up risks of slashing incidents and security risks. Even with all security provisions and utmost care, there is always a sliver of risk due to unforeseen circumstances. Most staking providers have been reinstating trust in their customers by providing their own form of "internal" insurance—insurance by which the staking provider is liable to pay the damages in case of a mishap.

Even though this form of insurance coverage is well recognized among investors and staking providers ,it can also be a burden and source of uncertainty for institution-grade investors. Enter external insurance, where a third-party insurer steps in to take on an extra layer of safety for investors. This traditional form of insurance is preferred across industries and is considered the standard approach to risk management. In this article, we will delve deeper into these two types of insurance, how they fit into the staking space, and the future of staking insurance.

Understanding the Risks in PoS Staking

In the PoS (Proof of Stake) staking landscape, both stakers and staking providers navigate a series of risks that are inherent to the nature of blockchain technology and its mechanisms. Understanding these risks is pivotal for maintaining the integrity of the staking process and understanding the need for safety nets such as insurance.

  • Slashing Risks: Slashing is a punitive measure designed within PoS protocols to deter validators from acting maliciously or failing to fulfil their validating responsibilities. For stakers, the risk lies in the potential loss of a portion of their staked assets if the validator they are staking with is found to violate network protocols. Staking providers, serving as validators or facilitating the validation process, risk not only the loss of staked assets but also reputational damage.

  • Security Breaches: The digital and decentralised nature of blockchain networks exposes them to various security threats, including hacking and exploitation of software vulnerabilities. For stakers, the risk of losing their digital assets in the event of a security breach varies significantly depending on whether they are using custodial or non-custodial staking services. In custodial staking, a third party has control over the user's private keys, potentially increasing the risk if the custodian's security is compromised. Non-custodial staking, where the staker retains control of their private keys, may reduce some risks but it still can’t address the vulnerabilities within the blockchain. Staking providers, whether offering custodial or non-custodial services, face significant financial losses, erosion of trust among users, and legal and remedial costs associated with security breaches.

  • Operational Risks: These encompass a range of issues that can arise from the failure of internal processes, human errors, system failures, or external events that disrupt the normal functioning of staking operations. Stakers might experience delays in receiving rewards, loss of rewards, or difficulty accessing their staked assets. For providers, operational disruptions can strain resources, lead to financial losses, and damage their reputation, affecting their competitive position in the market.

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The impact of these risks on stakers is significant, primarily revolving around the potential loss of staked assets and rewards. Such losses can severely undermine the financial incentives that make staking an attractive investment opportunity.

For staking providers like Luganodes, addressing these risks is paramount, necessitating the implementation of various policies, standards, and techniques to uphold a high standard of service. To mitigate security risks, Luganodes has achieved triple security certification, a testament to our commitment to safeguarding our infrastructure. Additionally, our operations are under 24x7 monitoring, ensuring that operational risks are continuously managed and minimized.

When it comes to slashing risks, Luganodes has taken a proactive approach by engaging Quantstamp for an in-depth slashing risk assessment. This collaboration has significantly bolstered confidence in our infrastructure's resilience.

Despite these measures, there remains a universal solution that provides a comprehensive layer of protection against all these potential risks: insurance. Insurance stands as the ultimate safeguard, offering peace of mind to both stakers and providers by covering potential losses and ensuring the stability of the staking ecosystem.

Internal Insurance Mechanisms

Most staking providers in the space have an internal insurance policy in place. The internal insurance policy, in other words, self-insurance is a system in which the company chooses to bear the risk themselves, instead of relying on a third party. Usually, this is achieved by keeping a reserve pool to cover any potential losses.

Firstly, internal insurance makes the whole process self-reliant. Everything from setting up policies to gauging risk is all done in-house. In a staking and cryptocurrency environment, there are more factors than one can predict. Therefore, it is advisable to implement internal insurance tailored to specific scenarios.

Internal insurance remains a mainstay in the staking industry, proving very useful when individuals, smaller businesses or groups decide to stake. The provision of such a system from a validator helps provide confidence and security for investors from various backgrounds. An ideal case where we tend to use internal insurance is one where a unique client such as an individual investor wants to diversify their investments, allocating a small part of their total investments to staking. Internal insurance ensures an optimum experience for their crypto investment venture.

Many staking providers, such as Luganodes, continue to provide internal insurance as part of their business development approach. Policies provide coverage up to a certain period and a certain amount against any slashing or missed rewards. The ability to custom tailor these agreements lies at the validator's discretion, based on the client.

However, internal insurance can only achieve so much. With the inevitable burgeoning of the staking industry, major players and institutions are willing to set foot into the safest form of cryptocurrency investment, staking. Many institutions are looking for solutions tailored to corporate investment with transparency on their profits, and high grades of security.

Internal insurance does not suffice in this case. In the unfortunate event of a large-scale calamity, there can be great financial strain on the provider, as well as losses for the investor. Moreover, to provide self-insurance in such a scenario, there will be a need for a larger insurance pool and significantly lower risk appetite. Managing these funds requires a delicate balance between allocating enough resources to cover potential risks and maintaining profitability. Larger funds can place additional operational and financial pressures on staking providers. To continue making steady progress, providers need to have a realistic approach to insurance.

Hence, in large-sum institutional investments, we believe it's best to have strong external insurer expertise. This provides investors with surety and allows the validators to continue doing what they are best at - staking!

External Insurance for PoS Staking

The rise of staking and its evolution into one of the main pillars of Web3 has been an incredible journey. Staking's simplicity and perceived safety have facilitated institutional interest and, over time, attracted significant investment. This evolution necessitated an accompanying upscale in security infrastructure, a part of which included the advent of external insurance.

Unlike internal mechanisms that rely on self-funded reserves, external insurance involves third-party insurers providing coverage against specific risks associated with staking activities. This arrangement allows staking platforms and their users to transfer the financial risk of potential losses to an insurance company, in exchange for a premium. Insured providers usually offer an insurance opt-in with a fee.

The insurance sets terms with certain situations and amounts predefined in the agreement. Most often, situations most prone to risk, such as slashing, are insured. Frequently, there is also a reinsurance deal in place, by which insurance providers transfer some of their risk to another partner. Reinsurance is a practice where insurance companies purchase their own insurance to mitigate the risk of large claims or losses. This process helps the original insurer manage its risk exposure and maintain financial stability by sharing the potential burden of large or numerous claims with the reinsurer.

Practical Implementation - Luganodes

To look at all this from a real-life example, Luganodes has Chainproof insurance in place for slashing. All institutional investments have slashing insurance included as a part of the standard agreement. Munich Re, one of the world's leading reinsurance companies, provides reinsurance coverage to Chainproof.

To better explain how the whole External insurance is implemented, we shall take our own example and give you a highlight of the journey. We start by defining the players involved in our insurance process.

Players and Their Contributions

  • Luganodes: A blockchain staking service that prioritises security and investor protection, offering institutional-grade staking services.

  • Quantstamp: A security company that performs comprehensive audits on blockchain platforms, ensuring high standards of security are met.

  • Chainproof: Provides slashing insurance, offering a safety net against specific risks associated with blockchain staking.

  • Munich Re: A leading reinsurance company that backs Chainproof's offerings, enhancing the robustness of the insurance provided.

Implementation Overview

Security Enhancement and Audit:

Luganodes underwent a detailed security audit by Quantstamp, aimed at identifying and mitigating potential vulnerabilities. This step was crucial in strengthening Luganodes' security framework and ensuring a solid foundation for its staking services.

Achieving the Verified Staking Provider Pro Badge:

As a result of the comprehensive audit and subsequent security improvements, Luganodes was awarded the Verified Staking Provider Pro Badge by Staking Rewards. This achievement signifies Luganodes' commitment to maintaining high-security standards and excellence in staking services.

Adoption of Chainproof Slashing Insurance:

With the enhanced security measures in place, Luganodes secured slashing insurance from Chainproof. This insurance is designed to protect institutional investors from the financial risks associated with potential slashing events, reinforcing the trust and safety of Luganodes’ staking services.

Reinsurance Support from Munich Re:

To ensure the sustainability of the slashing insurance, Chainproof is backed by reinsurance coverage from Munich Re. This step underscores the reliability of the insurance offering and ensures that Chainproof can effectively manage the risks associated with large insurance claims.

Chainproof, Quantstamp and Luganodes worked closely to bring forth this agreement to bring forth this unique, best-in-class offering. You can read more about this in our announcement blog.

Investor Protection FAQs: Your Safety Net with Chainproof Insurance

At the heart of our enhanced security measures and insurance protections lies the institutional investor. Below, we address some frequently asked questions to shed light on how these processes benefit our valued institutional investors.

Q: What happens if Luganodes faces operational challenges or becomes insolvent?

A: Chainproof insurance provides a crucial safety net, ensuring that investors can recover their funds even if Luganodes is unable to cover losses internally. This arrangement guarantees the security of investments under adverse conditions.

Q: How does Chainproof insurance work for investors in Luganodes?

A: Specifically designed to mitigate staking-related risks, such as slashing, Chainproof insurance steps in to cover financial losses if Luganodes' internal resources are insufficient, thereby protecting investors' assets.

Q: Is Chainproof insurance coverage included for all investors?

A: Chainproof insurance is an integral part of the standard service agreement for institutional clients, ensuring comprehensive protection as part of their investment. The fees for this insurance are factored into the overall package, offering a seamless and secure investment experience. For individual clients, we provide effective internal insurance mechanisms, designed to offer a high level of protection for their staking investments. We are committed to the security of all our clients, tailoring our insurance solutions to meet the diverse needs of our investor base.

Q: What assurances do investors have regarding the fulfilment of claims in case of a loss?

A: The collaboration between Luganodes, Chainproof, Munich Re, and the security endorsement by Quantstamp forms a strong protective framework for investors. This multi-layered approach ensures that investments are secure and that any claims will be responsibly handled and honoured.

The primary advantage of external insurance is the significant reduction in financial risk for both staking providers and participants. By transferring the risk to an insurer, staking platforms can operate with greater confidence, knowing that they have a safety net in place to cover potential losses. This enhances the attractiveness of staking as an investment option, potentially drawing more participants to the platform. For stakers, external insurance provides peace of mind, knowing that their investments are protected against a range of unforeseen events. This level of security can make the difference for institutions considering whether to stake significant amounts of digital assets.

External insurance does come with premiums, and relying on it requires careful consideration. However, for Luganodes, as a company focused on security, the additional premiums are considered a worthwhile investment. Moreover, given that the industry is still in its early stages, there aren't many insurers available, as many are still evaluating the risk landscape. In fact, Chainproof is the first regulated insurance provider to have backing from the traditional insurance industry.

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The overarching ambition of the Web3 sector is to enhance the viability, usability, and security of cryptocurrency, steering the digital currency landscape towards a brighter and more robust future. In pursuit of this objective, integrating established and reliable financial tools like insurance into the cryptocurrency domain is not just beneficial—it's essential. The unique challenges this industry faces call for a nuanced approach that adeptly combines the strengths of both internal and external insurance mechanisms.

As we look ahead, we're optimistic about the growth and evolution of insurance within this space, anticipating a future where questions of security and trust no longer cloud the judgement of investors. Our commitment is to foster a collaborative ecosystem, bringing together insurance partners, blockchain innovators, and forward-thinking investors. Together, we aim to build a foundation of unwavering trust and security, ensuring that the potential of cryptocurrency can be realised fully and confidently.

About Luganodes

Luganodes is a world-class, Swiss-operated, non-custodial blockchain infrastructure provider that has rapidly gained recognition in the industry for offering institutional-grade services. It was born out of the Lugano Plan B Program, an initiative driven by Tether and the City of Lugano. Luganodes maintains an exceptional 99.9% uptime with round-the-clock monitoring by SRE experts. With support for 40+ PoS networks, it ranks among the top validators on Polygon, Polkadot, Sui, and Tron. Luganodes prioritizes security and compliance, holding the distinction of being one of the first staking providers to adhere to all SOC 2 Type II, GDPR, and ISO 27001 standards as well as offering Chainproof insurance to institutional clients.

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