Insurers ‘lack understanding’ of fast-evolving cryptocurrency market

This year has seen record volumes of trading on the cryptocurrency markets as investors were tempted by soaring valuations in an uncorrelated asset class. However, the markets remain volatile and the recent drop in prices has underlined warnings about potential losses.

The best known cryptocurrency, Bitcoin, has ridden a rollercoaster over the past 12 months, as its value rose from under $10,000 to over $62,000, before falling back again to under $32,000, according to investor media platform CoinDesk.

Despite the dramatic drop in its value, market analysts continue to make bullish forecasts, with some predicting that Bitcoin will eventually reach $250,000. Meanwhile, cryptocurrency adoption will hit 200 million users by 2030, as reported in a Deutsche Bank report published in January 2020.

However, trading, owning and storing cryptocurrencies comes with a number of associated risks.

For example, in June 2021, Binance - the world’s biggest cryptocurrency exchange - was banned from “regulated activity” in the UK by the FCA. The regulator has previously warned crypto investors that they must be prepared to lose their entire investment.

Meanwhile, the founders of Africrypt, South Africa’s largest cryptocurrency exchange, vanished in June - along with nearly $3.6bn in Bitcoin - after telling investors the exchange had been hacked.

Such incidents highlight the precarious nature of cryptocurrency trading. In response, the insurance market for cryptocurrency continues to develop and evolve.

Ankur Kacker, senior vice-president in the financial and professional practice at Marsh JLT Specialty, said: “There’s a host of Lloyd’s market [firms] writing cryptocurrency cover [and] there are a few company [market firms] in London writing cryptocurrency risks.

“There is a hard market across the world and in all lines of business. A lot of insurers are looking at cryptocurrency because they think the pricing is right to get in. There are new entrants and also old players looking for new areas. There is new capacity coming in, but it is not as quick as we would like.

“This is a fast-evolving area - that’s the problem. Insurers traditionally lack understanding of technology [because] technology moves a lot faster than insurance.”

Kacker added that the insurance market has an “inability” to keep pace with “technology” in terms of being able to “understand it properly”, which has a knock-on effect on being able to accurately underwrite the risk.

Current cover options

Cryptocurrencies do represent value, so loss remains the main risk - whether caused by mysterious disappearances, complex ransomware problems or keys getting lost.

There are a number of Ponzi schemes, exit scams and malicious insiders pretending to be exchanges, which have also caused losses.

Marsh and Arch have collaborated on Blue Vault, which provides insurance protection for the secure storage of digital asset private keys held in traditional vault facilities. Private keys are the alphanumeric data that enables the transaction of digital assets, such as cryptocurrencies, on a blockchain.

Meanwhile Atrium’s Lloyd’s syndicate teamed up with UK specialist Coincover to launch protection for cryptocurrency held in online wallets.

The policies have a dynamic limit that increases or decreases in line with the price changes of crypto assets. This means that the insured will always be indemnified for the underlying value of their asset, even if this fluctuates over the policy period.

Elsewhere, Coincover offers a cryptocurrency will product, in response to four million Bitcoins - worth around $30bn - being lost as a result of people dying without adequate plans in place.

In October 2020, Bitstamp, the world’s longest-running crypto exchange, revealed that it had substantially increased insurance policy limits of indemnity for its crime insurance cover, which is underwritten by various insurance companies and certain syndicates at Lloyd’s of London.

The policy applies to digital assets held at Bitstamp, either offline or online, and covers an array of crime-related cases, such as employee theft, loss while assets are stored at any premises, loss in transit, loss caused by computer fraud or funds transfer fraud and loss related to legal fees and expenses.

The crime insurance policy supplements Bitstamp’s existing insurance of assets held in cold storage.

Cold storage refers to keeping private keys on a hardware device, disconnected from the internet. The policy means that more of the assets at Bitstamp are protected, even while they are held online or during transit.

Hot storage, on the other hand, refers to data that needs to be accessed right away.

“The insurance market for digital assets has evolved significantly over the past year but extending protection to hot wallet exposures is still a very involved process that remains available to only those operators with mature risk management processes and controls,” explained Jacob Decker, vice-president and director of financial institutions at US broker Woodruff Sawyer.

Higher price points

According to Kacker, the most available insurance cover for cryptocurrency is cold storage insurance, followed by hot storage, then directors’ and officers’ (D&O), errors and omissions (E&O), or professional indemnity.

However, he warned that as demand continues to outstrip supply, the price points for these covers are relatively higher than any other industry at present.

He said: “D&O and E&O, or professional indemnity, is an area where clients are looking for cover, but the market is just not there. There’s a lack of knowledge and understanding - it is a very difficult market.

“The regulators really need to step it up. They need to create regulations as quickly as possible so they create entry barriers for companies that are looking to get into this space.

“Ultimately the goal of regulators is investor protection and that’s what they have to keep in mind for a stock exchange, bank, equity trader or anybody else.

“They may not have encountered this technology before, but it has been there for decades.”