The emerging insurance market for cryptocurrencies is still very small in terms of premium
income but with that most irresistible of social forces – demographic change – driving the widespread adoption of cryptocurrencies, the mood among the small number of carriers and brokers operating in the market is highly optimistic.
According to a recent report on the topic, the millennials who are driving the adoption of digital assets are maturing with the market, gaining in influence and committing more resources to grow holdings, all of which is instilling the confidence to make this new asset form take root and pushing it past the point that leads to mass adoption; this is predicted to occur over the next few years. The prediction is by 2030, 70% of Americans will own crypto- currency – the same level of adoption as credit cards.
The belief among crypto insurers and brokers is reliable insurance provision will have to be an essential part of the ecosystem if the use of cryptocurrency is to reach its true potential. With waves of cyber crime targeting cryptocurrencies, they argue, no one wants to hold an asset when they believe there is a distinct possibility of waking up one morning to find it is simply gone. In this regard, the stellar rise of internet of things devices will pose the biggest security risk by 2025.
There has been a notable expansion in the number of underwriting entities, including specialist crypo asset carriers and managing general agencies (MGAs) in the crypto asset insurance market over the past two years or so, with an estimated 12 to 24 companies operating in the space today.
At present, the primary digital assets are cryptocurrencies such as Bitcoin and Ethereum, but there are several other developments illustrating how this market is evolving. These include the increase in developments aiming to tokenise assets such as gold, art and stocks; the discussions about the development of central bank digital currencies; the tokenisation of illiquid assets, as well as traditional assets such as stocks, bonds and real estate; and the development of specific projects like Libra, the digital currency championed by Facebook.
Although regulations in the crypto asset space continue to evolve (faster in some jurisdictions than others), the lack of certainty is an issue not just for insurers, but also for companies operating in this space. This raises a key question for the market: given the nascent state of both the crypto asset regulatory environment and the corresponding insurance market, what are the main considerations for under- writers looking to build a sustainable book of business?
Sarah Downey, co-leader of the digital asset risk transfer (Dart) team at broker Marsh, says insurers can build a sustainable portfolio of business, even in areas where the regulations continue to develop, by considering a number of factors when underwriting coverage for any new industry or asset class. “These factors include – but are not limited to – a company’s financials, the background of the management team, the com- pany’s vision and proven ability to execute, their technology, compliance procedures and work with outside vendors such as law- yers or accountants,” she adds.
Indeed, Downey points out there are a number of commercial insurers that have built sound portfolios of blockchain technology/ digital asset company business.
Marsh’s Dart team was formed two years ago and now consists of a global team of about 20 brokers focused on clients in the blockchain and/or digital asset space.
Joe Ziolkowski, managing director at Relm, a Bermuda-based insurer that specialises in emerging business categories, including cyptocurrencies, agrees that by underwriting in a selective and measured way it is possible to offer insurance cover on a sustainable basis to the emerging cryptocurrency sector. But he says it is absolutely critical the underwriting process is focused on client engagement.
Clients’ willingness to provide transparency with respect to operations, as well as internal and external risks, will immeasurably enhance an underwriter’s ability to make informed decisions. “Combining client engagement with modelling based on likely scenarios rather than a limited operating track record makes it possible to provide quality enterprises that maintain effective governance controls and risk management with a comprehensive insurance product,” Ziolkowski says.
But to get to this point, insurers and owners of cryptoassets need to fully understand the risks involved, according to Ankur Kacker, a specialist in specie and digital asset risks at Marsh. This includes understanding the exposures associated with the various exchanges on which digital assets are traded, which range from regulated exchanges to licensed exchanges to exchanges that are entirely unregulated.
According to Kacker, the underlying exposure does not really change for a regulated or an un- regulated exchange, as it is the technology behind the exchange being used to store the private keys in “hot” (connected to the internet) or “cold” (offline) wallets that makes the difference. “In large part, the crime and specie insurers are underwriting the technology. From the directors’ and officers’ perspective, there is an argument the exposure varies based on the extent of regulatory compliance of an exchange,” he says. “However, in most jurisdictions, there is a lack of regulatory clarity about which regulatory body regulates and to what extent each type of exchange.
“In a vacuum, there is no black- and-white answer about the range of exposures per se and we look at each client for who they are, what processes and technologies they have in place, who their management team is and what their over- all vision is, among other things.”
The opportunities for the insur ance market in insuring cryptoassets are huge, but the market needs to understand this is a new risk and invest more heavily in understanding it, according to J Gdanski, chief executive and founder of specialist crypto asset MGA Evertas, says. “In terms of the insurance policies in this area available today, there is not one that has clearly published what it covers and what its exclusions are. There are also a few legal issues and terms in the sector that still need to be resolved for the market to really develop,” he adds. Evertas, which claims to be the world’s first cryptoasset insurer, was founded in 2017 as BlockRe, before rebranding last month.
As things stand, traditional in-surers are adopting a range of plans for entering the cryptoassets insurance sector. Some traditional insurers, Gdanski says, are “dabbling” in the sector to help keep abreast of developments and see what is happening to premiums. “Others are waiting for the market to become more developed before they take it more se- riously, and some are waiting for other insurers to lead and they will then follow. Others are look- ing to partner with experts like us to help them develop their propositions,” he adds.
According to Kacker, the crypto insurance market is developing every year as a result of continuing education, experience and data. “We remain optimistic and believe that in the next three to five years, we will see more insurers involved, especially as the regulatory environment becomes more certain,” he adds.
Kacker, however, stresses the importance of the increased involvement of traditional commercial insurers in the development of the cryptocurrency insurance market. “The traditional commercial insurance markets have a proven track record of paying claims and being able to sustain a challenging market and, as they become more comfortable in the blockchain space, the capacity they are willing to offer will increase,” he says.
He points out all of Marsh’s liability insurance placements for Dart clients have been underwritten by commercial markets in the US and London. “In fact, we have seen the capacity in this space in- crease substantially over the past two years. We are confident it will continue to grow.”
In addition, he says Marsh has created a consortium called Blue Vault with Lloyd’s syndicate Arch. Blue Vault provides capacity of $150m for “cold” storage risks. For Kacker, this is just one example of what the traditional commercial insurance markets can do in this space.
Gdanski says the cryptoasset market will continue to enjoy strong growth and evolve, but there will be high levels of volatility along the way. “The industry needs much better data and underwriting, and with no known covered claims having been made in this area, we still have much to learn in terms of how the claims process needs to adjust,” he says.
There is likely to be a huge roll- out of blockchain infrastructure and significant tokenisation of a range of assets, which represents a huge opportunity for insurers. “As blockchain becomes more central to the mainstream operations of organisations and tokenised assets become more common and widely used, traditional and existing insurance policies, such as business continuity and financial line covers, need to adjust to acknowledge and cover these new risks. There will be clearer guide- lines on how the digital asset insurance market operates, but much of this will be driven by insurers as opposed to regulators,” Gdanski says.
But for Ziolkowski, it is import- ant the industry, and its insurers, learn from past failures, as evidenced by a number of US class action lawsuits involving digital asset companies, which highlight problems related to misrepresentation, fraud and other alleged crimes against investors.
Since the inception of Bitcoin, he says, many cryptos have come and gone. “Whether the tokens involved celebrity promoters or ‘white papers’ that (mis)repre- sented the commercial value of the product/service underlying a particular token issuance, many cryptos that may have appeared promising are now dead.”
In fact, according to website Coinopsy.com, there were reportedly 1,085 failed cryptocurrencies as of November 2019. From an underwriting standpoint, there are some important lessons to be learned from these failures. “Most importantly, how do we decide to accept a risk that would not meet basic underwriting requirements for more traditional operations? How do we underwrite an organisation’s financial condition in the absence of audited financial statements?” Ziolkowski asks.
“How do we confirm whether an organisation has sufficient cash or credit to fund its operations and service its debt during the policy period in the event the token issuance fails to raise the targeted amount of funding? How do we evaluate claims history for a start-up? But, perhaps most relevant to the digital asset space, how much internal and external analysis has been conducted to determine whether federal securities laws apply to a proposed offering?”