The lack of a clear legal framework surround ing digital assets such as cryptocurrencies, security token offerings and other forms of assets that are held digitally has been one of the most significant barriers not only to the main stream adoption of such assets, but also to the development of an insurance market providing cover to companies operating in the digital asset sector.
But the crypto asset sector is continuing to expand and a small, but growing number, of crypto asset insurers and brokers have emerged over the past three years to provide risk transfer solutions to companies operating directly in the sector, such as custodians, depositories, cryptocurrency exchanges and digital asset mining operations, as well as to companies that support and service these core operators, such as alternative asset managers, blockchain developers, payment processors and lending platforms.
Given the emerging nature of the crypto asset insurance market, the key exposures and the range of coverages available in the market at present are surprisingly wide, if limited in terms of the actual cover, and include directors’ and officers’ (D&O) liability, professional liability, commercial crime and cyber and specie coverage solutions.
For the insurers and brokers active in the market today, this merely indicates the huge potential of the sector in terms of the broader application of these and other covers in jurisdictions with clear legal frameworks in place. This includes defining what is a cryptocurrency, but also what constitutes the legal difference between cryptocurrencies and other digital assets.
Depending on who you talk to, cryptocurrencies are either a type of digital asset or something completely separate and apart, ac cording Joe Ziolkowski, managing director of Relm, a Bermuda based insurer that specialises in emerging risks such as those faced by digital asset enterprises and cannabis and hemp related businesses. Relm is also in the process of developing insurance solutions for companies operating in new industry sectors such as digital banking, the sharing and gig economy, autonomous vehicles and artificial intelligence.
Digital assets, whether crypto or non crypto, can take a variety of forms but at its core, a digital asset is anything that comes in a binary format such as file information stored in a two state sequence used in computer programming, with a right to use, Ziolkowski says.
In this sense, the digital asset spectrum is very broad and the exposures associated with it extensive. “Considering the electronic and proprietary nature of these assets, cyber perils such malicious attacks that result in the damage or destruction of data, cyber extortion, unauthorised access and distribution of such data can have significant financial and reputational consequences. Additionally, there are potentially significant exposures related to the abatement and defence of intellectual property rights,” Ziolkowski adds.
To provide cover in this kind of environment requires carriers to combine a very high level of digital asset and new technology knowledge and expertise with the pragmatism of traditional insurance industry expertise. Indeed, the crypto asset market in many ways represents a digital mirror of the traditional specie insurance market. According to Sarah Downey, co leader of Marsh’s digital asset risk transfer team, the current crop of crypto asset crime insurance policies can respond to losses as a result of acts committed by employees or third parties and provide protection for cold, warm, and hot storage digital wallets. Similarly, the cryptocurrency specie market provides coverage for loss of digital assets from internal and external theft or for the damage or destruction of private keys. “The specie market, which traditionally insured vaults for gold, diamonds, cash and other physical items of value, now also insures the vaults used by crypto asset custodians to store the private keys,” Downey says.
But despite the best efforts of brokers such as Marsh and insurers such as Relm, most of the crypto asset insurance policies available in the marketplace today tend to be of variable quality, according to J Gdanski, chief executive and founder of specialist crypto asset managing general agency Evertas, one of the first crypto asset insurers in the market.
Often, Gdanski says, it is not clear what is covered and/or excluded in these policies. “This is partly the result of a poor understanding of the risks associated with crypto assets, insufficient levels of underwriting and the incomplete regulatory environment for crypto assets,” he adds.
This is the result of these markets being relatively new and there being a poor understanding of the risks involved of operating in them by both the businesses themselves, as well as by many insurers. “The poor regulatory processes, coupled with a general lack of understand ing of the risk, have contributed towards a lack of transparency around policy wording and what is covered and this is holding back growth in the crypto asset sector and the specific insurance market that serves it. There is a very limit ed knowledge in the insurance sec tor around the risks associated with crypto assets,” Gdanski says.
But things are in the process of changing For example, there have been recent moves by the authorities in Bermuda, Canada, France and Australia to impose professional indemnity requirements on digital asset businesses seeking a licence, while in the US efforts are under way to clarify which operators need licences, certifications or registrations to create or trade digital assets.
Although the UK is lagging be hind these other jurisdictions with regard to digital assets, a government appointed task force published a landmark legal statement in October providing long awaited clarity as to how cryptocurrencies, distributed ledger technology and smart contracts might be treated under English law.
In particular, the statement recognised crypto assets (including, but not limited to, digital currencies) can be treated as property, accord ing to Karen Boto, legal director at Clyde & Co. The statement also made clear smart contracts can satisfy the requirements of contracts in English law, making them en forceable by the courts.
The ability to classify crypto assets as property is important, Boto says. “Because this means they can be owned, which may give rise to important proprietary rights that can be recognised against the whole world. It may also suggest important proprietary remedies can be relied on more readily where crypto assets are lost or stolen,” she adds.
Although there are several complex legal issues that will need to be decided on by the courts or legislators in future, the statement is highly encouraging for insurers writing crypto related risks. In particular, the statement will be welcomed by markets providing crime cover to crypto related businesses for hacking incidents, as it may increase the prospects of recovering losses. “This may, in turn, reduce the losses being claimed from insurers in the first instance and/or pave the way for subrogated recoveries to be made in future,” Boto says.
In this regard, Bermuda’s Digital Asset Business Act 2018 (DABA) – the statutory basis for regulated digital asset businesses in Bermuda – is widely seen as an exempla ry piece of legislation. According to Ziolkowski, it is clear even from the most superficial perusal of the legislation that the Bermuda Monetary Authority (BMA) has deployed a significant amount of resources both to understand and provide oversight for DABA licensees.
This was one of the main reasons behind Relm’s decision to locate itself in Bermuda. “In this sense, working with Bermuda domiciled DABAs, we know these companies are required to go through a rigorous process to obtain their DABA licence and therefore the BMA indirectly becomes a part of our under writing process,” Ziolkowski says.
Furthermore, in addition to promulgating legislation, the Bermuda government has created a fintech business unit, which is geared to ward building an environment that both accommodates and regulates fintech initiatives. “From an underwriting perspective, evaluating a crypto business domiciled in an unregulated jurisdiction provides a stark contrast to a business operating within a regulated environment,” Ziolkowski adds.
Class action lawsuits
But until there is a level playing field in terms of the global regulation of the fintech and cryptocurrency sectors, insurers will continue to face a number of challenges. This was most recently highlighted by number of US class action lawsuits involving digital asset companies, accused of misrepresentation, fraud and other alleged crimes against investors and are likely to trigger coverage under some of the new digital asset D&O policies issued in the market.
Downey believes many of the lawsuits involved companies that did not have insurance in place. “Like any industry in its infancy, there are growing pains. Insurers are very experienced when it comes to underwriting D&O insurance and they know the risks and exposures to look for,” she says.
Gdanski says the lawsuits represent a reputational risk to insurers in that the companies being prosecuted are clients and that these lawsuits are slowing down the development of crypto asset insurance products broadly, and D&O products more specifically. “But they won’t stop the industry from growing. However, it does prevent high quality companies from get ting insurance and differentiating themselves from more questionable operations, which would not have insurance,” he says.
The regulatory uncertainty is not helpful and the inability of these businesses to get D&O coverage ultimately is counterproductive to what regulators are trying to achieve: a safer and more professional industry. “This is why it would be good to see all regulators providing great er clarity around what they expect from the development of crypto assets and the companies in this sector,” he says.