This article considers the current state of the crypto insurance market, some key points for crypto firms and investors to be aware of when considering incepting crypto insurance, and whether a seismic change in the crypto insurance market may be on the horizon.
If you were to ask any would-be crypto investor, from micro to macro, to identify their principal concerns about investing significant sums in the crypto market, the security of their initial investments would feature at or very near the top of the lists of a significant majority.
Crypto investment is a high risk, volatile yet potentially high reward market. The prices of even the most established of cryptocurrencies can be much more volatile than many other investment assets. The shape and potential impact of future regulatory changes affecting the sector is also a concern. Taking into account the potential for cyber-attacks, crypto scams and thefts, safeguarding investments must be at the forefront of any sensibly minded would-be investor’s priorities.
Perhaps the most obvious solution to mitigate at least some of these risks and to open the door for further crypto investment is crypto insurance. There are indeed some limited policies on the market designed to protect investors against losses associated with cyber scams and cyber-attacks. It is perhaps initially confusing as to why, in the face of such a seemingly obvious solution, it is widely reported that only 1% - 2% of all crypto investments are currently protected by any form of insurance cover.
As the popularity of cryptocurrency has grown as an investment, so too has related cybercrime, particularly the theft of those investments. There has been a high-profile string of such hacks and thefts over recent years. In its 2022 Crypto Crime Report, Chainalysis recorded that cryptocurrency-based crime in 2021 hit a new all-time high, with illicit addresses said to have received around $14 billion in proceeds during the year, up from $7.8 billion in 2020. This is expected to grow again in 2022.
Combining with that, as any crypto investor will be aware, there has been a dramatic downturn in the market during 2022, plunging crypto into a bear market. Some of the longest-established cryptocurrencies such as bitcoin have dropped more than 50% in value, others have frozen withdrawals and some have collapsed entirely.
The effect of the combination of these events appears to have been a marked shift in the attitude of the investor market. At the market’s peak, peddling insurance for digital assets could be a hard sell. With the recent hardship affecting investors and crypto firms alike, there appears to have been a significant change in mentality as the market has soured.
Unfortunately, however, despite the increased demand from these bodies for suitable and appropriate insurance cover, the availability of such cover (and in many cases the adequacy of the cover which is available) remains severely limited.
There are a number of reasons for this current lack of supply of adequate insurance cover in the market.
Firstly, and principally, given the lack of regulation in the cryptocurrency market, there still remains a relatively small number of insurers who are currently willing to underwrite crypto risks. Insurers are, understandably, also reticent to underwrite risks for a market which is undeniably volatile and high risk.
Of the limited crypto-related risks that some insurers are willing to underwrite, cover is most readily available for theft. Policies, however, tend to be tightly worded in order to protect the insurer against the volatilities of the market and the response of the policy to any loss is characteristically made subject to an extensive list of policy conditions. For example, for theft claims, policies will stipulate that, for cover to operate, the insured asset must (at the time of the theft) be held in what is known as ‘cold storage’, ie assets held in offline wallets. If not, no loss will be covered.
While a stringent set of conditions is necessary for the insurer, there are a number of potential consequences of this rigorous application of policy conditions for investors and the market, not least that compliance with an onerous set of such conditions may put some policyholders off incepting cover at all. Further, and more concerningly, there is a real risk that investors may misunderstand the scope of the insurance in place and believe they are covered where they are not.
A number of crypto firms are now advertising that they have policies underwritten by reputable insurance companies in place to protect their clients’ assets as a means to attract new investors. However, given the stringent conditions which apply to many policies, in some cases these firms are running a real risk. If they are not expressly and explicitly clear with investors about the actual scope and limitations of that cover, they may find themselves on the wrong end of litigation if an incident occurs and cover is declined (where the investor has been led to understand they ought to be covered).
Another vehicle through which crypto firms are seeking to use insurance to mitigate the risks to themselves from a volatile market is via expanded Directors and Officers (D & O) liability insurance, which provides cover for claims made against the directors and officers of crypto firms by investors or shareholders, where the directors or officers of the crypto exchange are said to have fallen short of their regulatory obligations in some way.
There has been a recent uplift in such claims against directors of crypto firms, triggered by the recent collapses of various crypto companies. Investors should be keen to know whether a crypto exchange has such insurance in place before investing. Any talented individual considering becoming a director of any crypto exchange should also ensure that suitable D & O cover is available to protect them against such claims.
Unfortunately, the potential exposure for underwriters from such risks, combined with limited competition amongst insurers, given the small number of players in the market, means that these policies tend to be prohibitively expensive, especially for smaller or less established crypto companies. The relative absence of competition, for the time being, allows insurers to protect themselves through combining unusually high premiums with low limits of indemnity. D & O cover for technology and crypto firms is typically double but can be up to five times more expensive than D & O cover for more traditional financial bodies of commensurate size.
A final obstacle facing those crypto firms or investors wishing to protect themselves via insurance is simply a lack of comprehensive cover among the limited options available on the market. In order for a prospective policyholder to protect all their crypto assets against a full suite of typical risks, they would likely need to mix and match several different policy options together in order to obtain a full spectrum of cover.
There is no doubt that there are a significant number of insurers for whom this market is still too volatile to touch. However, the overall trend does appear to be towards insurers continuing to join the fray, notwithstanding the recent downturn in the market more generally, albeit on an incremental basis.
New insurance products for crypto businesses and investors continue to be released regularly and it is easy to understand why insurers are keen to explore this market. Crypto risks represent a huge potential market for insurers which, at 1% - 2% coverage across the piece, is a largely untapped pool of potential business in a multi-billion-pound industry.
Although it would be wrong to suggest that insurers are jumping in with both feet, there is continued incremental growth. Most insurers who do underwrite crypto risks are fairly muted about widely publicising their offering (presumably in an attempt to keep exposure low while they test the waters and compile data). However, insurers are inching in steadily, one toe at a time.
Most insurers entering the crypto sphere are generally considered to be doing so profitably but there is an ongoing caution regarding their ability to quantify the risk. Insurers do not have the same historic claims data which is available for other risks and there is an understandably careful approach to writing risk across the crypto insurance market.
Notwithstanding the ongoing incremental growth in supply, the market has not reached the stage where competition between insurers might serve to drive down premiums and open up policy conditions to the point where incepting cover is a more financially viable option for a wider pool of crypto firms and investors.
But the trends in the market indicate that such a tipping point may be on the horizon. The ability for investors to mitigate risk via insurance could then open up the market to a new wave of a more risk-adverse investor and may be the stimulus the crypto market needs to recover from the current slump.