Viewpoint: Crypto asset risk and insurability
Traditionally used to insure high-value assets, specie coverage is being considered for digital assets
The unpredictable nature of crypto assets is compounded by slowly evolving regulation
As crypto assets such as cryptocurrencies and non-fungible tokens (NFTs) continue to gain in popularity, the issue of what measures insurers are taking to protect their clients from risks in this unpredictable environment emerges.
Since the advent of Bitcoin, insurance firms have grappled with the challenges posed by the unpredictable nature of crypto assets, compounded by slowly evolving regulations. Cyber crime, hacking, theft and fraud threats have been significant deterrents to coverage of digital assets gaining mainstream acceptance. Furthermore, the volatility and encrypted characteristics of digital assets make recovery of incurred damages from such risks a challenging endeavour.
As insurers contemplate providing insurance capacity for digital asset coverage, a specialised form of coverage traditionally used to insure high-value assets such as art collections is being considered: specie coverage.
Specie coverage is an important, lesser-known product insurers have used to cover portable items such as precious metals, numismatics and fine art, as well as crypto assets.
Where cyber security policies may cover ransomware attacks or hacking, specie coverage is often available to cover loss by theft or destruction of assets while in cold storage (storing cryptocurrency offline in a hardware wallet).
Because cold storage is offline, assets are more resistant to theft by hacking or phishing attempts. That said, like other precious assets, cryptocurrency remains susceptible to loss or damage from a variety of other perils.
The specific policy issued to crypto-based companies will continue to evolve as courts and governments provide companies with much-needed clarity.
Challenges in US and UK courts
As courts throughout the world deal with data custody issues in cyber breach cases triggering commercial crime and general cyber policies, insurers (and their counsel) should apply lessons learned to new crypto asset specie offerings.
For instance, recent holdings in the US have relied on the interplay between adequate custody and the importance an organisation places on cyber security best practices to determine the merits of claims and adequacy of pleadings. Insurers should pay keen attention to court interpretations as the number of crypto coverage claims increases.
In addition, a large percentage of crypto insurance litigation in the UK and the US centres on various key definitions such as “property” and “direct physical loss” as they apply to crypto assets. This is because the legal classification of crypto assets remains an unresolved question, with US laws yet to define “digital asset” or digital assets relying upon cryptography.
In the US, the number of insureds filing coverage claims continues to grow and disputes arise from losses of digital assets under homeowner and even cyber policies.
For instance, in the case Atwal v NortonLifeLock Inc, a New York doctor brought suit against NortonLifeLock for coverage of $12m in losses related to identity theft through the unauthorised use of key credentials by a third party. The court denied, in part, two motions to dismiss by NortonLifeLock and held the plaintiff’s complaint adequately alleged a loss under the defendant’s policy.
In Ali Sedaghatpour v Lemonade Insurance Company, the plaintiff argued theft of cryptocurrency stored on a hot wallet server constituted a “direct physical loss” under his homeowners’ insurance policy. The court disagreed, holding: “Physical impact to covered property is required for a ‘direct physical loss’ to have occurred. And no such physical impact to cryptocurrency is possible because it exists wholly virtually.”
In Kimmelman v Wayne Insurance Group, the plaintiff had $16,000-worth of Bitcoin stolen and filed a claim with his insurance provider. The carrier took the coverage position only $200 would be covered under the sub-limit. The court disagreed, citing the Internal Revenue Service’s treatment of virtual currency as property.
Future of crypto insurance
Cryptocurrencies such as Bitcoin and Ethereum have exploded in value, but their prices remain volatile and difficult for insurers to underwrite. This is further complicated by thousands of “meme tokens” that are even more complex to insure. Apart from currencies, NFTs are also volatile assets with an added layer of complexity since some NFTs often act as “membership cards” or provide other value that is difficult to appraise.
To further complicate matters, legislation in the US has been slow-rolling. The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) continue to regulate crypto assets with little co-ordination, creating more confusion for market participants. The confusion has spread to the courts, where the Southern District of New York has issued differing opinions on whether digital assets are securities.
Lack of uniformity in regulation and judicial decisions highlights the need for comprehensive regulation in the US. With clear regulations, the ambiguity surrounding digital assets could decrease, allowing for more consistency in the market and reduced volatility, and insurers may feel less hesitant to underwrite digital asset coverage.
Alternatively, insurers may elect to transition from annual to monthly premium models, enabling insurance companies to better accommodate volatility, ensuring they can maintain pace with the rapidly shifting values of these assets. Such a shift would promote accurate pricing and flexibility and potentially foster greater trust between insurers and policyholders. However, asset security would need to remain a focal point, with cold storage being the preferred method.
As crypto assets become more mainstream, the number of claims brought under traditional homeowners’ and cyber policies may increase, causing the courts to re-examine the policy language as it may apply to digital assets. As a result, insurers will be forced to account for these potential claims in their policy forms, whether they decide to afford coverage or to exclude it.
Until the crypto industry is allowed to neutralise its early setbacks, insurers will continue to create innovative products in the space, using existing policy frameworks to underwrite digital assets.
John Cahill and Jacob Moghimi-Danesh are associates at Wilson Elser