- Cryptocurrency companies need insurance to shield against the risk of digital assets loss through theft, fraud or scams.
- Companies have ventured into the crypto insurance market to offer services for the highly evolving industry.
- A ready market exists for investors who would gladly purchase crypto insurance if the right product was identified.
The cryptocurrency market has exploded in the recent past. Interestingly, the past couple of years witnessed significant fluctuations in cryptocurrency values. Rapid oscillations in investor interest caused the rise and the consequent fall in the value of cryptocurrencies. However, the crypto market has shown signs of recovery, with most assets valued much higher than their initial prices. Consequently, many people now prefer to hold their assets as cryptocurrency.
The growth in the crypto markets has attracted players from other industries, including insurance. Cryptocurrency companies need insurance to shield against the risk of digital assets loss through theft, fraud or scams. Crypto insurance is particularly crucial for exchanges and other entities holding significant amounts of assets on behalf of their customers. This creates an opportunity for insurers so long as they can mitigate risks.
A 2018 Bloomberg report predicted that crypto insurance could become a massive industry for insurance providers. Since then, companies have ventured into the crypto insurance market to offer services for the highly evolving industry.
What is crypto insurance
In the years following the introduction of Bitcoin, most traders relied on self-insurance. As such, they accepted personal responsibility for safeguarding their cryptocurrencies and private keys. In case of a security breach, the owner bore the losses.
As the market expanded, self-custody became less practicable, particularly for large, complex organisations with numerous employees. As with Mt. Gox in 2013, big crypto exchanges could go insolvent due to a significant theft. In other instances, such as the 2016 Bitfinex hack, the crypto exchange used its transaction fee profits to compensate consumers over an extended period.
As participants from conventional finance entered the cryptocurrency markets, they demanded more responsible risk management. Large, regulated institutions, including mutual funds and pension funds, began seeking methods to acquire cryptocurrency exposure without storing their digital assets. This opened up market opportunities for businesses that could offer cryptocurrency insurance.
Generally, insurers are hesitant to underwrite policies for crypto companies, and the premiums are typically higher than those of other businesses. Typically, insurance premiums are determined using historical data limited to cryptocurrencies. It is common for valuations to fluctuate by three figures, affecting premiums by reducing the number of coins insured. Regulatory ambiguity and a lack of supervision at cryptocurrency exchanges can further complicate matters for insurers interested in serving the industry.
Insurance companies have always kept a close eye on cryptocurrency. As early as 2015, Lloyd’s published a report detailing the digital currencies risk factors. “The establishment of recognised security standards for cold (offline) and hot (online) Bitcoin storage would greatly assist risk management and the provision of insurance,” the company wrote. In addition, server-side security, cold storage, and multi-signature wallets were mentioned as potential risk mitigation strategies.
What has contributed to the crypto insurance market growth
Crypto regulatory clarity
A lack of crypto regulatory clarity has remained a challenge for the industry. However, crypto regulation appears to be taking shape. Institutions across the globe are taking action to offer some crypto regulatory clarity and protect investor interests.
This regulatory progress will allow traditional financial institutions to adopt digital currencies. Crypto regulatory clarity will also pave the way for even more significant investment in the industry. Reassured by the growing regulatory framework, other organisations that have explored the benefits of cryptocurrency will likely take steps to invest in this field. As such many observers agree that proper regulation could help usher cryptocurrency into the mainstream.
A more evolved regulatory framework will additionally boost the willingness of traditional firms to offer crypto insurance capacity in this market. However, additional public awareness remains necessary at this time. And as the regulatory landscape grows increasingly complex, the rising risk of regulatory activity helps insurers comprehend what risk transfer options exist to help minimise potential exposure.
Growing cryptocurrency adoption
Most traditional financial institutions have waited for the green light from cryptocurrency regulators before publicly adopting digital assets. As such, banks have closely watched the market and prepared internally for several years. The growth in crypto adoption rates has incentivised organisations to explore these opportunities, with the regulatory framework finally taking shape and more assurance of the crypto market’s longevity.
Conventional entities could declare considerable investments in this field in the coming months. And while they likely have crypto insurance coverage in place, they should carry out comprehensive reviews of their existing policies to guarantee that digital assets do not fall outside the scope of coverage.
Growth in decentralised finance (DeFi)
DeFi has continued to grow since its inception and higher popularity through the crypto industry. The industry was historically fixated on the retail customer base. However, DeFi has evolved into institutional involvement in the last two years. And with the quest for crypto regulatory clarity taking shape, regulators may also seek a better understanding of the DeFi space.
From a risk standpoint, standard insurance covers that safeguard against technological fails and directors’ and officers’ liability (D&O) remain helpful for companies seeking secure their balance sheet and those who run the company. Even though DeFi companies significantly differ from each other, making it sometimes hard to find a one-size-fits-all solution, the DeFi boom can lead to creative crypto insurance solutions.
Challenges facing crypto insurance
Many insurance agents remain aware of their customers’ needs and are willing to offer insurance to tap the enormous market potential. However, many insurers remain reluctant to underwrite crypto insurance policies despite the growing demand. The reluctance stems from the various challenges associated with insuring cryptocurrency.
Who is to insure?
One of the significant challenges associated with crypto insurance lies in determining the party that needs a cover. Buyers purchase crypto. However, crypto exchanges maintain the records. Then again, some companies specialise in offering digital wallets to crypto investors.
In case of a cyber-attack, all these parties bear the risk. Thus, determining which party to compensate in case of loss remains critical while drawing a crypto insurance contract. Moreover, if multiple parties need compensation, the contract must specify the ratio for premiums payments.
The unpredictable nature of cryptocurrencies
Past experiences help to determine insurance premiums. The probability of unfavourable outcomes is calculated based on experience data collected and analysed statistically. The issue with cryptocurrencies is that such information is unavailable for calculation purposes. Additionally, it is impossible to anticipate developments in cyber technology.
The crypto insurance company may determine a premium based on the security configuration and cyberattack susceptibility. However, these probabilities may change as technology develops. To cover the risks, insurers must keep up with technological advancements. Since such constant monitoring is not feasible for insurance companies, not many companies are willing to offer coverage to policies dealing in cryptocurrency.
Currency of crypto insurance claim
Another common issue with crypto insurance policies is the currency in which to pay claims. Typically, insurers settle claims in the local currency of the country to which they pertain. For instance, insurance claims in India are settled in Indian Rupees, while those in the United States are paid in US dollars.
The issue with cryptocurrencies is that they fluctuate relative to fiat currencies. Therefore, if one bitcoin is insured, its value could fluctuate between $17,000 and $10,000 on any given day. As a result, the amount guaranteed by the policy would be market-driven and subject to daily fluctuations. This is unacceptable to insurance companies. Also, many regulators find this unacceptable because it becomes difficult to determine whether an insurance company has set aside an adequate amount of money as reserves.
Allowing insurance companies to retain a certain quantity of cryptocurrency to pay these claims is one solution to the problem. However, many nations oppose the proliferation of cryptocurrencies, and this model may not be viable in those nations.
Insurance companies may be required to establish wholly new entities that deal exclusively with cryptocurrencies. These entities can both accept and make cryptocurrency payments. This would eliminate the currency risk to some extent.
Anonymity defines the whole essence of people transacting in cryptocurrency. Insurance and anonymity are incompatible concepts. Unnamed beneficiaries cannot be issued insurance policies. Consequently, crypto insurance might probably not meet the requirements of many cryptocurrency investors.
The bottom line is that a ready market exists for investors who would gladly purchase crypto insurance if the right product was identified. However, insurers are unable to provide coverage due to the above factors.