The “1 percent” is on my mind quite a lot these days. (No, not that 1 percent!) The 1 percent on my mind is the amount of Web 3.0 digital assets currently subject to insurance cover. You don’t need your calculator to see that means a huge 99% of digital assets are uninsured.
Given that insurance is ubiquitous in most areas of our lives (life insurance, holiday insurance, car insurance, home insurance, professional indemnity insurance, bank deposit insurance…the list goes on) why is the figure relating to the insurance of digital assets so low? It is certainly not because they are risk-free.
Let’s begin by asking the question, what are Web 3.0 Digital Assets?
They are a representation of value in the form of tokens (e.g. Cryptocurrency) and Non-Fungible Tokens (NFTs) that are stored and transferred as data via a Blockchain or other form of Distributed Ledger Technology (DLT) and secured by cryptography.
For ease of understanding, Bitcoin, the world’s leading cryptocurrency, is a good example of a Token, and Beeple’s ‘Everydays: The First 5000 Days’, which sold for $69m, is a well-known example of an NFT.
It is possible for custodians of these Digital Assets to insure against the risk of potential losses associated with holding these assets.
Digital asset insurance, like most commercial insurance, provides three primary benefits to policyholders:
Risk Transfer: from the holder of the asset to the insurer
Risk Mitigation: required safeguards against the occurrence of the insured event
Marketing: the insured party’s ability to promote the additional security available
Insurance of digital assets commonly comes in two varieties:
Insurance in respect of ‘Hot Wallets’: The biggest and most widely used cryptocurrency exchanges – such as Binance, Coinbase, Kraken and Gemini – keep just enough cryptocurrency in a readily accessible hot wallet to meet trading demand. Hot wallets live on the internet as they are used for trading and are therefore more vulnerable to hacking and theft.
Insurance in relation to Hot Wallets usually comes in the form of a traditional Crime Policy.
Insurance in respect of ‘Cold Wallets’: The same exchanges will typically hold most of their digital assets in Cold Wallets. Cold Wallets are segregated from the internet and only used for the secure storage of assets. This means there is comparatively less risk attached to Cold Wallets (when compared to Hot Wallets).
Insurance in relation to Cold Wallets usually comes in the form of a traditional Specie Policy.
Specie policies do not typically cover any risks associated with ‘hot wallets’ and are there to cover risks like employee collusion, theft or physical destruction of the private keys on a physical hardware device. Think of this cover as akin to insuring jewellery in a safe. There’s a valuable physical object that can be stolen or destroyed which is the object of insurance.
Other forms of insurance that should also be considered in this space include:
Professional Indemnity: Protection for claims arising from Errors & Omissions in your Technology Platform or Financial Service
Cyber: Protection for your own data breach costs and business interruption, third-party defence costs and any resulting awards for damages from the unauthorized disclosure of data
Directors & Officers Liability: Protection for claims alleging wrongful acts committed by individuals in their capacity as a Director or Officer of your business
General Liability: Protection for claims alleging third-party injury or property damage due to your negligence
Cover for Digital Assets is still a relatively new product in the insurance market. Very few traditional insurers even consider offering cover related to Digital Assets as they are still perceived as high-risk.
The lack of competition inhibits the growth of insurance in the space, as very few have the requisite knowledge to effectively advise on securing appropriate cover.
The lack of volume reinforces the general opinion amongst many insurers that there simply isn’t the actuarial data required to effectively set the pricing of insurance policies which depends on having access to data on two key criteria: 1) the frequency of loss, and 2) the severity of the loss. The relevant data simply does not yet exist, which has led to high premiums levied in the space. Which again stifles growth in the sector.
Why is insurance take-up so low
Many businesses in the Digital Asset space are either start-ups or early-stage and are being operated by tech-centric individuals that simply don’t have insurance at the forefront of their business plan, they are mainly focused on development and growth.
A lack of knowledge and experience in the insurance market means that the products currently available aren’t being proactively sold, so in many cases, businesses are trying to source cover but not finding the right solution for their needs.
The businesses that do manage to find cover aren’t always motivated to buy due to the relatively high cost that can be prohibitive for early-stage companies.
What is changing
There is a slow but steady increase in awareness and interest relating to Digital Asset risk among insurers, therefore capacity is growing. As time progresses, insurance practices are improving, more data is becoming available, and insurers are starting to appreciate the opportunity available for prudent underwriters.
Increased regulation of the space means the general risk perception has been improving and some regulators also mandate a minimum level of insurance coverage be implemented. Crypto overall is also becoming more mainstream, with many banks and financial institutions entering the space.
In addition, many of the businesses in the space are now starting to mature, along with their attitudes towards risk management and transfer. They are taking on new board members that highlight the need for insurance cover, or they are procuring significant contracts that require appropriate insurance as part of the terms.
All of these factors mean that the Digital Asset insurance market - however slowly - is growing. This is of cold comfort to those who have already suffered losses due to the well-publicised thefts, frauds, scams and scandals but a necessity to help others avoid suffering the same fate and for the evolution of the industry.
Author: Stuart Griffin
Account Manager with Superscript and a specialist in the provision of insurance for digital assets and companies involved in the Web 3.0 space.