Vol: 45 Issue: 4 | December 2022
- Cryptocurrencies offer significant opportunities for insurers, although there are challenges to overcome.
- The volatility of the currencies is a major concern.
- There is a pressing need for clear and consistent regulation globally.
The transaction volume of cryptocurrencies tracked by blockchain data platform Chainalysis grew to US$15.8 trillion in 2021, up 576 per cent on the previous year. Over the same period, criminals acquired cryptocurrencies worth US$14 billion — a significant but much smaller increase of 79 per cent.
This combination of rising popularity and threat sounds like a massive opportunity for insurers, but, so far, the industry has been characterised by huge demand with little supply or capacity.
Most of the cover that is available is designed to protect institutions such as crypto exchanges against the loss of assets following a breach of security. Assets can include the currency itself and non-fungible tokens.
‘This is still a very new market and there aren’t many insurers who are willing to underwrite the risk,’ says Timothy Chan, senior associate and insurtech lead (Australia) at Norton Rose Fulbright. ‘
'The main obstacle is that the crypto sector has suffered so many hacking losses.’
Within a crypto exchange, assets are protected by private keys.
‘Anyone who has a private key can access everything in that account,’ says Chan.
'Essentially, these keys are just a combination of letters and numbers and, as exchanges hold so many, they can unlock a great deal of wealth. This makes them an irresistible target for hackers.’
Wotton + Kearney senior associate Jessica Chapman, who won the Australian Insurance Law Association’s inaugural Gill Award for her paper on insuring the cryptocurrency industry, points to the importance of the checking process. ‘Insurers must be willing to conduct in-depth due diligence on the cybersecurity, governance and storage perspective of every prospective client,’ she says.
The second type of cover, transaction risk, relates to smart contracts on the blockchain. Smart contracts, usually denominated in a cryptocurrency, can be used for real-world transactions such as lending money. They can also fund parametric insurance — a policy that automatically triggers under certain circumstances, such as if a cyclone occurs.
‘In this case, insuring the smart contract would provide cover for the unexpected — for example, if a cyclone does occur but the contract fails to pay out due to a coding error or malignant intervention,’ says Chan.
Instead of shifting this kind of risk to traditional insurers, decentralised finance (DeFi) projects are offering protection.
Says Chan: ‘DeFi uses smart contracts to allow participants within crypto markets to share the risk with each other, so it’s also a form of investment for those who take part.’
The widely publicised volatility of cryptocurrencies is a challenge for insurers.
‘Payouts can fluctuate significantly, especially if they’re in a fiat currency,’ says Chan. ‘For instance, if you’re insuring bitcoin and the insurer either buys bitcoin or pays out in Australian dollars, that could theoretically end up being a dollar or millions of dollars. On the other hand, if insurers pay out in crypto, they may need to hold crypto in reserve, and that creates regulatory risk.’
Lack of regulatory certainty is another serious concern.
‘In the Asia-Pacific region, there are huge disparities between whether and how cryptocurrencies are regulated,’ says Chapman. ‘China and South Korea are among the strictest jurisdictions and others tend to be growing stricter year on year.’
In New Zealand, Inland Revenue treats crypto assets as a form of property like gold, as neither can produce income until it is sold. A tax applies to both the acquisition and sale of cryptocurrencies.
In Australia, the Australian Securities and Investments Commission has issued guidance to the effect that, in most cases, a crypto asset will be treated as a financial product for regulatory purposes. Cryptocurrency exchanges, which facilitate the sale and exchange of cryptocurrencies, may then be treated as financial markets.
‘If this is the case, the operator of the exchange will be required to hold an Australian market licence and be subject to applicable regulatory rules,’ says Chapman. ‘The government has also released several consultation papers flagging other potential regulatory and licensing models to make sure any remaining regulatory gaps are plugged in the crypto asset ecosystem.’
Shrouded in secrecy
There are examples of insurers globally starting to enter the cryptocurrency insurance market; however, they are relatively few and far between and minimal details have been made public.
‘In early 2018, XL Catlin, Chubb and Mitsui Sumitomo were reported as providing cover for companies which held cryptocurrencies,’ says Chapman, ‘and AIG has had an interest in cryptocurrency theft coverage since as early as 2015, though few policies have been written.’
To date, no Australian-based insurers have publicly expressed interest in the sector, although Independent Reserve became Australia’s first insured cryptocurrency exchange in 2020.Underwritten by Lloyd’s of London and launched through its syndicate Atrium in conjunction with Coincover, the product is designed to insure cryptocurrency held in online wallets.
‘This is a new type of liability insurance policy with a dynamic limit that increases or decreases in line with the price changes of crypto assets,’ Lloyd’s said in a statement. ‘This means that the insured will always be indemnified for the underlying value of their managed asset, even if this fluctuates over the policy period.’
There are also a few insurance options for individuals.
‘BlockRe offers policies to crypto asset holders providing cover for loss or theft of private access keys and hacking, among other things,’ says Chapman. ‘In September 2019, Axa XL announced it would provide contractual liability insurance to Hoyos Integrity Corp for amounts paid out if there was a breach of its digital hot wallet. Wallet users could be reimbursed up to US$1 million.’
In New Zealand, cryptocurrency retailer Easy Crypto guarantees customer funds as they transit through the company’s systems. However, unlike an exchange, Easy Crypto doesn’t store cryptocurrency funds, so the cover is limited.
Despite the challenges, Chapman sees significant opportunities for insurers.
‘The market for cryptocurrency insurance is estimated to be worth between US$200 million and US$500 million in annual premium revenue once insurers work up the courage to accept the risks and establish guidelines and internal policies around them.’
An Asian first
OneDegree Hong Kong entered into a three-year strategic partnership with Munich Re in April this year to launch OneInfinity, a digital asset insurance product.
OneInfinity was designed specifically for digital asset trading platforms, custodians, asset managers and technology providers. It bundles OneDegree insurance with solutions provided by cybersecurity assessment platform Cymetrics.
Helen Ye, chief commercial officer of OneDegree, says the partnership with Munich Re is a ‘game changer’ that will enable both companies to ‘broaden our understanding of the full spectrum of risks relating to end-to-end digital asset operations’.
‘We are confident that the partnership will contribute to establish best practice in risk management for the digital asset industry,’ she says.
Insuring non-fungible tokens
Non-fungible tokens (NFTs) are units of data stored on a blockchain. Broadly, ‘non-fungible’ means that the token is unique and irreplaceable, and NFTs can represent ownership of anything — including digital assets such as music or art. The NFT can be compared with an original, physical artwork in that it’s easy to reproduce, but there can only ever be one owner. However, issues such as copyright are still somewhat hazy.
There are still currently very few ways to insure NFTs.
‘There’s only a handful of specialist insurers that cover NFTs, with no appetite for this risk among larger insurers so far,’ Steadfast’s broker technical manager Michael White writes
on the Steadfast website. ‘Insurers in general are less inclined to provide cover over digital assets or are only prepared to provide restricted cover. In particular, the increasing incidence of scams involving NFTs [makes the risk] unpalatable to mainstream insurers.’
Those who do offer cover tend to be fine art and specie insurers rather than cyber specialists.
‘Insuring NFTs is more closely aligned to protecting real-world art against physical loss or damage, as it relates to physical storage of the private keys,’ says Norton Rose Fulbright’s Timothy Chan.
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