Underwriting crypto asset risk – what are the odds?

Crypto assets are privately-issued digital assets secured with cryptography.¹ They can take the form of cryptocurrencies, which perform the role of currency. They can also be tokens, which are digital representatives of interests, or rights to (access) certain assets, products or services. For example, investment tokens provide holders ownership or entitlement rights similar to dividends. Investment tokens can also provide rights to virtual assets, such as Non-Fungible Tokens (NFTs), and to physical assets such as collectibles and real estate. From an investment perspective, crypto assets have been referred to as a potential hedge against inflation or uncorrelated alternative assets. Notably, re/insurers have not yet made significant investments in the sector due to the high volatility of the assets and other uncertainties.

Crypto assets theft is of growing concern. Hackers reportedly made off with several billions of dollars in virtual assets in 2021.² An open question for insurers in this regard is whether certain crypto assets are implicitly covered by existing property or cyber policies.

Recently, crypto assets have also been a contentious topic in court as they may be used to hide funds from authorities. For instance, dividing a family’s Bitcoin assets has become a major source of contention in divorce cases. There is a growing industry of forensic investigators who charge large sums to track the movement of cryptocurrencies like Bitcoin and Ether from online exchanges to digital wallets, in order to investigate whether a spouse has correctly declared the amount of crypto assets owned.³ Similarly, directors and officers may hide funds by investing them in crypto assets. This can increase court costs for personal lines and D&O covers.

With the rapid growth of the crypto asset sector, the question of insurability of such assets with new covers becomes more relevant. Digital assets, including digital artwork in the form of Non-Fungible Tokens (NFTs), cannot be insured against physical risks. However, insurers could consider providing coverage for the private key that ensures access to the NFT. In the case of offline physical storage of such access keys – a so-called “cold wallet” – insurers could also offer cover for loss of or damage to the wallet. Similarly, online accounts on crypto exchanges are vulnerable to hacking. Here insurers could provide cyber coverage, either for the operating entity of an exchange or to the individuals trading on it.

A relatively new development is the tokenization of material assets, from collectibles to real estate. If tokenization of collectibles such as art works or other luxury goods gains traction, an increasing number of collectibles will need to be stored and maintained at dedicated physical locations. The storage facilities will need insurance coverage and could face accumulation risk as many valuable assets may be stored in the same location. In all cases, the lack of historical data and the dynamic nature of the crypto asset space make design and pricing of respective insurance covers difficult. In addition, a significant challenge for insurers in this space is the price volatility of such assets, as well as the challenges of verifying a loss such as a theft.

Due to the high energy consumption and resources required for server infrastructure, insurers may be reluctant to provide coverage barring improvements on emissions. Similarly, insurers would need to be able to clearly distance themselves from illegal activities associated with crypto assets.

Large uncertainties remain around the regulation of crypto assets. Many financial institutions have concerns about becoming directly involved in providing services such as insurance for the crypto asset segment due to the perceived regulatory risks. The fluidity and “invisibility” of ultimate ownership make it hard to ensure compliance with regulations such as anti-money laundering (including “know your customer” requirements), international trade and economic sanctions, and “proceeds of crime” laws which would continue to apply to the financial institution counterparty.

Regulators continue to investigate ways to fill the gaps. Some countries prohibit trading in certain crypto assets, which will hold back market development. Less restrictive but clear regulation and thus certainty would both accelerate sector growth, and open new opportunities for insurers considering investing in or providing insurance covers for crypto assets.