In many jurisdictions around the world, the banks provide some kind of insurance protection, usually against theft, for their clients’ fiat money deposits in the bank. Although there is a maximum limit for the sum insured for each customer (in the US, it is $250,000 under the FDIC insurance), it does give some relief to the bank’s customers. Additionally, businesses have access to Money Insurance for loss of fiat money kept at its premises or in transit and Fidelity Guarantee Insurance for loss of fiat money through employee embezzlement.
But should you keep cryptocurrencies with a crypto custodian or an exchange, in most cases you are your own insurer, since most of them do not provide any insurance protection for their customers’ cryptocurrencies kept in their wallets. Likewise, for businesses neither Money Insurance nor Fidelity Guarantee Insurance is available to cover loss of their digital currencies. This, inter alia, is a major impediment to the growth and wider adoption of cryptocurrencies and blockchain backed businesses.
Across the world, central banks are reportedly thinking about and researching on how Central Bank Digital Currencies (CBDC) could replace traditional fiat money. Although they are researching into it, a survey by the Bank for International Settlements, shows their work is primarily conceptual and only a few of the central banks intend to issue CBDC in the short to medium term. Should they issue CBDC, we can possibly expect them to extend FDIC type of insurance to cover the CBDC held by the banks in their respective jurisdictions. Even then the insurance facility will be provided by the banks to its customers for CBDC deposits held in the bank and not for other digital currencies held by its customers.
Although, Banks’ customers are the first to receive a safety net from their governments and central banks for their fiat money deposits in the bank, businesses and individuals who hold digital currencies in the exchanges or with the custodians or in their wallets, do not get any such reprieve because of the lack of meaningful crypto insurance market for businesses and individuals.
We do hear of crypto insurances arranged by businesses such as bitgo.com, curv.co, coinbase.com, kingdomtrust.com, nexo.io, BC Group, anchorage.com, gemini.com, and a few others. These are few and far between considering the huge number of businesses and individuals in the crypto industry.
We shall explore below the reasons for the lack of availability or otherwise of crypto insurance both for the businesses and the individuals.
1. Technology still being developed and fine-tuned
The main technology that powers the cryptocurrencies, the DLT, is a new technology that is being fine-tuned and/or augmented with as we speak. Issues relating to scaling, privacy, interoperability, security and many others are being addressed and being improved upon on a continual basis. Innovative technologies like lightning network, atomic swaps, zero knowledge proofs, layer 0 protocol and many others have been or are being developed, tested or deployed. In a sense, we can say that the technologies powering the cryptocurrencies have not fully matured. Hence the issues relating scaling, privacy, interoperability, security and others remain hot issues, which makes the insurance market naturally apprehensive and slow to react.
2. Without reinsurance protection, there will be no insurance
Unknown to many is the existence of reinsurance market. Insurance covers the risk exposures of businesses and individuals. Reinsurance, on the other hand, covers the risk exposures of the insurance companies. When insurance companies insure the risks of the individuals and businesses, those risks of the individuals and companies are contractually transferred to the insurers. These transferred risks, however, could be beyond the financial capacity of insurance companies which is limited by their paid-up capital and reserves. A single policy claim could technically wipe out this capacity. Hence, these insurance companies manage these risks by transferring a part of these risks to specialist insurance companies known as reinsurers. Reinsurers specialize in insuring only the risks underwritten by the insurance companies.
Without these reinsurance companies providing reinsurance coverage insurance companies will not be in a position to underwrite many of the risks they insure. In most cases insurance companies reinsure more than 90% of the risks they underwrite retaining 10% or less for their account. In some large cases involving values (sum insureds) in hundreds of millions or billions of dollars, their retention could go as low as 1% or lower.
Naturally, if there is no reinsurance market for a specific type of risk, then the capacity of insurance companies to underwrite such risks will be hamstrung. This has been the case for crypto based risks for some time in the past. Only recently some of the reinsurance market participants have been warming up to crypto risks. But the number of reinsurers with appetite for crypto risks is still small.
In the face of a new, complex and ever changing technology-based risk, and with little historical data to go by, reinsurers are being abundantly prudent in their crypto risk portfolio by accepting only risks they truly understand well and accepting only insured values that are considered safe to protect their balance sheets.
The key to enticing reinsurance companies to accept crypto insurance lies in making sure that they have a deep understanding of crypto risks. Reinsurers need to understand and know the technologies involved, the risks that these technologies carry or resolve, details of the risk events that the industry has witnessed to-date and what could have prevented the those risks events from happening. Those proposing insurance (exchanges, custodians and others) should ensure that such information is made available to the insurance broker and explained clearly in writing and records of such communication kept for later reference.
It needs emphasis here that insurance contracts are deemed, at law, to be contracts of uberima fidei (utmost good faith). That simply means there is an obligation on the person proposing the insurance to provide the insurance company all material information. Material information are facts that would influence an insurer in deciding, whether to reject or accept the risk and if accepted, the terms and conditions to impose and the amount of premium to charge. The insurance proposer has this strict obligation even if the insurer does not request for such information. Failure to do so, entitles the insurance company to reject claims for breach.
For this reason alone, we cannot emphasize enough the importance of putting every communication (including conversations) in writing and keeping a record of the same for later reference.
3. Lack of technical knowledge and experience among underwriters
Reinsurers and insurers who wish to underwrite crypto risks probably already have IT and blockchain specialist on their staff. Even if they do have such staff, these staff are likely to be new to the insurance industry and will need time to learn the other aspects of the insurance industry, such as principles of reinsurance and insurance, risk assessment and management, underwriting and a thorough knowledge of the present state of the crypto industry itself.
The insurance proposer need to be mindful of these limiting factors and assist the insurance and reinsurance companies to understand the risk in whatever way they can.
4. Regulatory Hurdles
Insurance companies and reinsurance companies operate in highly regulated environment. They are required to have operating licenses and are subject to strict supervision by the regulatory authorities in their respective jurisdictions. Many of these jurisdictions impose heavy penalties on the insurance companies and reinsurance companies for failure to comply with the regulations. In addition, the chief executive and senior management staff are often held criminally liable for breaches with heavy fines and in some cases imprisonment. For serious breaches, their licenses could also be revoked.
Insurance and reinsurance companies are therefore extremely cautious not to be in anyway linked with businesses directly or indirectly involved in forbidden activities.
Such stringent regulations and the cautious attitude of the insurers and reinsurers alike stand in the way of insurance for crpto-based risks because cryptocurrencies by their very nature could easily be used for terrorism financing, money laundering or other nefarious activities.
Things you need to know as an insurance proposer
Insurance brokers are insurance intermediaries who broker the insurance on the insured party's behalf as his agent with the insurer and the reinsurers. At law, insurance brokers are considered professionals, just like doctors, engineers or lawyers. Hence, if they are negligent in the performance of their work resulting in your claim being declined by the insurance company, you have a right of action against the broker for professional negligence for your losses.
In most jurisdictions, brokers are required by law to procure Professional Indemnity policies to protect themselves against professional negligence claims. Since these brokers often negotiate and secure insurances with sum insureds running into millions and sometimes billions of dollars, their potential liability for professional negligence claims could run into hundreds of millions of dollars.
The mandatory legal requirement to procure a Professional Indemnity policy could be satisfied in most jurisdictions with a minimal coverage of say, even, $1 million per claim. Unfortunately, some brokers do procure just enough coverage to meet the minimum legal requirement and not their real risk exposure. Some of these brokers have been known to resort to contractual exclusions to escape liability. These contractual exclusions usually appear in their correspondence with you. If your staff are not legally trained or legally trained but unfamiliar with insurance law, they are likely to pass over these exclusions as something not unusual in the industry.
Allow us to repeat our earlier statement that insurance brokers are insurance intermediaries who broker the insurance on behalf of the insured party as his agent with the insurer and the reinsurers. This has legal consequences. One of which is that if the broker fails or neglects to forward any of the insured party's communications (instructions, information etc) to the insurer (reinsurer) or communicates it with errors (this can happen if the insured party gives verbal instructions), and if such information is material information then the insured party is deemed to have failed in his duty to provide material information to the insurer. The insured would then be in breach of the terms of the policy and claims, if any, will be denied. There is little an insured party can do in such circumstances except to sue the broker.
Conclusion
In this post we discussed crypto insurance for corporations such as custodians and exchanges. In a future post we will address crypto insurance for individuals.
Stay tuned.
