Already, big-time insurers are emerging as major players in the market: Lloyd’s of London, a centuries-old insurer with a net worth of $45 billion, partnered with Coinbase last year to provide a $255 million policy in April this year.
The growth in popularity of cryptocurrencies has, in many ways, outpaced the infrastructure built to support it. In terms of security, cryptocurrency exchanges that serve both as a marketplace and a store of the digital assets have become a hacker’s favorite target. Now that the cryptocurrency market has grown to its current capitalization of more than $200 billion, demand for crypto insurance is gaining traction.
Apart from Coinbase, other cryptocurrency custodians that have purchased insurance include Gemini, Kingdom Trust and Anchorage.
Why is there a need for crypto insurance?
Despite the remarkable technology backing cryptocurrencies, recent reports show that cybersecurity is still one of the biggest threats to the industry. Security research firm CipherTrace estimates that more than $4 billion worth of crypto funds was lost through theft and fraud in 2019.
For example, Binance, one of the biggest crypto platforms, announced in 2019 that it had “discovered a large-scale security breach” that resulted in hackers stealing 7000 Bitcoins worth a whopping $40 million.
According to Binance, the hackers used phishing and viruses to access the company’s hot wallets that allegedly contained about 2% of the company’s BTC holdings. Fortunately, Binance created a Security Asset Fund for Users (SAFU) in 2018 to protect users and their funds in such cases. Since 2018, the SAFU has been receiving 10% of all Binance’s trading fees as funds that are set aside in cold storage to be used in extreme cases.
Another case which highlights the need for crypto insurance is the Bitfinex hack of 2016. In June 2019, two Israeli brothers were arrested in connection to the cyber attack that saw the firm lose nearly 120,000 BTC (worth around $72 million at the time).
Since the start of this year, at least seven crypto exchanges have reported a large-scale hacking attack on their platforms. One of these is Bittrue – a Singapore-based cryptocurrency exchange that lost about $5 million in XRP and Cardano.
These reports highlight just how prevalent cyber attacks have become in the crypto space. What’s more disturbing is that cybersecurity experts reveal that “such attacks can be carried out with far more rudimentary levels of self-taught skills.”
While speaking to Cointelegraph, Hartej Sawhney, the co-founder of cybersecurity agency Zokyo Labs, said that, “there’s an array of low hanging fruits for hackers”, adding, “you don’t need military training to conduct cybercrime on today’s centralized exchanges.”
The challenge of insuring cryptocurrencies
With millions at stake, not to mention a growing cryptocurrency market capitalization, the insurance industry can provide a safety net for crypto investors. Traditional insurers can restore investor confidence in cryptocurrencies as a store of value.
Giant crypto exchanges like Binance, Gemini and Coinbase have already put in place insurance covers to compensate users in case of an incident. For instance, Coinbase claims in an insurance document that it maintains “commercial criminal insurance in an aggregate amount that is greater than the value of digital currency” it holds in hot storage.
The document further reads that Coinbase’s “insurance policy is made available through a combination of third-party insurance underwriters and Coinbase, who is a co-insurer under the policy.”
In October 2018, Gemini also obtained insurance services from Aon and the Federal Deposit Insurance Corporation. The company’s head of risk said:
“Consumers are looking for the same levels of insured protection they’re used to being afforded by traditional financial institutions.”
However, regulatory uncertainty is one of the biggest challenges that insurers are facing at the moment. All over the world, regulators are concerned about money laundering risks presented by cryptocurrencies, yet few have set out clear policies and frameworks on how cryptocurrencies should be traded and used.
While speaking to Cointelegraph, Yusuf Hussain, Gemini’s head of risk, also agrees that, “The biggest concerns from traditional insurers are rooted in the lack of regulatory clarity.” He adds:
“Thoughtful regulation in cryptocurrency will be the lynchpin for increased availability of crypto insurance. Done right, it can pave the way to healthy and sustainable markets and fuel long-term innovation that unlocks the promise of cryptocurrency and transforms society for the better.”
In his opinion, the best way to provide crypto insurance is to include appropriate licensing while “building an institutional grade infrastructure that meets the standards established by traditional financial markets.” Hussain says:
“An independent evaluation of the design and implementation of an exchanges security controls is also important since obtaining a SOC 2 report helps the industry move from saying it’s secure, to demonstrating it’s secure.”
The volatility of cryptocurrency prices also contributes to insufficient insurance coverage in the industry. In January of last year, data from coinmarketcap showed that the total market capitalization of the cryptocurrency industry was valued at over $800 billion, while currently it is fluctuating at just over the $200 billion mark. Volatility affects the valuation of insurance premiums, thus limiting the number of coins that can be insured in case of a hack.
A lack of insurance statistics in the cryptocurrency industry also presents problems of coverage pricing, as historical data is normally used to calculate premiums. In a volatile industry characterized by three-figure price swings, insurers can only manage to cover a small number of lost coins.
Coinbase, for instance, only insures a $255 million limit of its hot storage coins with Lloyd’s of London. It is unknown whether there is insurance for the rest of its cold storage coins.
What insurers stand to benefit
There is still a big education gap and a lot of misunderstandings preventing traditional insurance companies from providing full covers for the cryptocurrency industry. Add that to the challenges highlighted above, and suddenly it’s understandable why exchanges are having a hard time getting worthwhile insurance for their customers.
Despite the overall hesitant approach, insurance companies like Lloyd’s of London have always paid attention to Bitcoin. In a 2015 report, Lloyd’s assessed the risk factors of crypto insurance, mentioning that “the establishment of recognized security standards for cold and hot storage would greatly assist risk management and provision of insurance.”
Apart from Lloyd’s, a report by Bloomberg noted that other major players in the insurance industry such as Aon, Allianz and Marsh & McLennan are also paying attention to cryptocurrency insurance.
Cointelegraph talked to Timothy Fletcher, the lead of Aon’s western region Financial Services Group (FSG), who believes that:
“Certain insurers are willing to deploy capital and create bespoke insurance solutions for digital asset companies, many remain conservative given the evolving nature of the underlying blockchain technology.”
Fletcher added that, “a number of the larger, established insurers have taken a hard line and do not participate in the crypto sector at all.” In Fletcher’s opinion:
“A lack of regulatory clarity and limited insurance loss experience” are among the main issues causing the hesitant approach of the insurance market towards crypto.
On the other hand, the Bloomberg report showed that although the crypto industry is rife with heists and fraud, there are many insurers “betting they can avoid the pitfalls” to benefit from the substantial premiums of crypto insurance.
When asked to comment on possible methods that could be used to improve crypto insurance, Fletcher suggested that crypto exchanges should partner with a brokerage representative who is “knowledgeable about digital assets and understands how to navigate a volatile insurance market.” Fletcher also believes that insurers will need to understand the unique risks of each crypto exchange company while being mindful and respectful of the underwriting process.
For example, underwriters can charge up to five times or more for coverage against loss or theft. With a growing number of crypto startups considering insurance as a must-have in these times of cyber insecurity, there are greater opportunities for insurers to offer products tailored to each client’s specific needs. Furthermore, clients looking for wider coverage will need more underwriters in a practice that will reduce risk when disaster strikes.
Insurers are learning the space
Despite the many hurdles facing the cryptocurrency insurance space, the growth of the market over the years is hard to deny. All things considered, the insurance business is a people business and, therefore, the most effective way to improve engagement between crypto exchanges and insurers is to have in-person meetings. Such interactions will allow insurers to get a feel for a company’s management, culture and compliance.
Insurers can benefit from the increased demand for crypto insurance and boost their yields with bespoke products. Considering the growing trend in the number of insurers who are investing time to understand the risks and opportunities involved in the crypto space, it is time for insurers to consider offering coverage in this emerging industry.
Fledgling companies in the insurance world are already moving in to provide tailor-made products. Market experts like Fletcher foresee an influx of insurers into the space:
“Many insurers will offer coverage in this space; however, the coverage terms and conditions can vary greatly (e.g., coverage for hot vs. cold storage).”
While there is a need for more education around the subject of crypto insurance, another important factor to be considered is transparency. Traditional insurers are looking for full transparency to tackle some of the custody challenges of the crypto insurance market. Perhaps it’s time to rethink insurance policies and design them for individual cryptocurrency owners instead of custodians.