Insuring Cryptocurrency Losses
Cryptocurrency is characterized as a digital currency that operates independently of a banking system and leverages encryption technology to transfer its value through the internet. There are several different types of cryptocurrency, but the largest by market capitalization is bitcoin. Despite its intangible form, cryptocurrency functions similarly to physical cash across many countries and governments. This currency has become increasingly popular in recent years, with many businesses embracing it in the processes of selling goods or services online, accepting payments from customers and providing deposits to vendors.
Utilizing this virtual currency can provide a number of benefits for businesses, including faster transactions, fewer processing fees and exchange rate concerns, limited chargeback risks and the ability to attract additional customers. Yet, cryptocurrency also carries potential exposures. In fact, software company Chainalysis revealed in its annual Crypto Crime Report that $14 billion was stolen from cryptocurrency exchanges in 2021 alone, almost doubling the previous year’s total.
Furthermore, due to the unique and evolving nature of the cryptocurrency market, businesses may experience difficulties finding sufficient coverage in this space. That’s why it’s crucial for businesses to have a clear understanding of the virtual currency risk landscape and how to maintain ample protection for related losses. This article provides more information on the challenges of insuring cryptocurrency losses and explores the different ways commonly held commercial policies may respond to these losses.
Challenges of Insuring Cryptocurrency Losses
Various aspects of the cryptocurrency market have made commercial insurers hesitant to offer businesses coverage for associated losses. Specifically, financial experts frequently classify this emerging market as a volatile, high-risk environment, thus exposing insurers that operate in this space to potentially large-scale payouts. For example, several recent headline-making cryptocurrency theft incidents resulted in multimillion-dollar losses among the affected parties, including a $615 million loss from a blockchain project owned by gaming universe Axie Infinity and a $23.3 million loss from blockchain network Ronin.
Additionally, the cryptocurrency market is still a relatively new entrant to the global economy, carrying many unknowns. Given its short track record, the market is also largely unregulated, limiting the space’s legal standards and theft safeguards. Though government agencies and organizations such as the U.S. Securities and Exchange Commission and the Federal Deposit Insurance Corporation are in the process of better regulating this market, implementation will likely take time. Altogether, these factors have made it challenging for insurers to gather enough historical data and conduct comprehensive risk analyses on the cryptocurrency market, both of which are critical activities for establishing and providing coverage. As a result, businesses could face difficulties obtaining adequate insurance for cryptocurrency losses.
Nevertheless, the rising popularity and continued maturity of the cryptocurrency market has motivated certain parties in the insurance sector to begin expanding their coverage offerings in this space. Namely, global insurance market Llyod’s of London launched a handful of cryptocurrency coverage initiatives in 2021 and shared that it has written “a small number of policies in recent years for cryptocurrencies.” Moving forward, it’s certainly possible that additional insurers could follow suit. In the meantime, the lack of industrywide standards on wording for cryptocurrency coverage and designation to which segment of the insurance space such coverage should be allocated may allow businesses to use their existing commercial policies for protection from digital currency losses.
Ways Different Policies May Respond to Cryptocurrency Losses
Some commercial policies don’t explicitly address cryptocurrency exposures and related losses. Without concrete exclusions in place, these policies could possibly be utilized amid such losses. Here’s an outline of ways commonly held commercial policies may respond to cryptocurrency losses:
Commercial property and specie insurance—Most commercial property policies provide financial protection for direct physical losses to specified business property caused by covered events (e.g., adverse weather conditions, fires, vandalism and theft). While these policies are intended to cover tangible property losses, such as damage to commercial buildings and their contents, cryptocurrency losses arising from hacking incidents or the theft of digital wallets stored on offline platforms—also called cold-storage wallets—may also be covered. After all, some courts have ruled that bitcoin qualifies as physical property in the scope of insurance. But, other courts have determined that investment losses, including those involving virtual currency, do not constitute tangible property and are barred from coverage. With this in mind, it’s best for businesses to review their policies’ wording to understand the extent of their coverage. Regardless, businesses can look to specie insurance—a niche type of property policy covering high-value portable assets—for further protection. Specie insurance may offer more expanded coverage for cryptocurrency losses than traditional property policies.
Cyber insurance—Standard cyber policies typically protect against various first- and third-party losses resulting from cyber incidents (e.g., data breaches, ransomware attacks and phishing scams). Given that bitcoin has become a preferred form of payment among ransomware attackers, it’s possible that extortion-related cryptocurrency losses could be covered under cyber policies. Further, some cyber policies expressly offer protection for virtual currency losses or are otherwise worded broadly enough to imply coverage for such losses. When assessing the capabilities of their cyber insurance in relation to cryptocurrency losses, businesses should focus on their policies’ definitions of the terms “money” and “securities,” both of which are generally deemed covered losses. Some courts have held that bitcoin constitutes money, therefore qualifying for coverage. Litigation surrounding whether cryptocurrency qualifies as a security is currently underway.
Commercial crime insurance—Most commercial crime policies provide financial protection for first-party property losses arising from business-related crimes (e.g., forgery, robbery, employee theft and computer fraud). These policies usually define “computer fraud” as damage to money, securities and other property caused directly by the use of a computer to fraudulently transfer such property from the physical business premises. As such, computer fraud-based cryptocurrency losses may be covered by commercial crime policies. Similar to cyber insurance, this coverage will depend on how these policies define “money” and “securities” as well as whether losses occur on-site. However, businesses should keep in mind that some commercial crime policies specifically exclude coverage for virtual currency losses of any kind. In these cases, businesses may be able to purchase policy endorsements for protection from cryptocurrency losses.
Directors and officers liability (D&O) insurance—Traditional D&O policies generally provide coverage for losses stemming from third parties suing business leaders for wrongful acts (actual or alleged), including those causing adverse financial outcomes. As a result, these policies could offer protection for losses arising from business leaders being held accountable for lackluster security and recovery protocols amid cryptocurrency theft incidents or making poor investment decisions with digital currency. Yet, businesses should pay attention to policy restrictions that may minimize the scope of coverage for cryptocurrency losses, including electronic data and criminal conduct exclusions.
Conclusion
The cryptocurrency market has grown in recent years, attracting businesses worldwide. By staying informed on how to maintain sufficient financial protection against virtual currency losses, businesses can successfully navigate this emerging market. It’s best for businesses to consult trusted insurance professionals to review their existing commercial policies’ wording regarding digital currency losses and discuss additional coverage options. For further insurance guidance and solutions, contact us today.
This Coverage Insights is not intended to be exhaustive nor should any discussion or opinions be construed as legal advice. Readers should contact legal counsel or an insurance professional for appropriate advice. © 2022 Zywave, Inc. All rights reserved.