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Key Takeaways from Insuring the Cryptosphere: Understanding and Underwriting Risk on the Financial Frontier

The cryptocurrency industry is growing at a rapid pace, with the market capitalization of crypto assets reaching $3 trillion in November this year. With new investors entering into the crypto space, it is essential to have robust insurance solutions in place to manage and hedge risks in the cryptosphere. Our panelists Oliver Tonkin (Co-founder and Director, BCB Group), Shelley Schachter-Cahm (Group Head of Compliance, Mode Global Holdings), Ed Gaze (Senior Manager, Lloyd’s Lab), James Gadbury (Division Director, Costro Brokers Ltd.), George Beattie (Head of Incubator Underwriting, Beazley) sat down with our very own Natalie Hall (Marketing Director, EMEA & APAC) to discuss some of the opportunities and challenges related to insuring the cryptosphere.

1. Crypto space presents product innovation and revenue opportunities for the insurance sector

George Beattie highlighted three areas of opportunities where the insurance industry may tap into crypto. Firstly, the fast-growing crypto sector can act as a huge source of revenue for insurers, as the premiums that can be earned from insuring crypto risks will be substantial. George Beattie observed that “the premiums that are being earned are largely new to the market and competitively this is kind of interesting. You don’t get many markets, or many kinds of revolutions, that create this kind of income opportunity.”

Secondly, insurers can take advantage of the growing demand for crypto insurance to boost their yield by creating bespoke products. George Beattie further noted that insurers need to create products relevant to the crypto market by learning more about the crypto space and engaging with crypto companies to understand unique risks attached to different types of digital assets and platforms. Once they do this, they can offer insurance products tailored to each clients’ insurance needs. Ed Gaze added that a starting point for insurers could be to first figure how traditional products can be adjusted to meet the needs of crypto businesses, for example figuring out how crypto businesses can be provided coverage under D&O [directors and officers liability] and Professional Indemnity [PI] insurance.

Thirdly, the insurance sector can leverage blockchain technology to improve product development, streamline processes, and foster innovation For example, smart contracts can be used to speed up claims processing and payouts, and blockchain technology is used to enable automated real-time data collection and analysis. As George Beattie noted, “if we look at standards like Ethereum, we look at the ability to code smart contracts and other instruments using blockchain. We have a massive opportunity to change some of the anachronisms around traditional products in terms of how they operate, how they're triggered, how we pay, whether there is as much intermediation required on them.” 

2. Insuring crypto is not as risky (or difficult) as it seems

One of the main hurdles faced by insurers around placing and underwriting crypto risks is overcoming the general perception of crypto’s high risks. George Beattie observed that many insurers may be dissuaded from entering the crypto market due to the negative narrative, such as crypto being the preferred medium of choice for facilitating ransomware payments or its use in Ponzi schemes. He reminded insurers that the “risks in the crypto industry are very similar to the types of financial crimes that have already been around for generations and that you shouldn’t hang a whole new industry on reports of its illicit activity because it happens in any industry you look at whatsoever.” The panelists also pointed out the perception of risk in the cryptosphere is much more than the reality today, for example, contrary to the popular narrative less than 1% of Bitcoin activity is illicit. 

According to the panelists, volatility of the asset price is one of the key challenges faced by both the insurers and the insureds. Price volatility negatively affects the valuation of insurance premiums and the amount of insurance coverage to be provided. One of the things, according to the panelists, that insurers are looking to do is to fix the price of the crypto asset within the policy, however, the implication of this would be that the insured may get less compensation amount if the price of the asset increases.

Oliver Tonkin shed light on the geographical and operational complexities that both the insurers and crypto industries have to navigate. He stated that though this may not be true for all crypto platforms but for “a lot of crypto businesses, it is difficult to pin down where an exchange is situated, where it is located based on its operations, and where the people running the exchange are based. Since these exchanges are geographically dispersed it might be very difficult to assess the call price.” Further, the lack of uniform laws and regulatory clarity add to the geographical complexities faced by the insurers.

3. Brokers are beginning to work with the crypto industry to fill large insurance offering gap 

Presently, lack of access to adequate insurance coverage remains one of the major barriers hindering crypto businesses' growth, depriving their ability to create safeguards for customers’ funds in case of fraud, scams, exploits, etc. Shelly Schachter-Cahm explained that despite taking all possible measures to de-risk their crypto payment service provider business, Mode was unable to find an underwriter who was able to discern how risk-averse Mode was as a business. “If it were not for the heroic efforts of our brokers to secure an extension on our existing policy. We would have been left without cover for D&O and PI liability, which is unthinkable for an FCA registered business.” Agreeing with her, Oliver Tonkin stated that it is very difficult for crypto businesses to not only obtain but also to keep everyday D&O type of cover. 

On the flip side, James Gadbury noted that brokers are working closely with both crypto businesses and insurers to create innovative insurance solutions such as coin coverage policy, which provides coverage for coins in both hot and cold wallets.

4. DeFi Insurance: challenges and the road ahead

The panelists explained that insuring decentralized finance (DeFi) presents its own new unique set of challenges, which may be very difficult to overcome. One of the biggest challenges in DeFi insurance is finding the responsible party in the event things go wrong. In addition, it is also difficult to define insurable interest in the DeFi space.

George Beattie also noted that despite the existence of on-chain and multichain solutions, the problem surrounding the payment of premiums might not easily get solved. “It still doesn't get you beyond the fact that you have someone has to pay a premium. So could you foresee a situation in which premiums are pulled from all the different uses of a decentralized function? Possibly, but then who gets the benefit of the payment? I don't think that's an easy one to settle at all.” For DeFi insurance, he suggested that instead of looking for one responsible party, insurance companies should focus on uncovering entities/businesses that use DeFi protocols to do their business and will be impacted directly in the event of a loss. Further, he urged the insurers to make an effort to build a strong solid foundation by understanding the architecture on which the Defi protocols is built and how it works.

5. Bridging the crypto education gap is key to ensuring adequate insurance coverage for the industry 

Panelists emphasized that there still exists a huge education gap which is leading to a lot of misconceptions surrounding the crypto industry preventing traditional insurers from providing full coverage to crypto businesses. Ed Gaze explained that insurers may choose not to provide coverage to crypto businesses because they might not understand the business structure, risks attached to different digital assets, and their storage methods. 

To dispel the preconceived notions surrounding crypto, he encouraged insurers to have more conversations with crypto businesses regarding the specific risks surrounding crypto such as exploits caused due to attackers exploiting vulnerabilities in hot wallets or stealing clients’ private crypto wallet keys. Lloyd’s product launchpad is facilitating such conversations by providing underwriters with a platform to experiment with new ideas in a controlled manner, which balances the need for appropriate oversight with the risk of not innovating fast enough. Further, Lloyd’s Lab also launched a tech accelerator program that brought together tech businesses and the insurance sector providing them with an opportunity to interact with each other and create innovative products such as consumer-focused crypto-insurance solutions. Merkle Science participated in Lloyd’s Lab tech accelerator program where we spent 10 weeks understanding the needs of insurers and brokers looking to confidently and accurately place risk in the crypto space. Post its successful participation in the accelerator program, Merkle Science is working on creating ​​ a new tool to help address some of the challenges that the insurance industry is facing. Additionally, Lloyd’s has also created a new innovation class, which will allow insurers to write an additional 2% of their normal capacity for innovatively distributed products, making it easier for them to innovate.

How can Merkle Science Help?

In order to create effective insurance policies, insurance companies need to understand the level of risk exposures of their customers. Merkle Science provides a predictive crypto risk and intelligence platform, setting the standard for the next generation of crypto threat detection, risk management, and compliance solutions. We are creating the infrastructure necessary so that a full range of entities including crypto businesses, insurers, and banks may transact safely with crypto. 

Merkle Science’s highly customizable platform and proprietary Behavioral Rule Engine is easy-to-use, allowing institutions to detect illicit activity beyond the blacklists so that FIs may catch undetected suspicious activity that legacy providers might miss and better meet AML and KYC obligations as per guidance from jurisdictions around the world. To find out how Merkle Science works for your business, please contact us via our website.