The cryptocurrency industry continues to grow at a rapid pace, with the crypto’s market capitalization reaching $3 trillion in November this year. As the crypto market continues to mature, it is generating a lot of interest and opportunities from a wider array of audiences including the traditional financial institutions such as banks and asset managers.
Though financial institutions are slowly warming up to the crypto market, they are treading carefully, as blockchain and crypto still suffer from reputational problems. Financial services and institutions are bound by strict compliance standards, and are hesitant to move into the space due to crypto’s risks — both real and perceived. For example, financial institutions may refuse to bank crypto trading desks. Banks may not allot business accounts or close accounts held by crypto exchanges. In fact, major crypto exchanges such as Coinbase and Bitfinex have been known to lose important banking relationships in major markets like Europe, U.K. and the U.S. Between 2017 and 2018, Bitfinex was forced to pause deposits and withdrawals after several banks, including Wells Fargo.
Insurance is another example of a typical basic financial service for tech companies of all sizes that digital asset businesses do not commonly have access to. As these startups and businesses grow, the lack of coverage hinders the industry’s ability to evolve in a safe and healthy manner, depriving their ability to create safeguards for customers’ funds in case of fraud, scams, exploits, market gyrations or even black swan events. From the operational side, startups require business property and general liability insurance, and eventually directors and officers (D&O) insurance. In order to support the continued growth and maturation of the industry, it is imperative to have robust insurance solutions.
Challenges faced by insurers that are looking to underwrite crypto risk
Through its participation in Lloyd’s Lab programme, Merkle Science has learned that there are four main challenges around placing and underwriting crypto risks.
Overcoming perceived reputational risks
The first challenge is overcoming the general perception of crypto’s high risks. While some insurers and brokers recognize the opportunities in the crypto space, many are dissuaded from taking products to the market due to the industry’s negative reputation.
However, contrary to the popular media narrative, less than 1% of Bitcoin activity is illicit. While 1% is still a significant number, the United Nations estimated that between 2% and 5% of global GDP ($1.6 to $4 trillion) annually is connected with money laundering and illicit activity. This means that criminal activity using cryptocurrency transactions is much smaller than fiat currency and its use is going down year by year. The reality is that the majority of participants in the digital assets ecosystem make every effort to comply with local and global regulation, employ best practices and prevent illicit activity, anti money laundering and fraud.
Understanding anatomy of crypto risks
Secondly, the insurance industry lacks knowledge about crypto — more specifically, the anatomy of crypto risks. Lack of understanding and ability to define the anatomy of crypto’s risks deters insurers from entering the crypto sphere. Insurers may not know how to differentiate good actors from the bad ones.
In order to create effective insurance policies, the insurers need to understand different kinds of risks attached to crypto. They also need to understand their customers’ level of risk exposure. In crypto transactions, risk exposure refers to the amount of risk that originates from interactions between the target address and those addresses which can be linked to illicit and suspicious activities.
On-chain data — such as addresses known to be associated with sanctioned entities or mixers — can provide insurers with great insight. But also understanding whether the risks are direct or indirect, or how many hops away the illicit entity is, all have different weights when it comes to risk exposure.
On-chain data should also be evaluated against off-chain information, such as whether crypto businesses are compliant, the jurisdictions in which they operate, and team profiles.
Lack of tools giving access to historical data
Typically, insurance premiums are based on historical data, but insurers lack this type of data from the crypto sector. Insurers may not have the right tools to access the data and make informed, evidence based evaluations. Insurers require tools that are easy to use and can make both on and off-chain data understable and digestible so that they may decide whether to insure against the businesses and craft the right policies.
Lack of ability to conduct continuous monitoring
Finally, post-binding, insurers require the ability to monitor changes in insured companies’ risk profile so that policies can be adjusted accordingly. Factors such as law enforcement actions, acquiring licenses in key markets, or exposure to emerging risks as the technology evolves all contribute to a company’s risk exposure. Insurers should be alerted and have the ability to adjust their policies.
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 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.