As cryptocurrency markets mature, they are attracting players from other industries. The insurance industry is one them.
According to a Bloomberg report, cryptocurrency insurance is poised to become a “big opportunity”. A spokesman from Allianz, one of the world’s biggest insurers, told the news publication that the company was exploring product and coverage options in the space because cryptocurrencies were “becoming more relevant, important, and prevalent on the real economy.”
Why Does The Cryptocurrency Ecosystem Need Insurance?
Currently, the cryptocurrency business, which mostly consists of startups and exchanges, is not big enough to provide substantial revenues for the insurance industry. Based on publicly available information, even North America’s largest cryptocurrency exchange Coinbase holds only 2 percent of its coins insured with Lloyd’s of London. These coins are held in hot storage (or are connected to the Internet). The rest are disconnected from the internet and not much is known about their insurance status.
Insurance for cryptocurrencies becomes important, when you consider the instability of the cryptocurrency ecosystem. The skyrocketing valuation of bitcoin and other cryptocurrencies has resulted in massive thefts of online wallets and exchanges. For example, cryptocurrency worth $500 million was stolen from Japanese cryptocurrency exchange Coincheck in January of this year. The cumulative result of these hacks is a vulnerable ecosystem that the mainstream finance ecosystem either ignores or refuses to take seriously. (See also: Coincheck May Have Suffered The Worst Hack In Cryptocurrency History).
As an example of the perils of cryptocurrency insurance, consider the case of BitGo, a blockchain security company. In 2015, the company claimed to have secured insurance for coins held in its custody from XL Group. But it temporarily removed and, subsequently, reinstated a blog post making the announcement after a hack at Bitfinex, a cryptocurrency exchange which was also a customer, that resulted in theft of $70 million worth of cryptocurrency.
Bitcoin and cryptocurrencies present unique challenges for insurers. Typically, insurance premiums are based on historical data. Such data is absent for cryptocurrencies. Volatility in valuations, where three-figure price swings are not uncommon, can also affect premiums because it reduces the total number of coins being insured. Regulatory uncertainty and lack of oversight at cryptocurrency exchanges can further complicate matters for insurers interested in providing services to the industry. (See also: Why Is Bitcoin's Value So Volatile?)
To be sure, bitcoin has always been on the radar of insurance companies. As far back as 2015, Lloyd’s came out with a report listing risk factors for the cryptocurrency. The establishment of recognized security standards for cold (offline) and hot (online) bitcoin storage would greatly assist risk management and provision of insurance, the firm wrote. It also mentioned server-side security, cold storage, multi-signature wallets as possible methods to mitigate risk attacks.
A Source Of Revenue
But problems within the cryptocurrency ecosystem could also be a potential source of revenue for the insurance industry. Most insurance products aimed at the industry are bespoke products that have tailored to fit client needs. According to the Bloomberg report, startups and companies operating within the cryptocurrency industry typically opt for theft coverage, which includes cyber insurance and crime. Hacks, however, are excluded. Startups can end up paying as much as 5 percent of their coverage limits, according to the report. Insurance Journal estimates that annual premiums could be as much as $10 million for theft coverage. In cases of large amounts, the coverage is split between dozens of underwriters for amounts ranging between $5 million to $15 million to ensure that no single insurer is on the hook in cases of hacks.
Attracted to the opportunity, insurance companies have devised new ways to calculate premiums. Christopher Lin, the head of AIG’s North American Cyber Insurance practice head, compared the crypto industry to a digital armored car service. He said that he had adopted a strategy of finding an established business without a similar risk profile.
Investing in cryptocurrencies and other Initial Coin Offerings ("ICOs") is highly risky and speculative, and this article is not a recommendation by Investopedia or the writer to invest in cryptocurrencies or other ICOs. Since each individual's situation is unique, a qualified professional should always be consulted before making any financial decisions. Investopedia makes no representations or warranties as to the accuracy or timeliness of the information contained herein. As of the date this article was written, the author owns small amounts of bitcoin and litecoin