Crypto companies are finally looking to buy insurance. But are the policies out there worthwhile?
There is a cliché in crypto that bear markets are a time to focus on building. A time, in other words, to eschew splashier work like fundraising and partnerships in favor of the quieter business of product development.
For one of the world’s largest insurance brokers, USI, it’s been quite the opposite. The firm’s digital asset team is using this period to make a concerted push for clients and deals.
USI has quietly been building out a crack team of 40 individuals who specialize in risk associated with cryptocurrency and fintech since 2019.
Brokers act as the intermediary between consumers and insurance companies. Their role is to act as an advocate for the insured and to help find the best policy for their needs. Insurance companies rarely directly interact with clients.
The digital assets sector is woefully underserved by the broader insurance market, in part because it is so young but also due to its volatility. Broker Aon estimates the crypto market insurance rate is below 2%, according to a Bloomberg Law article.
But crypto firms are now starting to realize how valuable insurance can be, and demand is on the rise. Besides USI, specialist insurance firms like Evertas and Relm have emerged to offer crypto-specific insurance policies.
Still, these policies are prohibitively expensive for many smaller firms. And some wonder whether they are worthwhile.
Taming a crypto Wild West
Crypto firms can look to take out insurance for a variety of reasons, whether to cover loss of assets or secure property protection for data centers and miners. Last year, at the height of the bull market, insurance for digital asset firms could be a hard sell.
The crypto market was a “Wild West,” said Dave Roque, head of digital assets insurance at USI.
“Do we want to buy insurance? Maybe yes, maybe no,” said Roque, recalling conversations with clients who range from some the largest exchanges to crypto mining firms.
That mentality shifted dramatically as the market soured.
From roughly the start of this year, crypto plunged into a bear market. Bellwether cryptocurrencies like bitcoin and ether dropped more than 50% in value as investors grappled with rising interest rates, surging inflation and geopolitical tensions.
Struggling with multiple macro challenges, the crypto industry started to tear at the seams. A popular algorithmic stablecoin TerraUSD (UST) collapsed, taking an estimated $40 billion in value with it.
Several crypto lenders struggled to navigate a subsequent liquidity crunch. Players like Celsius and Voyager froze withdrawals, leaving thousands of retail customers in the lurch.
Hacks on crypto protocols and projects also became more prevalent this year, too. A Chainalysis report shows that $1.9 billion worth of crypto had been stolen as of July, compared with $1.2 billion in July of 2021.
“I think now more than ever, they realize how important insurance is,” said Roque, noting that the plausible prospect of new regulation has made it even more important. With little-to-no crypto-specific regulation, the average purchase of insurance varied from client to client compared to other industries, whereas future regulation might demand “sufficient insurance” for crypto companies, Roque said.
Whatever the motivation, now crypto companies are actively taking steps to become sufficiently insured.
In the last year, USI has seen a 350% increase in client acquisition, and all are fintech or crypto companies, Roque said.
Not every crypto company waited until the bear market to secure insurance. USI’s digital assets team has been serving customers since 2019.
“That first policy, I can tell you, it was a bit scary,” Roque said.
The policy involved multiple exposures, including coverage for decisions made by executives and directors, with no limitation on crypto as well as industry specific exposures like loss of crypto funds, breach and embezzlement, Roque said.
“Thank God, we had the backing of USI, who was 9,000 [people strong],” said Roque. “And we have great technical resources here that was able to help us in really building that first policy.”
Specialist firms like Evertas and Relm have cropped up to serve crypto clientele. They offer insurance for everything from theft and loss in relation to crime and custody, to more niche services like coverage for malfunctioning smart contracts and losses from when a staking validator is “slashed” for what the network considers harmful behaviour.
Over the years, big name companies like custodian BitGo and exchanges such as Gemini and Bitstamp have all integrated insurance into their services.
It's all about that D&O
The hottest service right now by far, however, is known as directors' and officers' (or D&O) insurance.
A D&O policy can cover claims made against directors and key managers from regulators, investors, employees as well as third parties.
It’s been a growing trend for last year or two, said Jeff Hanson, senior vice president at Paragon Brokers — and demand is only intensifying in the bear market.
The collapses of multiple crypto companies this year has triggered a corresponding increase in lawsuits filed against crypto firms and their directors. One prominent example is a lawsuit filed against bankrupt lender Celsius, which accuses the firm’s CEO of running a Ponzi scheme.
Breaches of fiduciary duty owed to the company and its shareholders will typically be covered in D&O policies, said J. Gdanski, CEO and founder of Evertas. With no clear regulatory direction laid out yet, however, the actions of an aggressive regulator can’t be covered, he added.
Gdanski describes this as the “Gensler effect”, referring to the Securities and Exchange Commission chair Gary Gensler. He explains that if Gensler were to wake up one day and sue a significant number of crypto companies that would be a massive hit for the insurance companies.
Insurers fear the risk because there are no standards or clarity around what could trigger regulatory action, Gdanski said. This makes D&O high risk, which makes it expensive and hard to find, he added.
Still, as companies start to strengthen their board compositions, talent is asking, ‘how much D&O do you have?” said Hanson.
“You're actually, in many cases, preventing some of the high quality, high calibre, risk minded veterans of various industries joining crypto companies, because there is no D&O insurance,” Gdanski said.
Wave Financial is one example of a crypto asset manager that has managed to get D&O insurance.
“When we were getting insurance — again, SEC regulated, large, profitable, have a high level of big-name advisors around us and things like that — it was very expensive,” said David Siemer, CEO of Wave Financial, describing how only three out of 50 companies would bid on the policy.
“If you're an early-stage startup, you don't have a million dollars a year for just D&O insurance,” he added. “So, I know a very few companies in crypto that actually have that.”
Is it worth it?
Getting a good quote is based on many core elements such as the company’s management team, employee turnover, size of balance sheet, litigation history and capital raising initiatives, said Joseph Ziolkowski, co-founder and CEO of Relm, an insurance provider for emerging industries.
“We start with traditional reserving methodologies and then we tailor the products and the pricing, and I'm reserving based on some of the unique characteristics of the crypto marketplace,” said Ziolkowski. He then tailors the policy to account for the uncertain regulatory environment and the volatility of the cryptocurrencies.
For those that can secure insurance, however, it remains questionable how useful the policies are, due to how proscriptively insurance companies approach the outlined risk factors and potential exposures.
For instance, companies often need to list out exactly what policy and procedures they have and the corresponding risk factors. The majority are self-declared activities that are almost impossible to follow, Wave Financial’s Siemer said.
“If you do get it, it's probably so narrowly written that it wouldn't be useful in a bad event anyway,” Siemer said. He explains how human error is rarely covered making the value of these policies questionable.
“You're paying an enormous premium for very weak insurance in almost every case,” he added.
Finally, there’s another crypto-specific problem. Whereas most crypto companies operating a traditional business model are at least able to get a quote, insurance companies are much less certain about more experimental models like Decentralized Autonomous Organization (DAOs).
“That's still a bit of a work in progress,” said Hanson.
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