For this week’s episode will be shifting our focus from blockchain itself to one of blockchain’s most popular applications, cryptocurrencies. Specifically, we will be discussing the challenges and opportunities of brokering crypto assets.
To help us we have a panel of experts including Rachel Turk, Head of Directors and Officers insurance at Beazley, Rhys James, Head of Management Liability and Financial Institutions at Paragon Brokers and Ed Ventham, Client Executive at Paragon Brokers.
Blockchain in two minutes
A blockchain is a distributed ledger that is maintained by a network of users. It is powered by its users, who keep it secure through cryptographic algorithms. This is a distinguishing feature of blockchain that ensures the ledger is safe and trustworthy.
Cryptocurrencies are the tokens of value that exist on specific blockchains. The Bitcoin blockchain, for example, uses Bitcoin. The US Securities and Exchange Commission designated cryptocurrencies as a currency, saying they work as a “replacement for sovereign currencies”. This distinguishes them from a safe security and has great implications on how insurers perceive cryptocurrencies.
1. Mined vs premined
A mined cryptocurrency, such as Bitcoin or Ether, is what people generally understand cryptocurrencies to be. Multiple users on the network solve the complex algorithms that keep it secure and are rewarded with the currency.
A premined currency involves creating a number of coins before the currency is launched to the public. The currency is then distributed over time onto the blockchain for its specific use case. Premined cryptocurrencies have a negative connotation in the crypto community as some argue gathering all the coins upfront allows companies to easily manipulate the market.
2. ICOs: utility and security tokens
Initial Coin Offerings (ICOs) are used to raise capital and involve the distribution of utility or security tokens. Utility tokens represent future access to a company’s services and are not designed as investments. This created difficulties for companies and insurers alike. When insurers were discussing ICOs and SAFT agreements, what they were really trying to cover was the legal risk inherent in the agreement.
Rhys informs us that, in the last few months, there has been a shift towards security token offerings. A security token offering is essentially an equity or dividend offering, with security tokens having an inherent security designation by the SEC. From a risk point view that means clients are preparing private placement memorandums and adhering to SEC rules around security offerings. This changes the risk of the ICO race and moves the market forward, making a great difference to insurers who can now know they are dealing with well-established securities laws.
3. The crypto industry
When examining the crypto industry it is important to distinguish between its different sectors. These include pure blockchain companies, cryptocurrency exchanges and cryptocurrency custodians. Each sector has different regulatory responsibilities and can benefit from different insurance products. While there are some more general services such as regulatory indemnities, cryptocurrencies have also led to the creation of specialist products. For example, custodians require crypto wallet insurance to protect the private key for their wallets’ public addresses.
Thankfully, Rhys is here to explain what that means. The public address (also known as public key) is similar to an individual’s sort code and account number while the private key is the credentials needed to access the account. With cryptocurrencies, the best way to secure the key is to take it offline. This leads to a high value password and a custodian usually holds several of these private keys.
4. Regulating the crypto industry
Cryptocurrencies are borderless by design. This has created a novel challenge for regulators around the world, who have adopted a piecemeal approach to regulating them. Rachel points out insurers must therefore adopt a global perspective when examining cryptocurrency regulation. The US SEC takes a different approach than Malta or Gibraltar and it is too early to discern the dominant regulatory regime. However, Rachel believes regulation will not be based on where the company that founded the currency is incorporated. It will more likely depend on where the owners of the tokens or the company’s shareholders are based.
Insurance and the crypto industry
While the insurance industry had been very hesitant to insure crypto assets, insurers are gradually waking up to the opportunity.
1. Type of client requests
Ed and Rhys inform us Paragon has been receiving numerous requests for crypto asset insurance. These come from companies of all sizes. It can be a small startup ready for an ICO who need D&O and cybercrime cover. It is often difficult to help these companies. Even if they have an amazing idea and investors are lining up, the risk is very difficult to place. With no background or history, insurers are reluctant to take on the risk and brokers cannot do much to help.
Larger companies have also entered the cryptocurrencies market. These companies are more after the traditional insurance packages, such as D&O, PI, and cybercrime cover. It is generally easier to provide insurance to these companies as they have an established board and business background.
Pointing out Kodak’s ICO (yes, the camera one), we asked Ed if it is easier to work with an established company doing an ICO or a startup raising money through the traditional means. Ed informed us it is more important to focus on the different client needs instead.
Insurance brokers are client advocates. This means that the role and responsibility of the broker depends on the stage the client is at. With a startup, a broker will discuss when it’s the right time to come to market, evaluating the costs and benefits of insurance. The larger companies, on the other hand, have budgets commensurate to the insurance market. While this makes it easier to bring these clients to market, they also tend to be riskier.
The difference ultimately rests on the broker’s role at each stage. The technology is there and a good broker will be able to craft an appropriate solution for a client regardless of whether they are a startup or an established business.
2. Finding the right policy
Cryptocurrency has created a paradigm shift which will lead to new utilities and added customer value. However, Rhys informs us it does not require a complete overhaul of insurance products. It is possible to cover the needs of the crypto market by tailoring traditional insurance policies.
The first step is to discern in which sector the client is in. For example, a client could be an exchange, a cryptocurrency custodian or a startup doing an ICO. Then, the broker can understand the needs of the client in terms of risk and prioritise them according to the client’s budget. Finally, the broker creates the solution, which will be implemented using traditional insurance contracts that are tailored to be fit for purpose.
Designing bespoke solutions means the learning curve is steep for brokers and insurers alike. Rachel draws an analogy with the first wave of internet companies. There was a day when Google and Amazon were just starting out and insurers had to understand what they do and how the internet works. However, they were still buying the same insurance products as traditional retailers. The same can be said for the crypto market.
3. Working together to understand the risk
The difference with traditional insurance sectors is that, in order to cover the risk, insurers need a strong knowledge of the cryptocurrency market. Our panel unequivocally agrees cooperation is necessary to achieve this. Underwriters and brokers need to work together with clients to understand the client’s risks, create the right products and price them accordingly.
Fitting in with our recurring theme of customer-centricity, this perhaps involves a change in mindset from the traditional culture of the insurance industry. Rachel points out it is important for insurers to try new things and get involved. The learning curve is steep and some insurers may decide crypto assets are not for them. However, deciding whether to provide crypto insurance should be the result of gathering and analysing information, rather than rejecting an opportunity due to a lack of understanding.
4. Underwriting crypto risks
Before an underwriter gets to assess the risks, the client has already been through the lawyers, regulators and brokers, in a sense creating a bona fide of business. When it is the underwriter’s turn to examine the submissions, it is important for them to understand what business need the company fulfills. Rachel recalls the dot-com bubble, where companies would just add “.com” after their name and get a huge valuation. It is therefore important to distinguish between the people who are passionate about a great idea and the ones who try to cash in on the ICO trend.
Underwriting is both a science and an art and the underwriter will also have to rely on their gut feeling. “The part of underwriting you can never explain”, as Rachel puts it. This means underwriters must accept they might make mistakes. Paying claims is an opportunity for underwriters to reevaluate their offering and better understand the market when the next opportunity comes up.
5. Educating the insurance industry
Our panel firmly believes education is integral to tackling the crypto insurance market, helping insurers understand customer needs and deciding whether to cover a risk or not.
Ed believes the market is through the top of the hype curve and more mature businesses are coming to market. Insurers should grasp this opportunity and not be afraid to make a mistake or two. The end goal, however, should always be to close the knowledge gap. While underwriters have some appetite for the market, they will choose the best clients to partner with. Brokers, on the other hand, are trying to increase the depth of the market for offering these solutions. That happens in different verticals, such as D&O and physical private key storage. Each sector moves at a different pace but the market will only grow if individuals across each sector move to market.
Rachel points out clients also play a part in educating the industry. She recalls meeting with a US custodian company and leaving with a clear understanding of the company’s product, ethos and management team. Some clients, however, take little time to explain their product and just pay lip service to the requirements. A company with the ability to simply explain its offering to regulators and investors will have a much better start and is more likely get insured. Rhys adds that it is the positive client experiences, along with specialised external consultants, that educate the industry and drive the market forward.
It is also up to the individuals within the insurance industry to educate their companies. People with the willingness and desire to understand cryptocurrencies need to act as advocates within their own organisations to help the market grow.
The future of crypto insurance
Blockchain and cryptocurrencies are still very new and the market needs time to mature. Ed recalls a loss adjuster telling him a big claim is necessary for that. It would help insurers quantify their exposure and better understand the challenges and opportunities behind crypto assets.
It is also important to remember the insurance industry does not operate in a vacuum. It is part of a global, fast-moving environment where investment acts as the catalyst driving business forward. As investors become confident and capital flows in the blockchain and cryptocurrency space, companies need insurance to protect their new capital. Similarly, as regulators work to make new industries safer, insurers can more confidently underwrite new risks. This cyclical process can close the knowledge gap and help the crypto insurance market grow.
This may take some time but our speakers ensure us the crypto insurance market is gathering momentum. The technology is solid and stakeholders believe in it, making crypto assets an area worthy of attention.
Rachel, Rhys and Ed gave us a great overview of how crypto assets work and the challenges they create for the insurance market.
If you liked this episode please do review it on iTunes – your reviews make a huge difference. If you have any comments or suggestions on how we could improve, please don’t hesitate to add a comment below. If you’d like to ask our panel a question, feel free to add a comment below and we’ll get them over to our site to answer your questions.
Big thanks to Rachel, Rhys and Ed!