FTX collapse
Difficulties obtaining adequate coverage for these assets are likely to be exacerbated by the recent implosion and insolvency of the once $23-billion crypto exchange FTX. The FTX collapse in November 2022 stemmed from a liquidity shortfall that occurred when clients attempted to withdraw funds from the platform. This shortfall led to the discovery that $10 billion of customer funds had allegedly been improperly transferred from FTX to another company. The U.S. Justice Department has charged former FTX CEO Sam Bankman-Fried with, among other things, wire fraud, securities fraud, money laundering and campaign finance offenses in connection with the collapse.
The debacle left millions unable to access their assets and uncertainty about the ability to recover those assets in the future.
Insurers’ response
The industry response to the collapse has not been encouraging for consumers currently seeking to insure their crypto assets, or for those companies with coverage already in place. Insurers appear to be proactively denying coverage to clients with exposure to FTX, leaving crypto participants potentially uninsured for any losses from hacks, theft or lawsuits.
For example, Lloyd’s of London broker Superscript recently started requiring clients holding FTX assets to complete a questionnaire outlining the percentage of their potential exposure. The lead for digital assets at Superscript, Ben Davis, described the questionnaire, stating:
Let’s say the client has 40% of their total assets at FTX that they can’t access, that is either going to be a decline or we’re going to put on an exclusion that limits cover for any claims arising out of their funds held on FTX.
Moving forward, insurers are also proposing broad policy exclusions for any claims arising from the FTX collapse. And some are considering not offering coverage for crypto losses at all. Bermuda-based Relm Insurance, Ltd. (which previously provided coverage to entities linked to FTX) has indicated as much. Relm co-founder Joe Ziolkowski stated, “If we have to include a crypto exclusion or a regulatory exclusion, we're just not going to offer the coverage.”
Future perspectives on crypto coverage
Moving forward, consumers should consider what types of insurance might best protect crypto assets and exposure to crypto losses. While some crypto exchanges and crypto custodians may offer insurance for their services, supplemental insurance on top of what these entities provide may be necessary to adequately protect from all crypto-related risks. Further, policyholders should examine their existing policies to assess whether they may currently cover crypto-related losses and, if they detect gaps in coverage, seek new or supplemental coverage.
Insurance for cryptocurrency may be written into a standalone policy or be included within general business insurances such as the following:
- Directors and officers insurance. D&O insurance protects directors and officers from claims stemming from their work in company management, and can serve to protect crypto companies and their executives if someone sues either or both for decisions relating to investing in cryptocurrency assets. Claims can include a breach of fiduciary duty, misuse of company funds, not complying with workplace laws, and a lack of corporate governance. Consumers should seek to negotiate broad definitions of the terms “Claim” and “Loss” to ensure coverage will be triggered for crypto-related losses. The term “Claim” should be broad enough to include civil lawsuits, criminal proceedings, administrative proceedings and investigations against directors and officers, and sometimes include demands to enter into a tolling agreement or requests for interviews or to produce documents made to directors and officers. The term “Loss” should include defense costs, damages, settlements, judgments, and pre- and post-judgment interest, and also should include certain fines and penalties, as well as punitive, exemplary and multiplied damages.
- Cyber insurance. Cyber insurance is designed to provide first-party and third-party coverage arising out of security or privacy breaches, such as cyber extortion and ransomware attacks. It may provide some coverage for a data breach where hackers steal, or attempt to steal, cryptocurrency from online wallets. For example, a policy may cover the expense related to engaging computer forensic professionals to determine the cause of the loss and to terminate the attack. A cyber policy could also help you recover your data and cover loss of revenue caused by a business interruption due to a data breach. However, cyber insurance typically excludes coverage for loss of “money” or “securities.” As a result, additional coverage may be necessary to cover the loss of cryptocurrency.
- Commercial crime insurance. Commercial crime insurance provides protection from losses related to crimes such as theft and fraud. Cryptocurrency – while intangible – still needs to be stored. Cryptocurrency is typically stored in a digital crypto “wallet” on a cryptocurrency exchange or some other type of online platform. As such, cryptocurrency is subject to risk of theft, and commercial crime insurance could provide coverage from losses stemming from theft from the digital wallet. Specifically, such policies typically provide coverage for loss of, or damage to, money, securities and other property resulting directly from the use of any computer to fraudulently cause a transfer of that property from inside the premises. However, some insurers have argued against coverage because the cryptocurrency was not physically located within the policyholder’s offices, thus presenting some challenges for recovery.
Don’t wait to protect your crypto assets
Given the risk associated with cryptocurrency assets, consumers should be proactive in taking the necessary steps to protect those assets.
