Having weathered the 2022 ‘crypto winter’, businesses in the sector are maturing and becoming more sophisticated insurance buyers in the process. However, carriers are likely to remain wary of crypto liability risks until global regulatory frameworks are implemented, says Anthony Tjong, senior vice president and deputy head of London Market Financial Institutions at Sompo International Insurance.
In the second quarter of 2022, the cryptocurrency market descended into a ‘crypto winter’. Following the collapse of stablecoin values earlier in the year, the flawed business models of more than one crypto exchange were exposed, causing a spate of bankruptcies and an extended period of low pricing for crypto assets.
Despite the turmoil that followed the insolvencies of some hey players in the crypto space, the market appears to have once more weathered the storm. Appetite for investment in crypto assets remains robust, and certain crypto risks remain highly insurable.
The current focus of Sompo International’s Global Markets FI team is on crime insurance for crypto custodians and this market has remained fairly stable. Appetite for the coverage remains consistent, capacity and line sizes have not been reduced, and carriers have held firm on rates.
However, policies covering professional indemnity and D&O risks for crypto companies are more likely to have been triggered by the recent insolvencies of firms like FTX, Celsius and BlockFi, threatening the sustainability of these classes of business.
As things currently stand, crypto is still a relatively unregulated sector, lacking a consistent governance framework for companies to adhere to. From an underwriting perspective, this can make crypto exposures a game of roulette when assessing the insurability of crypto entities.
But with the emergence of draft regulatory frameworks across some key territories, the crypto space is now getting closer to the point of effective governance, making it possible in future to construct a viable underwriting strategy around liability exposures.
EU aiming for clarity
In Europe, governments are pushing ahead with plans to implement an EU-wide legislative framework, following the passing of the draft ‘Digital finance: Markets in Crypto-Assets’ (MiCA) law, which was informally agreed by the EU Council in June 2022, and was passed by the European Parliament this April, alongside related legislation for the tracing of crypto asset transfers.
MiCA is intended to cover crypto assets not regulated by existing financial services legislation and includes key provisions for the issuing and trading of crypto assets – covering the transparency, disclosure, authorisation and supervision of transactions, as well as regulating public offers of crypto assets. The text of the draft agreement now needs to be formally endorsed by the EU Council before it can enter into force.
In a press release on the passing of the framework, EU rapporteur for MiCA Stefan Berger, said the laws meant the sector could regain trust damaged by the FTX collapse, and would create a competitive advantage for the European crypto asset industry, giving it a “regulatory clarity that does not exist in countries like the US”.
UK playing catch-up
Although the UK is behind the EU in forging an equivalent framework, the UK government did commit to introducing a regulatory regime for crypto assets in April last year, while HM Treasury launched a consultation in February 2023, which closed at the end of April.
According to the official notice from HM Treasury, the consultation sets out proposals for the UK’s financial services regime for crypto assets, building on previous Treasury proposals which focused on stablecoins and financial promotion of crypto assets.
While it appears an established regulatory framework for crypto in the UK is still some way off, government and regulators are at least on the path towards producing meaningful governance for the market.
In a speech delivered at City Week 2023 in April, Sarah Pritchard, Executive Director of Markets at the Financial Conduct Authority (FCA), called for “an open debate about risk, mitigation and the limits of regulation” in relation to crypto. The FCA is keen to get industry input on any future regulatory regime for crypto assets, to ensure it is fit for purpose.
As Pritchard noted, the FCA is currently limited to ensuring crypto firms comply with anti-money laundering and counter-terrorism legislation, with specific powers for regulating crypto wholly dependent on legislative change.
US crypto regulatory environment remains uncertain
In the US, regulations governing cryptocurrencies are a confusing mixture of state and Federal laws. While New York, for example, has the ‘BitLicense’, which authorises entities to conduct virtual currency business in the state, at a Federal level there is little in the way of substantive regulations.
Instead, the focus seems to be on punitive measures for firms that issue or promote unregulated securities, with a consistently hard line on crypto regulation being taken by US Securities and Exchange Commission (SEC) chairman Gary Gensler. There are voices in the US Congress advocating for a regulatory framework for crypto that would enable the sector to thrive, but the general mood music is a little contradictory.
For example, the White House released The Administration’s Roadmap to Mitigate Cryptocurrencies’ Risks in January, with a statement that said Congress should “strengthen transparency and disclosure requirements for cryptocurrency companies so that investors can make more informed decisions”.
At the same time, the White House also expressed the view that Congress should avoid producing legislation that would “greenlight mainstream institutions, like pension funds, to dive headlong into cryptocurrency markets”, adding it would be a mistake to enact legislation that “deepens the ties between cryptocurrencies and the broader financial system.”
Without the presence of formal regulation governing crypto, directors and officers will continue to be faced with elevated exposures arising from an uncertain regulatory environment.
Insuring crypto risks
In the near term, theft continues to be a key concern for cryptocurrency investors. As a recent Chainalysis report notes, 2022 was the biggest ever year for crypto theft, with $3.8bn stolen, primarily by North Korea-linked hackers. Providing cover to clients against the risk of a crime taking place remains an underwriting priority for the Financial Institutions team at Sompo therefore.
Longer-term, as the crypto sector becomes better regulated and companies adopt stronger governance procedures, and attain greater credibility with investors and regulators, we anticipate an increase in market appetite for underwriting D&O and professional liability risks. Until robust regulatory frameworks are in place, however, this remains a volatile class of business.
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