This insights article is by Grace Best-Devereux, Major Complex Loss Adjustor at Sedgwick, who takes a deep dive into NFT insurance, which is a bit of a learning curve for some insurers. Knowledge is power, the power to quote…read on.
Since exploding in popularity over the pandemic, NFTs have established themselves as a controversial, volatile, yet exciting new paradigm for art and digital assets. Although the hype has since subsided and many have crashed in value, the questions they raise for insurers remain largely unanswered.
NFTs represent the concept of digital ownership – establishing the scarcity and provenance that determines value and subsequently demand for insurance. But although NFTs are accepted as art, their radical differences mean that traditional fine art policies cannot apply. Whilst NFTs remain relatively niche, the concept of digital ownership is here to stay, and it is vital we understand the challenges that must be overcome if insurance is to adapt.
NFTs and insurance – the story so far
NFTs are both an artistic format and technological medium that allow files to be traded on the blockchain. By ‘minting’ an NFT, an artist or collector establishes a record of ownership, and these assets are entwined with cryptocurrencies through their collector base, technological infrastructure, and methods of buying and selling. As with any emerging medium, NFTs are continuing to evolve, and this has played out through continued hype cycles and significant price volatility.
NFTs are an emerging market which insurance could serve as a risk mitigation tool, but also present an unknown frontier for how digital property can interact with an industry founded on quantifying the risks to physical objects. So far, major art insurers are yet to cover NFTs under fine art policies.
As a format that has been embraced by some serious collectors, institutions, and private individuals, insurers are aware of the demand for specialised NFT insurance solutions. However, as a nascent and volatile market, the incentive to design these products is limited. When the landscape shifts on a month-to-month basis, there is a risk that solutions will become outdated as soon as they are released, and the size of the market may no longer justify the expense. Consequently, NFT policies are unlikely to be a priority until they become a settled and established market.
Putting a price on a volatile asset
This ‘established market’ is crucial, as it provides the historic sales data required to establish ‘fair market value’. NFTs do not have this to draw on, and their volatility and allegations of market manipulation make the data we have an unreliable guide to ‘true’ value.
Apart from a few collections, notably Bored Ape Yacht Club and CryptoPunks, the vast majority of the NFT market has crashed in value. And even for these more resilient pieces, their price is typically pegged to cryptocurrencies such as Bitcoin or Ethereum, which are themselves highly volatile.
Establishing how much cover will be needed requires making a prediction on where the NFT and crypto market will be in the future. The difficulty of doing so means that policies may be significantly over or under valued by the time the claim is made.
Additionally, although NFTs intend to establish ownership, in practice they only prove who owns the NFT – not necessarily the asset it represents. This creates issues regarding authenticity. In the regular art market, export licenses and provenance documents can be cross referenced to establish legality of ownership for the physical asset, whilst tests can be performed to establish whether an artwork is
truly the work of a certain artist, for instance. But with crypto, it is nearly impossible to conclusively establish who you’re buying the work from, and whether the seller who ‘minted’ the token legitimately owns the artwork. Even if fair market value can be established, questions of ownership can still remain.
Physical insurance in a digital paradigm
Fundamentally there is the challenge of designing insurance for an artwork that is entirely digital and based upon blockchain data storage, and these challenges have been highlighted by artists experimenting with the medium.
For example, Damien Hirst released a work of a NFT corresponding to a physical artwork, in which he gives buyers the choice between a physical work or NFT. If the NFT is chosen, he films himself burning the physical work and that footage then becomes part of the conceptual nature of the NFT.
This case creates numerous conceptual grey areas. Is it the blockchain address, the burnt ashes of the artwork, or the video footage that is insured? How does fair market value differ between potential secondary market sales of the physical works, and the cryptocurrency trading of the NFTs? Questions like these encapsulate the contradictions that have made NFTs both an interesting medium for artistic expression and a challenge for art insurers.
Theft, damage, and provenance
Whilst these are philosophical questions as much as insurance problems, the properties of these assets are less ambiguous. Traditional art insurance is predicated on quantifying risk to physical objects, but damage and physical degradation is not a factor for NFTs.
So, if damage isn’t a factor, theft becomes the primary risk. But how can long-established best practice for determining these risks translate to digital pieces? When insuring a painting, it is relatively straightforward to price the risk of theft into the agreement, and conditions can be applied to its security. However, given NFT theft effectively constitutes hacking, the risk is tied to the security of the policyholder’s crypto wallet, and indeed the platforms they use, many of which are fragmented and unregulated. As many of these platforms are new and some have fallen victim to high-profile hacks, cover would again require specialised cyber insurance, not fine art policies.
As a way around this, a policyholder could store the key/ recovery phrase to their crypto wallet offline on a USB drive, in which case they could theoretically insure their NFTs under a general safety deposit box policy. However, this fails to solve the problem of agreeing a value for a volatile asset, meaning insurers are unlikely to cover them.
Clearly, there are meaningful hurdles to overcome. NFTs may be a legitimate artistic category, but as long as it remains volatile and unregulated, they are likely to remain exempt from art policies. The reality is that this may take some time – for context, mediums such as photography took more than 50 years to be truly accepted as art. For now, it’s a case of wait and see.
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