Why insurance is an obstacle for cryptocurrency industry's mainstream ambitions

Cryptocurrency exchanges and traders in Asia are struggling to insure themselves against the risk of hacks and theft, a factor they claim is deterring large fund managers from investing in a nascent market yet to be embraced by regulators.

Getting the buy-in from insurers would mark an important step in crypto industry efforts to show that it has solved the problem of storing digital assets safely following the reputational damage of a series of thefts, and allow it to attract investment from mainstream asset managers.

"Most institutionally minded crypto firms want to buy proper insurance, and in many cases, getting adequate insurance coverage is a regulatory or legal requirement," said Henri Arslanian, PwC fintech & crypto leader for Asia.

"However, getting such coverage is almost impossible despite their best efforts."

Many asset managers are interested in digital assets. A Greenwich Associates survey, published in September, said 72 percent of institutional investors who responded to the research firm believe crypto has a place in the future.

Last month, Mohamed El-Erian, Allianz's chief economic adviser said that cryptocurrencies would gain wider acceptance as institutions began to invest in the space.

Most have held off investing so far however, citing regulatory uncertainty and a lack of faith in existing market infrastructure for storing and trading digital assets following a series of hacks, as well the plunge in prices.

The total market capitalisation of crypto currencies is currently estimated at approximately $120 billion compared to over $800 billion at its peak in January.

"Institutional investors who are interested in investing in crypto will have various requirements, including reliable custody and risk management arrangements," said Hoi Tak Leung, a senior lawyer in Ashurst's digital economy practice.

"Insufficient insurance coverage, particularly in a volatile industry such as crypto, will be a significant impediment to greater ‘institutionalisation’ of crypto investments."

Regulatory uncertainty is another problem for large asset managers. While crypto currencies raise a number of concerns for regulators, including money laundering risks, few have set out clear frameworks for how cryptocurrencies should be traded, and by whom.

Insurance might allay some of the regulators' concerns around cyber security. Hong Kong’s Securities and Futures Commission recently said it was exploring regulating crypto exchanges, and signalled that the vast majority of the virtual assets held by a regulated exchange would need insurance cover.

Custody challenge

Keeping crypto assets secure involves storing a 64 character alphanumeric private key. If the key is lost, the assets are effectively lost too.

Assets can be stored online, in so-called hot wallets, which are convenient to trade though vulnerable to being hacked, or in 'cold' offline storage solutions, safe from hacks, but often inconvenient to access frequently.

Over $800 million worth of crypto currencies were stolen in the first half of this year according to data from Autonomous NEXT, a financial research firm.

Some institutions have started working to solve this problem, and may provide fierce competition to the incumbent players.

This year, Fidelity, and a group including Japanese investment bank Nomura have launched platforms that will offer custody services for digital assets.

Despite the industry's complaints, insurers say that they do offer cover. Risk advisor Aon, received some two dozen inquiries this year from exchanges and crypto vaults seeking insurance, according to Thomas Cain, regional director, commercial risk solutions, at Aon’s Asian financial services and professions group.

"It is not difficult to insure companies that hold large amounts of crypto assets, but given the newness of the asset class and the publicity some of the crypto breaches have received, applicants need to make an effort to distinguish themselves," Cain said.

The industry also says it is getting closer to solving the custody problem.

"This year there have been a number of developments, and some providers have developed custody solutions suitable for institutional clients' needs," said Tony Gravanis, managing director investments at blockchain investment firm Kenetic Capital.  

"Players at the top end of the market have also been able to get insurance," he said.

But this is not the case for all.

One cryptocurrency broker, declining to be named because of the subject's sensitivity, said insurers struggled to understand the new technology and its implications, and that even those who were prepared to provide insurance would only offer limited cover. "We've not yet found an insurer who will offer coverage of a meaningful enough size to make it worthwhile," he said.