— Internet of Value
Insurance Solutions for Digital Assets and Business Models based on Blockchain Technology
Blockchain technologies and the rapidly expanding potential of utilizing NFTs in a variety of contexts offer opportunities for innovative, efficient, and transparent business models in various economic sectors – from financial services to healthcare, the logistics industry and the art market.
Digital assets are becoming increasingly important in modern society. They are used for a growing range of purposes, including as a means of payment for goods and services or for representing things and rights in the digital space. Smart contracts and distributed ledger technology have expanded the way in which digital assets can be created, accessed, used, and transferred. This technological development will continue.
At present we predominantly associate the term non-fungible token with digital works of art. For example, the trading volume of NFT artworks, NFT collectibles, gaming and metaverse projects with linked digital goods in token form has grown to a multi-digit billion USD amount in the past two years.
Blockchain technologies and NFTs also place new demands on risk management and the insurance industry. Blockchain-based business models and the trading of digital assets are taking place in an increasingly complex environment in which new regulatory guidelines are also being set.
Companies that trade and hold cryptocurrency and other digital assets are more likely to be the target of cyberattacks, lawsuits, and reputational damage than most other companies and industries.
Therefore, it is all the more important to know and address the key risks in this environment. Some of the risks associated with digital assets are very specific, which can prove defining and negotiating appropriate insurance coverage to be a challenge. With a token-based economy, there are new requirements for due diligence of companies and consumers. Cyber security and control over sensitive data are more relevant than ever. In addition to the widespread fraud and theft scenarios, which mainly affect collectors of digital art and collectibles, companies, and platforms that trade, manage and take custody of digital assets are also increasingly victims of cyber attacks, social engineering fraud, copyright infringement and other losses with different causes.
Web3 – Vision of the future with potential and specific due diligence requirements
The Web3 pursues the vision that data sovereignty and property rights lie with the users. From the user’s perspective, Web3 also develops a whole new economic dimension – an internet which enables users to directly transact with one another without intermediary service providers. The Internet of Value is becoming a digital space for the storage and transfer of assets of various kinds, whether cryptocurrency, security token, music rights and other intellectual property, digital works of art or digital identities.
However, the decentralization of Web3 must also be viewed critically. KYC processes and rigorously practiced due diligence among market participants are crucial prerequisites for further growth and the insurability of risks associated with the use of Web3.
When it comes to security, blockchain and distributed ledger technologies offer specific advantages over centralized database technologies because they do not provide a central point of attack. However, this does not mean that there are no attack vectors at different levels. Digital wallets of users can be targets, but also the network, mining pools, interfaces between blockchains or smart contract protocols. In addition, the technology is not yet thoroughly tried and tested and still under development. It is difficult to predict as to how the technology itself and potential attack strategies of bad actors will evolve.
A major risk factor for theft of digital assets and fraudulent behavior on Web3 is the exclusive use of crypto identities in decentralized peer-to-peer networks and the resulting lack of sanctions and prosecution. It is to be expected that soon stricter market surveillance and increasing regulation of business activity on Web3 by the supervisory authorities will place marketplaces under an obligation to verify legal identities of market participants and keep this data available.
Fintech industry and digital assets – insurance solutions support innovation and further growth
In the fintech industry, blockchain technology offers potential for time- and cost-efficient transactions on a global scale. Alternative investment opportunities such as investing in NFTs, cryptocurrency and trading crypto securities not only require an appetite for innovation and risk but also specific expertise and willingness to learn. This is also true for insurance solutions for digital assets.
Companies that hold own digital assets in their custody or provide custody services to customers may incur direct financial losses due to theft, destruction and fraud. If third parties are affected, companies face a liability risk of a new type and dimension. In the event of loss due to a cyber-attack, the amount of loss incurred can be very high.
Crime Insurance offers insurance cover for financial losses that occur with the theft, loss or destruction of digital assets. The various custody solutions for digital assets such as hot, cold and warm storage as well as the two basic causes of risk, external and internal perpetrators, must be taken into account. A crime insurance solution also serves the purpose of maintaining and strengthening customer trust.
Preventum is an early advocate of digital asset insurance. We provide insurance advice to several companies in the fintech and art sectors. Based on an excellent international network in the digital asset insurance space, we design individual insurance solutions in that field which have been a novelty in the European market so far.
Regulatory risks and compliance risks
D&O Insurance protecting the management board and the company’s balance sheet
Advancing regulatory activity in the blockchain technology and digital asset space, business models that are in parts still untested and an international or global radius of operations result in high risk and increased liability exposure on the part of directors and officers with respect to their management duties. Claims for damages may arise from the sphere of investors, shareholders as well as business partners and customers, but also supervisory authorities can hold board members as well as the company itself accountable and start regulatory investigations and proceedings in connection with a failure to meet requirements for risk management, data security and consumer protection.
Errors & Omissions Insurance covering financial loss arising out of insufficient professional services
Protection against errors and omissions related to the provision of professional services is particularly important for companies operating in the blockchain space. Errors & Omissions insurance offers legal advice and defence in the event of a notice of liability. And it absorbs and pays financial losses if, for example, a customer claims for damages arising out of advisory services that are found to be incorrect or inadequate. Other cases can concern claims for damages stemming from custodial services that prove to be defective and enabled the loss of digital assets.
Risks of theft and fraud related to digital assets
Crime and Fidelity Insurance covering third-party liability and first-party loss in conjunction with safekeeping digital assets
Companies that own digital assets or safekeep digital assets on behalf of customers may suffer financial loss due to theft and fidelity risks. If the property of third parties is affected, this entails major liability risks for custody services providers.
Exposures in the areas of technology, data protection and cyber risks
Data protection issues and ever-growing cyber risk challenges can entail significant economic losses and reputational damage. Blockchain-based business models often go hand in hand with collecting, storing, processing, and using personal data. Companies in this area are therefore particularly exposed to the risks of cyber attacks and business interruption as well as data theft and liability arising therefrom. If these risks materialise, they can be associated with identity theft and fraud, damage to the reputation, loss of confidentiality of personal data and data protected by professional secrecy and liability for compensation of financial loss and social disadvantage.
Errors & Omissions Insurance for financial loss in the event of technological malfunctions
Companies operating in the blockchain and digital asset space can face significant liability if customers suffer financial loss due to a technology-related error.
This coverage is not to be confused with cyber liability insurance. Both insure cyber risks, but from different perspectives. Cyber attacks are probably one of the biggest risks for tech companies. Cyber attacks are becoming more targeted. It is not so much a question of whether a cyber attack arises, but rather which vulnerable vector is attacked and at what time.
If a cyber attack succeeds and was made possible by a negligent omission in the technological foundation of the hacked company, a tech E&O policy covers the associated costs and losses. However, if it is determined that the cyber attack and the resulting data breach is not due to a failure or error based on the professional services of the company, the associated costs would be covered by cyber liability insurance.