Coinbase’s pioneering crypto-insurance program, and the dilemma it presents to insurers.
In the wake of BitGo’s announcement in February 2019 that it is providing $100 million of insurance coverage for Bitcoin and other cryptoassets in its wallets, leading cryptocurrency exchange Coinbase has followed suit.
On 2 April, Philip Martin, Coinbase’s Chief Information Security Officer, published a blog in which he announced that they “currently hold a hot wallet policy with a $255 million limit placed by Lloyd’s registered broker Aon and sourced from a global group of US and UK insurance companies, including certain Lloyd’s of London syndicates.” Mr. Martin points out that in fact Coinbase’s work in the cryptocurrency insurance sector dates back to 2013; gently reminding the industry that BitGo’s announcement was not necessarily as revolutionary as may have been implied.
As might be expected in any discussion of a burgeoning new industry, much of Mr. Martin’s blog looks to the future. His thoughts on development feature the following eye-catching observation regarding a weakness of the current market structure: “Policies are denominated in fiat but the assets are in crypto. This means that in bull markets it can be challenging for companies looking to grow insurance policy limits at the same pace as asset prices are moving.”
His solution? “Insurers need to hold digital assets in order to offer policy limits denominated in cryptocurrency to avoid differences in valuation.”
This is an intriguing suggestion, but it places insurers on the horns of a dilemma. On the one hand, cryptocurrency prices are notoriously volatile. A thousand bitcoins were worth around $3.79 million on 18 September 2017, rising to $17.06 million by 11 December 2017, before slumping back to $7.83 million by 5 February 2018. Between November 2018 and March 2019, prices were comparatively steady by Bitcoin’s standards, holding at or just below $4,000 per coin. However, in just the first ten days of April 2019, the value of those thousand bitcoins rose from $4.14 million to $5.28 million as investors reacted to signs of increasing regulatory clarity, amongst other factors.
This apparent end to a year-long Bitcoin bear market has prompted some observers to predict prices hitting tens and even hundreds of thousands of dollars each in the next two years. Clearly, pricing an insurance premium under these circumstances can be challenging. Some relief from this risk can be obtained by diversification, especially when insuring an exchange such as Coinbase that deals in multiple cryptocurrencies. However, there is a limit to the mitigation that can be achieved through diversification, especially in a market in which, although there are thousands of different cryptocurrencies, trading volumes are still dominated by the top ten or fifteen. Mr. Martin’s suggestion that insurers effectively insulate themselves from the effect of such price swings, by holding assets in cryptocurrencies and denominating policies accordingly, looks a tempting one.
However, insurers do not just take in premium payments and keep them in the bank until the time comes to pay a claim. A crucial part of an insurer’s annual revenue comprises investment income from the assets that it holds. Such assets must be invested such that they generate as much return as realistically achievable, while being available for withdrawal as and when claim liabilities crystallise. For Chubb, global net investment income amounted to $3.1 billion in 2017 and $3.3 billion in 2018 ; and for AXA the equivalent figures were EUR 12.6 billion in 2017, and EUR 16.6 billion in 2018 . In a competitive industry where, even for the big players, profit margins can be extremely tight, this income can be the difference between an overall profit or a loss.
The question therefore arises: where and how would an insurer invest its Bitcoin? It is easy enough to invest dollars and generate a safe, reliable return, but an insurer cannot convert its cryptocurrency to fiat for investment purposes without exposing itself to precisely the exchange rate risk that it needs to avoid. Like other areas of the industry, the cryptocurrency investment market is in a nascent state, with enough high-profile frauds and other disasters to present serious concerns to the insurer, who for obvious reasons cannot afford to be overly speculative. However, eschewal of that extra investment income may be reflected in higher premiums, and may ultimately make the exercise uneconomic.
Insurers’ increasing interest in cryptocurrency is a welcome step that has the capacity to provide security and peace of mind to the system. However, it can be difficult to know in which order to put the chicken and the egg. Insurers are in every bit as much need of peace of mind when it comes to their own investments and, at the moment, it is hard to see where an insurer can safely and profitably invest large quantities of cryptocurrency. Until a mature and reliable cryptocurrency investment market exists, insurers may find their efforts hampered. However, without the security of insurance, financial institutions such as crypto exchanges, which must underpin any such market, will find it equally difficult to develop. The cryptocurrency industry is a de facto financial system and, like any other financial system, it is a complicated machine made up of inextricably interlinked parts. We must hope that the parts will find a way to grow up together.