Regulation and the insurability of digital assets

This article was first published by Marsh here.


As the digital asset ecosystem develops, it is imperative it is able to transfer risk efficiently to allow for further innovation and growth. However, digital assets present a myriad of challenges to potential insurers.

Regulators are faced with a decision: try to apply existing regulation to digital assets or create bespoke regulation. Legacy laws and regulations were not designed with digital assets in mind and subsequently when applied the results can be vague, contradictory, and even nonsensical. In addition, creating new, tailored regulation is complex and has proven a cumbersome process thus far. This has allowed nefarious actors to commit fraud, with both casual and professional investors amongst the victims. This topic provided an engaging conversation at the recent FinTech LIVE London event in which Marsh UK’s Rupert Poland, VP - UK Financial Institution Digital Asset Lead, provided insights from the insurance market’s perspective.

The current regulatory approach ranges from ambiguous to non-existent. This has given numerous opportunities to bad actors to flourish in the space. The most pertinent example of this is the recent implosion of the centralized exchange FTX that culminated in retail and institutional investors losing billions of dollars. FTX CEO Sam Bankman-Fried is alleged to have funneled client’s deposits from his exchange to negate the gigantic losses suffered by the crypto-focused hedge fund Alameda Research. Whilst this alleged fraud is independent of the cryptography that underpins digital assets, ostensibly, any industry that may have allowed criminal elements to successfully embezzle billions of dollars from customers raises alarm bells for insurers. Regulation that prevents the occurrence of similar scenarios will make insuring this space significantly more attractive.

Regulators struggle to keep up with the fast-paced nature of the digital asset industry, which can lead to legislature that is onerous and confusing. This creates obstacles for both principled participants in the space and insurers looking to quantify risk. Regulation is vital to protecting consumers and ensuring financial stability of organisations, however, it doesn’t necessarily have to become an impediment for innovation.

Within the UK specifically, digital asset regulation is expected to be announced imminently, with the Financial Services and Markets Bill and the Electronic Trade Documents Bill currently being worked on. Both of these bills have large implications for digital assets. The UK has previously declared it wants to become a ‘hub’ in the industry to attract overseas capital and talent. Regulation is essential for bringing this vision to reality. These plans would also dovetail with discussions surrounding the creation of a Bank of England issued Central Bank Digital Currency (CBDC). The challenge for the UK government is to create clear and appropriate boundaries surrounding digital assets for companies to operate within. A balance must be struck that provides consumer protection, but doesn’t stifle centralised and decentralised organisations trying to provide essential digital asset services. Such boundaries will provide insurers comfort, as they gain greater understanding of whether an organisation is compliant and if they are aligning with societal values.

Professional indemnity and directors and officers insurers assume liability arising from the management and daily operations of companies. It is therefore crucial they are able to quantify the likelihood of a business incurring liability. The nascent digital asset ecosystem - troubled by regulatory uncertainty, high profile incidents, and uneducated investors - causes insurers concern. Nevertheless, insurance is available through demonstrating good risk management and strong principles. Transparent disclosure of assets and liabilities, proactive engagement with regulators, regular financial and security audits, and ensuring decision makers have the appropriate expertise are all looked upon favourably by insurers.

Building trust and cooperation in this evolving area is crucial as private and public blockchains are further integrated into both global societies and economies. Marsh UK is motivated in ensuring dialogue, education, and support are available to navigate the risks the digital asset environment poses; to find out more, please contact your Marsh representative.