Crypto Insurance. Why not require crypto projects to get special insurance after FTX crush?

There is extensive precedent for requiring companies providing critical infrastructure to get special insurance. Why not require crypto companies to back themselves with a market-based product, say the founders of Evertas, a crypto insurance provider.

According to Coindesk, the usual conversations are taking place about what new regulations need to be enacted to prevent another FTX. While it is obvious something needs to happen, experience makes clear that the current regulatory regime is not well equipped to prevent these events.

Even if the Securities and Exchange Commission, for example, did have the knowledge and agility required to adequately regulate Web3, its reach extends only to the limits of its jurisdiction and, as we have seen with the Bahamas-based FTX, that reach was too short by about 150 miles.

As founders of the first crypto and blockchain infrastructure insurance company, Evertas suggest regulator-required insurance as a market-oriented means of preventing the damage caused by crypto exchange insolvency and related catastrophic events.

There is extensive precedent for the federal government and its regulatory agencies encouraging and often requiring companies providing critical infrastructure to secure insurance, particularly those covering rapidly evolving risks which statutes struggle to keep up with.

Insurers are denying or limiting insurance coverage to clients with exposure to bankrupt crypto exchange FTX, leaving digital currency traders and exchanges uninsured for any losses from hacks, theft or lawsuits, according to Reuters.

Insurers were already reluctant to underwrite asset and directors and officers protection policies for crypto companies because of scant market regulation and the volatile prices of Bitcoin and other cryptocurrencies.

Now, the collapse of FTX last month has amplified concerns. Specialists in the Lloyd’s of London and Bermuda insurance markets are requiring more transparency from crypto companies about their exposure to FTX. The insurers are also proposing broad policy exclusions for any claims arising from the company’s collapse.

Crypto Insurance. Why not require crypto projects to get special insurance after FTX crush?

Insurers were requiring clients to fill out a questionnaire asking whether they invested in FTX, or had assets on the exchange.

Lloyd’s of London broker Superscript is giving clients that dealt with FTX a mandatory questionnaire to outline the percentage of their exposure.

If the client has 40% of their total assets at FTX that they can’t access, that is either going to be a decline or we’re going to put on an exclusion that limits cover for any claims arising out of their funds held on FTX.

When discussing opportunities for the federal government to work with the private sector in reducing terror threats, then-Secretary of the Department of Homeland Security Michael Chertoff said, “Sometimes it’s a question of letting the private sector find a coordinated way to make sure people can operate in a consistent manner across the board.”

Though much differentiates cyber and crypto insurance, the shared network security component makes cyber insurance a useful reference point.

Insurers will require a level of security as a precondition of coverage, and companies adopting better security practices often receive lower insurance rates. This helps companies to internalize both the benefits of good security and the costs of poor security, which in turn leads to greater investment and improvements in cyber-security.

A rigorous underwriting of an entity the size of FTX would have required an active and independent board of directors as a condition of insurability.

The underwriting process would also include a review of the histories of key personnel, accounts and associated crypto wallet addresses to ensure that only reputable people are involved, reserves are sufficient and assets are present.

This likely would have resulted in FTX selecting a chief compliance officer better suited to the job.

Finally, the underwriting process would examine the exchange’s policies to ensure that customer and institutional funds are thoroughly segregated, such that the former’s funds can’t be used to settle the latter’s debts nor finance their own trading. This would also see that assets are returned to their owners in case of insolvency.

Admittedly, the FTX terms and conditions did segregate account holder funds, though it appears that’s not how they were treated. If active deception is the goal, neither insurance nor regulation can prevent that.

Evertas believe that regulator-required insurance is the kind of agile, responsive and precise market-based solution that the Web3 community will accept and needs in order to allow present and future users, builders, participants and even regulators to view the sector with the confidence it deserves.

by Peter Sonner