Digital assets in the cryptocurrency market have seen explosive growth in recent years, surpassing $3 trillion in November 2021. That total was up from just $14 billion at the end of 2016. It is also estimated that 40 million Americans, or 16 percent of the population invested in cryptocurrencies last year—with more than 100 countries looking into the option of using cryptocurrencies in their central banks.
In March 2022, U.S. President Joe Biden signed an executive order calling on the government to examine the risks and benefits of cryptocurrencies.
But what is cryptocurrency, blockchain and Bitcoin? How will it impact businesses and their insurance coverage?
Cryptocurrency, blockchain and Bitcoin – the godfather of cryptocurrency
Cryptocurrency is a form of currency that exists digitally or virtually—Bitcoin being most known as the reigning king of crypto. These cryptocurrencies run on a distributed public ledger called blockchain that records all transactions updated and held on computers around the world.
Cryptography allows for the secure sending of cryptocurrency data between two or more digital wallets—where private keys are stored. The sender encrypts the message, and the receiver decrypts the message allowing for transactions to be both anonymous and secure.
When someone spends cryptocurrency, the digital ledger must be updated. Cryptocurrency miners, volunteers or nodes from around the world, are incentivized to secure the network by participating in a technological transaction validation process. Mining also involves the creation and issuance of supply and prevents the double-spending of digital currency.
The first cryptocurrency was Bitcoin. When Bitcoin was first established in early 2009, it was designed as a decentralized digital currency without a central bank or single administrator. As such Bitcoin can be sent from user to user on the peer-to-peer Bitcoin network without the need for intermediaries. This means it operates free from the oversight of banks and governments and is considered censorship resistant. For additional information on the principles and use case for Bitcoin, be sure to read the original nine page white paper by Satoshi Nakamoto, the name used by the pseudonymous person or persons who developed Bitcoin and authored the white paper.
Some analysts feel that Bitcoin will take market share away from gold and other more traditional investments in 2022 as digital assets become more widely adopted. It might even be the modern-day comparison to gold as an investment with a more stable moving value in the years ahead. Gold has stabilized at a price range of $1,500 to $2,000 in recent years. While Bitcoin remains much more volatile, we are still in the price discovery mode for this most common of cryptocurrencies until a terminal price range is established. It is important to note that Bitcoin is also a scarce resource. The maximum number of Bitcoin that can ever exist is 21 million. The finite number makes Bitcoin a deflationary asset and hedge against inflation. New Bitcoin are added to the total availably supply through mining. This takes place roughly every 10 minutes, which is the average amount of time that it takes to generate a new block (verified transactions) on the Bitcoin blockchain.
The influx of other cryptocurrencies continue
The next most common cryptocurrency by market cap is Ether (ETH), the native coin on the Ethereum blockchain. Market cap encompasses the total value of coins in existence and can be determined by multiplying the number of coins in circulation by the current market price of a single coin. ETH is the second-largest cryptocurrency with the Ethereum blockchain widely known for its smart contract capabilities. Ethereum has grown in popularity because of its utility for decentralized finance (DeFi), non-fungible tokens (NFTs), decentralized apps (DApps) and more.
There are estimated to be more than 10,000 other types of cryptocurrencies as of April 2022 and many of these new tokens or “coins” are extremely volatile, and therefore risky. The world of available cryptocurrencies continues to grow significantly however not all are active or valuable. The strongest types of cryptocurrencies will likely survive but will be based on the support of their ecosystems and experience of their management teams. In theory, stronger adoption of a coin is likely to take place if it is used to solve a problem, offer utility or meaningful contribution to the future of investing, business, and everyday life.
Some of the more common cryptocurrencies beyond the “big two” are Solana, ADA, BNB, and XRP. Many of these were designed to reduce transaction times even as they use different blockchains. There is also another grouping of cryptocurrencies known as stablecoins. These attempt to tie their market value to an external asset such as fiat currency (U.S. dollar) or gold. Some stablecoins even use other cryptocurrencies as collateral. One example is Tether which was launched in 2014 and pegged to the U.S. dollar.
Like other goods and services, supply and demand will continue to be one of the biggest factors in the market value of coins. While some will consider Bitcoin in particular a hedge against turmoil in the traditional financial system, bubbles will be created and burst from time to time, just like we have seen in the stock market for more than 100 years.
Geopolitical strife such as Russia’s invasion of Ukraine has reminded us that traditional financial systems are interconnected (consider oil prices). Many financial experts feel that investors should consider holding up to 5 percent of their portfolios in cryptocurrency as any worldwide disaster could increase the demand for unregulated cryptocurrencies.
How cryptocurrency will impact the banking and insurance fields
The financial services market is highly commoditized and transactional in 2022. Investors spend little time meeting with their banker or financial advisor in person. Online platforms allow anyone to trade investments anytime, anywhere, often with little to no fees. There is a need though for free capital to flow into the market at high yields with low fees, and at scale. This is one of the main benefits of cryptocurrencies.
This trend solidifies the idea that the banks of yesterday are not returning. Bankers who want to stay in the field will need to learn about the technologies associated with cryptocurrency because their jobs likely will evolve drastically in the years ahead.
Insurance brokers and industry professionals also need to keep current with trends, use cases and how the universe of blockchain continues to expand. Decentralized insurance providers currently exist where members can offer financial protection for smart contracts and exchanges surrounding theft of coins all while earning profits on the funds they contribute to the insurance pool. In these operations, members can vote on claims including payouts and receive compensation in return.
In addition to staying up to date on what is happing within our own backyard, more clients will need assistance with managing these evolving exposures. It is important as risk managers and counselors that insurance professionals can offer the guidance needed.
Cryptocurrency insurance coverage
There will be a growing demand for insurance that can protect cryptocurrency exposures, DeFi, and blockchain risks as this ecosystem becomes increasingly popular. Businesses will need innovative solutions to help mitigate the perils associated with smart contract failures, mining, theft of digital assets, and many of the risks that come from operating within this unique industry.
Burns & Wilcox has the expertise within the cryptocurrency environment, including blockchain, decentralized finance, smart contracts and more. Our knowledge, paired with our excellent relationships with carriers, allows us to identify needed specialty insurance solutions in areas such as Technology E&O, D&O, cyber liability, and crime coverage for wallets.
One thing is for sure—these needs will only continue to grow in the months and years ahead.
Contributor: David Derigiotis, Corporate Senior Vice President, National Professional Liability Practice Leader, Burns & Wilcox