Crypto doesn’t have an insurance policy

The crypto industry is cratering. Bitcoin prices are at their lowest since 2020; one platform has barred users from withdrawing funds, and many of the biggest crypto companies, including Coinbase and BlockFi, have announced layoffs. This disruption reflects the economic turmoil rippling through the broader market, but also serves as a stark warning to everyday people that, generally speaking, crypto can be valuable one day and worthless the next.

Although the companies that people use to buy and store crypto are in some ways similar to banks, these platforms don’t have the deposit insurance that bank or investment accounts have. If the companies that operate these platforms were to fail, there’s no guarantee that people would be able to recover the value of their crypto. This lack of protection reflects the fact that regulators are still catching up to the crypto industry. It also serves as a reminder that while crypto platforms might seem secure — some are publicly traded companies — they’re operating in an industry that has almost no rules and few safety nets. Even UST, a “stablecoin” cryptocurrency that’s supposed to track the value of the United States dollar, crashed last month, eviscerating the equivalent of tens of billions of dollars.

“My sleep was severely disturbed, I lost 4 kilograms of weight in a few days, I was in an extremely depressed state,” Yuri Popovich, a Kyiv-based web designer who transferred his family’s savings into UST amid the war in Ukraine, told Recode. “Unfortunately, in our country there is no legislation covering such types of losses.”

While investing in crypto remains incredibly risky around the world for many reasons, regular US bank accounts enjoy some protection offered by the Federal Deposit Insurance Corporation (FDIC). Founded during the Great Depression to boost trust in the financial system, the FDIC is designed to guarantee that account holders will recover at least some of their money in the event of a bank’s collapse. Banks fund the FDIC, which, in turn, insures bank accounts up to $250,000.

Since crypto platforms aren’t technically banks and don’t pay into the FDIC system, individual crypto accounts don’t have this form of protection. Meanwhile, crypto investment accounts aren’t generally backed by the Securities Investor Protection Corporation, which insures accounts that are managed by brokerage firms, like Fidelity or Vanguard, up to $500,000 if the firm fails.

“Most people are buying cryptocurrency to speculate, right? They think of it as an investable asset,” said Lee Reiners, the executive director of Duke Law School’s Global Financial Market Center. “If you buy Apple stock, there’s really no insurance right there, either. The concept of insurance doesn’t really apply now.”

The risky nature of crypto has become a bigger topic of discussion as several crypto companies show signs of faltering. Coinbase, one of the world’s most popular crypto exchanges, said in an earnings report last month that users could theoretically lose access to their crypto if the company went bankrupt. (Coinbase later tried to walk back the warning in a blog post, and said there’s “never a situation where customer funds could be confused with corporate assets.”)

Things have only gotten worse for the crypto industry lately. In the wake of the UST crash, the Securities and Exchange Commission is reportedly investigating whether the company behind the coin, Terraform Labs, violated securities law. And last week, Celsius Network, a crypto platform that isn’t an actual bank but purports to offer high-yield cryptocurrency lending, suddenly barred its users from withdrawing from the platform; securities regulators in several states are now investigating that decision. Downtime can be extremely costly for crypto investors, since the value of a single coin can swing by hundreds or thousands of dollars within just a few hours. Amid all of the disruption, the price of bitcoin is around $20,000, a sharp decline from its November high of nearly $70,000.

“At the moment, there is no easy way for customers to determine the nature and extent of their exposure to the bankruptcy of a crypto trading platform,” Dan Awrey, a Cornell law professor, told Barron’s last month. “Customers should assume that a platform’s bankruptcy would expose them to significant delays in recovery, at the end of which they may only get back just pennies on the dollar.”

But there are other risks, too. A crypto wallet can be hacked, and once someone has stolen what’s in it, that crypto can be incredibly difficult to recover. Some people try to avoid this risk by protecting their crypto with what’s called “cold storage,” which amounts to storing the keys that people use to access their crypto on a hard drive that’s not connected to the internet. This method comes with the same kind of risks that any other piece of physical property does, and those risks are even more significant for companies that store lots of other peoples’ crypto in cold storage, and for crypto mining operations that produce new cryptocurrency using warehouses full of powerful computers.

“You got earthquake, flood, fire, lightning, wind, hail,” said Ben Davis, a team leader at Superscript, an insurance program that covers crypto and is registered as a broker on Lloyd’s insurance marketplace. “If you have a lot of very expensive equipment all in one place, you’re gonna want it insured.”

While some conventional insurance providers are slowly warming to covering crypto, there’s also an emerging crop of startups that focus specifically on crypto insurance. These include companies like InsurAce, which covers losses that result from crypto hacks, and Coincover, which offers NFT insurance, among several other crypto-focused products that come with insurance.

Some people are already filing claims for crypto losses. One judge in Ohio ruled in 2018 that bitcoin stolen from one man’s online account was legally property — not money — and should therefore be covered by the man’s homeowner’s insurance for its full value, which, at the time, was $16,000. After an explosion at a substation used by a bitcoin miner in upstate New York last month, a company that was affected, along with the crypto-miner, Blockfusion, said they would file a claim for the revenue they lost.

More recently, InsurAce’s Dan Thomson says the company paid out more than $11 million to people who bought “depegging” insurance for their UST, the stablecoin designed by Terraform Labs (depegging occurs when a cryptocurrency’s value no longer matches the fiat currency, or another type of asset, that it’s designed to track). The company also reimbursed some of its customers after hackers attacked a crypto platform called Elephant Money in April.

Although insurance is becoming a slightly bigger part of the crypto industry, coverage is still patchwork. And even when a crypto platform does buy insurance, there’s no guarantee that individual crypto holders who use that company’s platform are fully protected. Coinbase, for instance, says that while certain security events are protected by its insurance, even if the company tries to make people whole, its plan may not cover the entirety of someone’s losses. Overall, most of the activity in the world of crypto remains uninsured.

“It’s really, really, really small,” said Eyhab Aejaz, the co-founder and CEO of Breach Insurance, an insurance company that focuses on crypto. “There is just not enough insurance capacity out in the market to insure even a small fraction of the total exposure that is out there.”

This highlights a major problem when it comes to regulating crypto: There isn’t a strong consensus on what crypto is. Is it internet money, property, a scam, a digital asset, a security, a reasonable investment? And because there’s no agreement on what crypto is, it’s hard to come up with a good approach to insuring its value — or figuring out if it should even be protected in the first place.

Regulators are still studying how to approach crypto. The SEC has argued that at least some crypto products are securities, and earlier this year, President Joe Biden ordered federal agencies to start drafting new rules for the industry. A bipartisan bill from Sens. Kirstin Gillibrand (D-NY) and Cynthia Lummis (R-WY) aims to protect customers’ access to their cryptocurrency in the event the crypto exchange they’re using goes bankrupt, among other proposals for regulating the industry. At least one lawmaker, Rep. Josh Gottheimer, has proposed that the government expand FDIC coverage to certain types of stablecoin cryptocurrencies, as long as they’re provided by institutions that the government qualifies. The FDIC, Federal Reserve, and Office of the Comptroller of the Currency have suggested similar plans. Still, not everyone thinks that’s a great idea or makes sense for every type of crypto.

“If crypto is an entirely speculative investment, then I think it’s unwise to put the deposit insurance and government backing behind those crypto assets,” said Hilary Allen, a law professor at American University. “Investors need to understand that what they’re doing is not putting money in a bank. What they’re doing is gambling.”

The mounting effort to regulate the crypto industry probably won’t be over anytime soon. In the meantime, all the chaos in the crypto market has more people thinking about the fate of their money. That may not be good news for crypto investors, but it’s certainly good news if you’re in the burgeoning crypto insurance business.