When classic car collector David MacNeil bought a Ferrari 250 GTO for $70 million in 2018, he probably also got it insured. But when entrepreneur and investor Vignesh Sundaresan spent $69 million in March this year, he was buying something that no one is offering insurance for: a piece of digital artwork in the form of an NFT.
The first quarter of 2021 saw more than $2 billion in NFT (non-fungible token) sales. The protection gap this creates should inspire insurers looking for opportunities to write new business. But does the insurance industry have the confidence to underwrite this new asset class yet?
What is an NFT?
An NFT, or non-fungible token, is a type of digital asset based on a blockchain, a shared ledger.
The most well-known type of digital asset is cryptocurrency, of which Bitcoin is an example. Cryptocurrency tokens are fungible, which means every unit of the currency has equal value. Rather like a dollar bill, no one Bitcoin is worth more or less than another Bitcoin.
NFTs, however, are defined by being non-fungible. Each token is unique and irreplaceable. These characteristics make them suitable to be used as certificates of ownership over things like digital art.
Sundaresan’s $69 million NFT represents a digital collage by the artist Beeple, sold at auction house Christie’s. Twitter CEO Jack Dorsey sold his first tweet as an NFT for $2.9 million. These headline-grabbing examples form a small part of a large and active market, where NFTs are traded from as little as $5 into the hundreds of thousands.
Some believe that NFTs are just hype. But others believe that this is the start of a fundamental shift that will give artists a new way to sell their creations.
The value of NFTs is expected to fluctuate for some time, much like cryptocurrency. But economic depreciation is not the only risk associated with owning an NFT.
Some NFTs have ‘gone missing’, where a broken link has made whatever the NFT represented disappear. Imagine you had purchased a painting and, suddenly, it was an empty frame.
People lose access to their digital wallets by forgetting passwords or damaging their devices. Accounts are hacked: a recent attack saw users of NFT marketplace Nifty Gateway lose assets worth thousands of dollars. Since 2011, more than $11 billion has been stolen from cryptocurrency exchanges.
These losses are garnering media attention, and as awareness of digital asset risk grows, NFT owners will want insurance products to protect them.
The insurance industry
Insurers and insurtechs provide some digital asset coverage, but current products only apply to fungible tokens such as cryptocurrency, not NFTs. Coverage capacity lies in the low billions of dollars, whilst the total value circulating in cryptocurrencies recently soared to $2 trillion.
Many insurers have been hesitant to insure digital assets because of a lack of data. Fully understanding and pricing the risk is difficult. Underwriters generally gain diversification benefit on physical assets, but the risks associated with digital assets leave them exposed. As a result, most of the largest cryptocurrency policies are supported by several Lloyd’s of London syndicates rather than a single insurer.
Lack of data is a bigger problem when considering insurance for NFTs, since the NFT market is at such an early stage. The market is also volatile, creating another problem: how can the payout be calculated for a loss of something so abstract in a changing market?
Creative solutions to offer protection for NFTs are emerging from outside the insurance industry. New, blockchain-based, peer-to-peer networks are using a decentralised model to outsource the pricing of risk to a community. This creates a ‘prediction market’—in economic theory, people trading the outcome of events can be used to forecast true probabilities—to solve the problems of lack of data and volatility in value.
Examples of companies in this space include Nexus Mutual, Cover Protocol, Insured Finance and Tidal Finance. They offer protection for smart contracts, which are used to buy and sell NFTs. If something goes wrong with the smart contract resulting in a loss, a claim is made. But the blockchain-based peer-to-peer model could theoretically cover any sort of risk and these companies have ambitions beyond digital. Nexus Mutual is planning to offer earthquake cover, and Cover Protocol’s stated intention is to be ‘a platform where you can buy coverage on anything.’
Embedded products and risk reduction
Digital asset owners already make judgements about risk when choosing where to store their assets. Storage wallet providers and digital marketplaces compete on security features, making both natural partners for risk management providers. Integrating coverage into asset storage platforms also provides opportunity to implement risk reduction measures.
CoinCover, an insurtech founded in 2018 with capacity provided by the Lloyd’s Product Innovation Facility members including Atrium, TMK and Markel, has embedded its product in several wallet platforms. Its cryptocurrency insurance product includes offline storage of back-up keys and enhanced security features including facial recognition. BitGo, a digital marketplace and wallet platform for fungible tokens, now offers its own insurance with a capacity of $700 million, also backed by Lloyd’s.
Insured Finance and Tidal Finance have each announced partnerships with NFT marketplaces to offer insurance at the point of purchase to NFT buyers, and Insured Finance plans an ‘insured storage vault’ product for NFTs. The details of the vault’s security features are unclear.
There are unknowns in insuring digital assets, but as long as NFTs are worth as much as antique cars, there will be a market for NFT insurance products. Whilst the insurance industry is reluctant, decentralised risk management platforms are gaining traction. For insurers looking for new opportunities, getting in early to this market may help them get ahead of the pack. After all, MacNeil’s Ferrari was priced at $18,000 when new in 1963—3900 times cheaper than it is today.