Insurance and crypto mining

Insuring the crypto landscape

The digital world is fast-moving, especially if compared to the more traditional landscape of financial institutions, which can appear slow to keep up with the latest market developments and cutting-edge technology.

Until late last year few of us would readily admit to knowing what the metaverse really entailed, particularly in the context of businesses (unless you’ve seen Ready Player One). However, following Mark Zuckerberg’s Meta shift most of us now have at least some comprehension of what it is and what it might become. This is just one example of the speed at which the web3 landscape is developing.

The crypto industry is maturing

It could be said that the digital asset ecosystem is entering into its early adolescence. Indeed, is it now in the teenage years? Still with that rebellious disobedient streak, an air of knowing it all, often discounting age old wisdom. Surely experience and time in the market doesn’t matter! On the flip side the industry is growing up fast and taking on more responsibility (much like the grumpy teenager does), engaging with regulators in a collaborative manner and helping to shape the future of the industry. One can see how crypto is ‘growing up’ with the steady rise of the institutions, for every ‘crypto bro’ there's also a suit joining the scene.

It's perhaps most illuminating to compare where we are now to the late 1990's and the tipping point of internet adoption. Interestingly, digital asset adoption is happening at a much faster pace. In early 2021 the industry reached 150 million users, with the annual growth rate for digital assets at the time standing at 113%. If we compare this to the internet at the same stage, with the same number of users, it was achieving a mere 63% annual growth rate.

Even if the annual growth rate drops to 90%, digital asset users will still total over a billion by 2024. It's fair to say the digital asset ecosystem has achieved Malcolm Gladwell’s ‘Tipping Point’ in its adoption curve. The genie is out of the bottle, the toothpaste is out of the tube. The market has come a long way in a short space of time, in the last 18 months alone the market has gone from fewer than 14 digital asset companies with valuations over $1bn, to over 100 today. Investment in this technology continues to grow and the industry isn’t going away, is it then finally time for insurers to make the leap?

Risk is essential for growth

As an industry, insurers play a vital role in the economy, allowing businesses to take risks and grow.

Given the close to $2trn combined market cap of cryptocurrencies it may come as somewhat of a surprise that there’s very little to see in the way of cryptocurrency insurance offerings for digital assets. This is even more pronounced for cryptocurrency mining operations seeking insurance.

The proof-of-work consensus mechanism underpinning well known assets such as Bitcoin, Ethereum (for now) and Litecoin has been in existence for over 10 years following Bitcoin’s creation in 2009. As a result there are now a large number of well capitalised, well-funded and well managed crypto miners. For the insurance industry this should be an exciting new frontier, a new, growing industry bringing ‘new new’ buying power and premium to the market offering insurers opportunities that would not have existed even 5 years ago.

The advantage of crypto mining businesses

For those that choose to inhabit the digital asset ecosystem, what seems cutting edge to most is viewed as run of the mill, and to some crypto natives even ‘boring.’ Cryptocurrency mining is one such area, there are now over 20 publicly listed cryptocurrency mining companies, however some on the cutting edge of the technology stack have reduced focus on this area of cryptocurrency and moved on to projects considered far more exciting. Why worry about mining for bitcoin when you could be creating virtual NFT horses for racing and gambling?

The advantage of crypto mining businesses however, particularly for insurers, is that there are physical assets to underwrite, company structures to evaluate and experienced corporate management teams to speak to. Mining is the ‘bricks and mortar’ of the digital asset ecosystem and for insurers wishing to dip a toe in the space it is a good place to start.

Cryptocurrency mining operations are in fact very similar to traditional commodities producers in the way they are structured. Crypto miners have high initial CapEx requirements to set up business, with the most costly being infrastructure and mining equipment. Premises is another consideration, although within the industry there are differing levels of integration from fully integrated operations that own the energy production facilities (Exxonmobil and ConocoPhillips are both entering the space) to others that purchase the mining equipment only and host their equipment with other providers.

The main difference between traditional commodities producers and cryptocurrency miners is that crypto miners have been holding on to their output (bitcoin) rather than selling on the market immediately, which is the traditional commodities business model. One of the reasons bitcoin miners are such an attractive prospect to investors are the margins. The cost to mine bitcoin is currently ~$10,000 compared to the spot price of bitcoin on public markets which sits at ~$40,000 per coin. Unsurprisingly many investors are extremely happy with such healthy margins!

What’s next?

The question then is why haven’t we seen more big insurance players entering the space offering new products and solutions? Ultimately, it comes down to appetite, market timing and career risk.

Since 2017 insurers margins have been challenged by an above average frequency and severity of catastrophe events, social inflation and COVID-19 amongst others. For the past four years the Lloyd’s market has made an underwriting loss.

During tough times insurers and underwriters will retrench back to their strengths, enact remediation plans and raise rates to replenish the coffers and hope to swing back to profitability.

As the 2022 earnings season showed the Lloyds market has turned the dial enough to generate an underwriting profit of £1.7bn compared to a 2020 underwriting loss of £2.7bn. Now things are looking brighter and underwriters are finally breathing a sigh of relief following some hard graft, perhaps now they will be more inclined to look at this new industry that has come on in leaps and bounds over the past few years.

For those with the appetite there’s a whole new asset class full of new and exciting innovations. Traditionally, Lloyd’s is the place for cutting edge, complex risks to find a home, let’s ‘insure’ this continues for many years to come. It's time for underwriters to be forward thinking and help create the products that will enable this new and exciting industry to flourish.

How we help crypto businesses

The Superscript Digital Assets team are embedded within the DLT space which gives us a great understanding of the challenges crypto businesses face when looking for insurance. We don’t just insure the business as usual, we are at the forefront of emerging technology and emerging risk.

Being part of the web3 community allows us to build insurance solutions for the community, our experts are able to bridge the divide between the traditional insurance market and the emerging economy of digital assets. If you’re building technology or services in this space and would like to learn what your insurance options are, get in touch with our team.

George Frith is part of Superscript’s digital asset team and specialises in the digital asset ecosystem, covering everything crypto and web3. He previously spent six years underwriting property business for a well-known Lloyd’s syndicate, developing new product offerings and gaining a strong understanding of risk management principles.

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