Insurance is based on the sound principle that underwriters should cover only acceptable and clearly understood risks. Following last year’s challenges in the crypto world, crypto exchange insurers are increasingly focusing on more rigorous controls in this fast-moving and dynamic space. One thing is certain: crypto exchanges with a transparent and strong culture of governance, risk management and compliance will fair better in 2023 than those without.

The collapse of FTX has been called a ‘Lehman moment’, and it capped a shaky year of plunging values, large withdrawals, high-profile thefts and regulatory action. But that doesn’t mean we won’t see confidence restored in 2023 and the market grow again. A key part of this recovery is for firms to have the right safeguards in place and rebuild credibility with their numerous stakeholders.    

Volatility and uncertainty go hand in hand with technological developments and trends – think of the dot-com boom and bust – it takes time for all new marketplaces to evolve and implement the right checks and balances. This is why insurance is an essential tool for long-term stability and continued growth. It allows crypto exchanges to align with industry best practice risk management, while protecting the balance sheet should a risk event occur.

Working with the ‘good actors’

It would be a mistake for the events in 2022 to tarnish the reputation of all the good players in the digital asset industry and more widely the emerging world of Web3. There is huge potential for fruitful partnerships between insurers/reinsurers and well-run digital asset businesses, and, according to Cointelegraph, digital asset insurance is a ‘sleeping giant’ with only 1% of investments covered. However, following the collapse of FTX, there has been a big increase in requests for insurance.

The lesson from FTX is that the industry needs stronger controls, better (and more transparent) governance, and more rigorous risk and compliance management. Analysing FTX’s collapse, the rating agency AM Best flagged the “complete failure of corporate controls” and “a complete absence of trustworthy financial information”, which are both prerequisites for insurance. AM Best highlighted the lack of a board of directors, the lack of experience amongst the senior management team, and the concentration of power in the hands of Sam Bankman-Fried.

Crypto exchange risk

The collapse of a crypto exchange is a warning to investors that crypto accounts lack guaranteed protection if they go bust. Crypto exchanges are not the same as banks and other financial institutions: they don’t hold fiat currency, they haven’t been as heavily regulated and will not be protected by insurance and government guarantees. While no investment is totally secure, the legal and regulatory framework for crypto exchanges is still evolving and requires the same basic safeguards enjoyed by traditional finance.  

Customer protection insurance

Exchanges have been keen to show customers that assets are secured and protected by a range of audits in the past weeks, and now there is a new area of protection that is adding value for exchanges seeking new customer deposits: customer protection insurance. This effectively covers customers’ individual funds in a wallet if they are stolen in a cyberattack. It’s a valuable form of protection that is often bundled as an additional benefit for customers with premium trading accounts. This insurance can also be extended to a wider range of perils, offering protection for an individual’s data and technology against different types of cyber events.