Demystifying Digital Asset Custody Insurance

Insurance covering digital assets held by custodians is a topic that institutions frequently ask about during their onboarding with Komainu. This is a nascent market and there are a number of pitfalls and common misconceptions that need to be avoided by clients to make sure they are basing their choices on the best possible footing.

A robust insurance programme is a key risk mitigant to be considered by digital asset custody clients. At Komainu we view our coverage as part of a package – alongside regulatory oversight, audited financials, governance and operational processes, and certified security procedures – that can provide reassurance to clients in their decision making.

Common Misconceptions

Digital asset custody insurance is still maturing as a market does not have limitless capacity – impressive headline figures should be taken with a pinch of salt.

The bad news is, even if enough underwriter support could be found to cover the entire assets under custody of a custodian, any such programme would be prohibitively expensive. This would be the case both for the custodian and ultimately their clients through fees, and in any event would not necessarily be reflective of insurance coverage available for institutional custody in traditional finance. 

The existence of coverage also does not guarantee that there will be a full payout in the event of a loss, exclusions exist under insurance policies and a client may not be the only user of a custodian affected. The knock-on effect of this is that policies will often reflect only a fraction of assets under custody and should not be considered in isolation from other factors when considering a custodial offering.

The Reality

Komainu is into its fourth year of purchasing insurance coverage and progress is being made in the market. Industry understanding is growing and pricing is improving. It is not a trivial risk for underwriters to insure digital asset custodians and they will often undertake thorough and detailed assessments before providing quotes.

There are two main options for digital asset custodians to cover:

1. Specie: coverage is more affordable and allows custodians to provide higher headline figures, principally a policy would cover losses that derive from physical risks – such as loss, theft or damage of a transaction signing device or backup; and

2. Crime: coverage tends to be more expensive and covers digital risks, such as third-party computer and fund transfer fraud.

These can be mixed and matched by custodians, depending on their operational setup, to provide the most effective protection for their clients, but each has its limitations which need to be carefully considered in terms of the risks covered and pricing.

What Should Clients Consider?

- How long has a custodian had insurance? A longer period of coverage may be indicative of repeat assessments by insurers and a reliable track record.

- What coverage is behind the headline figure? What risks does the insurance cover? A bigger number may not be as useful as it first appears if it only relates to a small subset of a custodian’s wallet types, such as cold only.

- How does the coverage relate to a custodian’s total assets under custody? The proportion covered could be a more useful indicator of risk levels than just the headline alone.

- What other risk mitigants are there? Think regulatory oversight, auditor reports and industry certifications relating to a custodian’s financials, governance, security or operational procedures.

Get in touch with the team to find out more.