As the digital asset industry grows and evolves, investors are turning to digital asset custodians to securely store and manage their digital assets. These companies need robust, comprehensive insurance coverage tailored to the unique risks they face, which are constantly evolving.
An overview of digital asset custody
Although it is estimated that total cryptocurrency market capitalisation has topped US$1 trillion, the digital asset industry is still in an embryonic phase.
Digital assets, not just cryptocurrencies but also security tokens, stablecoins, CBDCs, NFTs, utility tokens and e-money tokens, have well and truly disrupted the traditional financial services industry with interest growing exponentially from consumers, institutional investors and financial institutions. They will undoubtedly play a key role in the future of the sector.
Digital asset custody involves the safekeeping of private keys, access codes, and authentication mechanisms that grant control and ownership over digital holdings. This process employs a sophisticated blend of offline storage, multi-signature protocols, encryption techniques, and rigorous security measures to thwart unauthorised access, cyber threats, and potential loss.
As the digitisation of financial instruments continues to reshape traditional finance, the need for a secure and reliable means of storing and managing intangible assets to protect them from theft, loss and fraud becomes paramount.
The risks are significant, as an example, in 2021 hackers stole $600 million in cryptocurrency from the Poly Network DeFi platform in what is thought to be the biggest crypto theft in the history of the industry.
To mitigate against these risks, investors are increasingly turning to professional custodial services.
The role of digital asset custodians
As the industry has evolved the role of digital asset custodians has expanded.
Digital asset custodians offer clients an array of financial services. Many provide integrated platforms that allow clients to execute trades, manage portfolios, and access liquidity in a secure environment. Additionally, custodians may enable lending and borrowing of digital assets, allowing clients to earn interest on their holdings or access assets for trading or other purposes. These functionalities cater to the growing needs of institutional investors, traders, and individuals who seek not only security but also a comprehensive suite of financial services related to digital assets.
And of course, secure storage in hot, cold or warm wallets, remains a critical function of digital asset custodians.
Hot storage refers to online, readily accessible storage systems that are connected to the internet, designed for quick and convenient access to assets. While hot storage offers easy availability, it is more susceptible to cyberattacks due to its constant online presence. Conversely, cold storage involves keeping digital assets completely offline, often on hardware devices or paper wallets. This method enhances security by significantly reducing the attack surface, but it sacrifices instant accessibility. Warm storage strikes a balance between these approaches, maintaining a portion of assets online for immediate use while storing the majority offline for enhanced protection.
Selecting the appropriate storage strategy depends on factors such as the asset’s value, frequency of access, and the risk tolerance of the owner.
The importance of digital asset custody for the industry
The significance of robust digital asset custody solutions for the digital asset industry cannot be overstated. Custodians securely hold investors’ assets in both digital and physical forms and play a pivotal role in building trust, security and legitimacy, and upholding market efficiency.
Digital asset custody not only safeguards the investments of individuals and institutions from theft, unauthorised access, and loss, but also fosters the confidence required for mainstream adoption by ensuring the protection of these valuable assets.
In addition, by entrusting their holdings to reputable custody providers, investors can focus on innovation and growth, knowing that their assets are protected by cutting-edge technological solutions. As the digital asset industry continues to evolve, the role of custody solutions will be key in this transformative financial landscape.
The risks and challenges faced by digital asset custodians
The digital asset industry is in its infancy but with innovation comes uncharted risk.
Digital asset custodians face a multitude of risks inherent to their role as guardians of valuable assets. These risks encompass the potential for cyberattacks, theft, and unauthorised access due to the digital nature of the assets, necessitating robust cybersecurity measures. Additionally, the evolving regulatory landscape can lead to compliance challenges, impacting the legality of their operations. Market volatility introduces financial risk, as the value of digital assets can fluctuate dramatically. Custodians must navigate these hazards while upholding the security, integrity, and legal responsibilities associated with safeguarding digital assets on behalf of their clients.
When investors choose a digital asset custodian, the custodian’s insurance coverage will be a key factor.
The role of insurance for digital asset custodians
As digital asset custodians have evolved so has the role of insurance. Primarily, the driver behind companies purchasing protection is to provide an extra layer should the worse-case scenario happen but at the same time, given the focus of the business itself (i.e. keeping digital assets safe on behalf of clients) the procurement of insurance can also provide peace of mind and evidence (via the underwriting process) that the custodian has been through a due diligence process to qualify that it is insurable. This in turn can be a advantageous when competing for business versus other custodians has increasing Web 3 companies are looking for insurance as evidence of additional protection and comfort.
Initially, some of the larger custodians competed in terms of how much coverage they could get and advertised the fact. This initial “race for capacity” has now died down with the focus being more on the right type of coverage rather than the amount of coverage available.
Available digital asset insurance solutions
Insurance coverage for the safekeeping of digital assets can be provided by two main types of insurance policies, specie insurance or crime.
Specie insurance has its genesis in high-value / high-end items, including fine art, gold bullion, and jewellery. As holders of digital assets have increasingly turned towards cold storage, the specie market has expanded to include the loss of private keys as part of its offering. Termed cold storage or custody insurance, this coverage can cover the following:
- Physical destruction of devices that store private keys by fire, flood, windstorm, earthquake, and other natural perils
- Theft of devices, by employees or third parties at sites that store private keys
- Theft or copying of private keys by employees or third parties while in transit from their place of custody
Crime insurance is a differently structured policy that has its origins in the traditional banking industry. Coverage can include:
- Employee Theft
- Theft on Premises
- Theft in Transit
- Third Party Computer and Funds Transfer Fraud
- Reimbursement of Legal Fees, Costs and Expenses
For both types of coverage, the procurement process is typically longer than most insurance policies given the information required for underwriters to understand all aspect of the custodians business. The evolving nature of the digital asset industry requires a comprehensive understanding of potential threats and a proactive approach to risk management. As the digital asset industry and associated risks change, it is important that your insurer evolves to counteract these shifting risks and provides the right coverage to address this.
Why work with Continuum?
We are leading the way with insurance solutions for the digital asset industry. We have built up significant experience of collaborating with digital asset companies in Asia, providing assistance to a diverse range of entities, including exchanges, funds, and custodians, to fulfil their insurance requirements. We work with crypto-friendly insurers and reinsurers in Singapore, Hong Kong, London, Germany and Bermuda to bring the latest insurance solutions to the digital asset industry in Asia.
Leveraging our extensive expertise in the industry and insurers’ preferences, we offer valuable guidance to clients in selecting the most suitable solutions to safeguard their businesses and enhance value for their clientele.
Whether you are a startup or an established business in the digital asset custodian industry, we would love to forge a long-term partnership with you to meet your evolving insurance needs. Please Contact Us for a free consultation or quote.
