Smart Contract Companies With Dumb Insurance Coverage

Opinion by: Darren Sonderman and Sydney Sonderman, financial lines insurance brokers at CAC Group

Digital assets, decentralized finance (DeFi) and tokenization are no longer fringe concepts — they are reshaping global finance. With real-world asset tokenization projected to hit $20 trillion within the decade, the race is on to establish strong legal and regulatory frameworks. 

The US is catching up as the Trump administration promotes stablecoin and crypto market structure legislation and the creation of key task forces. 

Meanwhile, governments worldwide are rapidly investing, innovating and advancing digital asset legislation. Disruptive technology is driving the global economy forward. As digital assets and decentralized technology reshape global finance, traditional insurance has failed to keep pace, leaving innovative companies exposed and highlighting the need for adaptive coverage. 

Digital assets will soon dominate the global landscape.

Is management liability insurance keeping up?

Management liability insurance is a foundational pillar for nascent industries, providing the risk transfer and financial certainty needed to attract capital, enable innovation and build trust.

Whether public or private, large or small, involved in traditional finance or disruptive technology, virtually every company needs directors and officers insurance. Companies will struggle to attract a high-quality boards of directors without functional insurance. The capital sought from investors will be forced to pay operational risk and legal costs that could have been satisfied by appropriately tailored insurance.

While some envision an onchain insurance future, TradFi insurers slowly embrace digital assets. Insurance rewards certainty, so many insurers sat on the sidelines in the early days of the technological revolution. Blockchain, crypto, DeFi and tokenization risks remain hard to quantify, leaving insurers hesitant to dive in.

When they do, insurance coverage is often porous and riddled with loopholes to allow denial of claims to provide affirmative coverage. Many in the digital asset industry struggle to find insurers willing to provide robust, predictable and efficient coverage for management liability insurance policies. 

Directors’ and officers’ liability insurance tailored to companies pursuing de-SPAC transactions or initial public offerings is challenging to secure, often lacking the necessary specificity to address the unique risks of these paths. Technology liability insurance that should protect intellectual property, trade secrets, confidential information, tokenized assets or the efficacy of novel technologies is virtually nonexistent. 

Cyber insurance, typically a foundational layer of protection, rarely provides adequate coverage for the theft or misappropriation of digital assets, ransomware incidents or attacks by nation-state actors. This lack of dependable insurance exposes companies in the digital asset economy precisely when taking on transformative risks. 

Related: The centralization crisis threatens data privacy

But despite obstacles, negotiating, placing and continuously improving insurance policies that work well can be done.

Management liability insurance: the details matter

Off-the-shelf insurance policies designed for TradFi do not cut it for the digital asset sector.

Customized, adaptive policy language is needed to ensure seamless coverage regardless of regulation, technology shifts or infrastructure changes. More than 30 key insurance contract modifications are required to make insurance effective and functional for companies operating in any sector directly or indirectly involved in digital assets/disruptive technology. 

These insurance policy modifications include eliminating common exclusions, introducing affirmative digital asset coverage and rewriting policy definitions to cover confidential information, trade secrets, intellectual property, tokenized assets, cryptocurrencies, stablecoins, derivatives, quasi-currency, securities, assets, private keys and alternative units of value. 

Purchasing the right (and necessarily tailored) insurance policy can be the difference between full and no insurance recovery. Companies and leadership teams taking the time to tailor insurance policies and invest energy and actions supporting a business relationship with insurers — as opposed to an insurance purchasing transaction — have benefited. They will continue to benefit from consistent and predictable superior insurance recovery outcomes. The importance of insurance is often not found until it is too late. Without taking preventative steps, the product that works will not be the product one has in a claims situation.

Regulation is the double-edged sword

Regulatory clarity is essential for global adoption of digital assets, but regulation can be a double-edged sword. Regulators today may be plaintiffs tomorrow — case in point, the US Department of Justice’s recent Civil Rights Fraud Initiative. Legal and operational guidance strongly encouraged by a prior administration’s regulatory agencies — the DOJ, Securities and Exchange Commission, New York State Department of Financial Services, Commodity Futures Trading Commission, Financial Crimes Enforcement Network and Office of the Comptroller of the Currency — have been the source of billion-dollar liabilities from these same agencies under new leadership. When administrative regimes change, litigation often follows.

We have seen this before. In the 2000s, banks were pushed to offer Department of Housing and Urban Development-backed home loans, only to face massive subprime litigation from the regulatory agencies whose guidance was being followed. Some insurers outright denied coverage, leaving financial institutions scrambling.

The lesson here? Insurance policies must be built to withstand regulatory shifts. Carefully crafted, battle-tested insurance policies have paid hundreds of millions in legal expenses and settlements without costly litigation.

Securing insurance in the token economy

TradFi enjoys billions in management liability insurance capacity, while tailored digital asset/disruptive technology insurance capacity still hovers in the hundreds of millions. As disruptive tech evolves to mainstream tech, insurance capacity will expand, and costs will decline.

Securing millions, not billions, of strategic and effective directors’ and officers’ liability, professional liability, technology liability, cyber and crime insurance coverage (management liability) remains critical for digital asset innovators.

Opinion by: Darren Sonderman and Sydney Sonderman, financial lines insurance brokers at CAC Group.

This article is for general information purposes and is not intended to be and should not be taken as legal or investment advice. The views, thoughts, and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.