The Federal Reserve has even begun exploring the possibility of a potential central bank digital currency (CBDC).1 This is not without critics as the crypto market lost $2 trillion in value from November 2021 to June 2022.2
The emergence of any new technology typically creates new opportunities and complicated risks for those involved. Throughout history, innovative insurance products have assisted with the advancement of new technologies by providing coverage for new and unknown loss events. But how do you build or set rates for a new insurance product with limited or no historical loss experience, especially one that is connected to the volatile cryptocurrency market? In this paper, we discuss the world’s first cryptocurrency, Bitcoin, and an insurance product that was developed for cryptocurrency mining operations.
Cryptocurrency mining: A brief introduction
If you mention the words cryptocurrency or Bitcoin to those around you, you may be met with a range of responses. Some will swear by its power, claiming that cryptocurrency is the wave of the future and the technology behind it represents the emergence of Web 3.0. Others may claim it has no value or choose to ignore it altogether.
Regardless of your stance on cryptocurrency, if you make digital payments online, then you can also gain a basic understanding of how this technology works. Bitcoins enter into circulation through a unique process called bitcoin mining. In mining, global networks of powerful computers attempt to solve complex algorithms to verify transactions, encrypt data, and secure the blockchain and network for which these transactions are sent. A blockchain is an open ledger of all the transactions that have occurred on a cryptocurrency’s network and system. Once a block is verified by the miners, it is added to the blockchain and payment is distributed to the miners that contributed to the verifying of that block. Payment is in the form of Bitcoin, which is new to the circulating supply in the open market.3
The diagram in Figure 1 compares the blockchain technology underlying Bitcoin transactions to other forms of payment that are commonly used such as a check or digital payment applications (apps).
Figure 1: Examples of forms of payment
A new, complex industry lacking insurance options
Like other industries, the cryptocurrency industry needs insurance. Most prominently, the cryptocurrency users are miners who own or rent large sets of powerful computers to perform the computations necessary to verify Bitcoin transactions and generate Bitcoins. These computers are typically housed in large data centers in locations where energy costs are relatively low. Some cryptocurrency mining operations, especially larger ones, own their own facilities. Others use a colocation or hosting model, in which they rent space from data center providers, effectively leasing space that comes with security and management of the physical location. The leased space can be within a data center or an open, outdoor space with a storage container or pod filled with mining equipment.
The type of insurance coverage needed depends largely on the miner’s business model and assets for which they are responsible. For example, companies that own data centers need coverage for the building itself, while those leasing a colocation space only need coverage for their computers. Colocation and hosting providers also need coverage for the storage containers or pods that house mining equipment in their facilities. In addition, miners and colocation providers may need commercial liability coverage—for example, in a situation where a miner’s computer catches fire and the miner is alleged to be liable for damages to the computers and equipment belonging to another miner or the colocation company.
Many cryptocurrency mining operations today are funded through debt, which makes a proper insurance solution even more important. As the market ebbs and flows, more miners are funding their growth by borrowing money instead of raising equity. Similar to any asset financed through debt, this often requires insurance coverage by the lender or financing company in an effort to secure the debt.
Assessing the insured value of cryptocurrency mining operations is complicated. The value of computers used in cryptocurrency mining is based on their potential three-year future Bitcoin earnings. However, an insured loss to a computer will need to be paid out in U.S. dollars. This can result in the value of cryptocurrency mining operations being subject to the exchange rate between Bitcoin and the U.S. dollar. The companies that own these computers also have monthly operational expenses, such as power costs, rent, taxes, payroll, debt, and financing, which are based in U.S. dollars. Bitsure estimated that the value of the mining equipment market in the United States was between $15 billion and $20 billion in November 2021 when Bitcoin was trading at a price above $60,000 per coin. The mining equipment has seen a sharp decline in value since late 2021, as Bitcoin was trading above $25,000 per coin in May 2023. Bitsure estimates the current mining equipment market in North America to be around $8 billion to $10 billion at the time of this publication.
Despite the need, cryptocurrency miners have found it difficult to obtain insurance. Many insurers consider cryptocurrency mining to be high-risk. Reasons for this include the volatility of Bitcoin and the perception it is correlated to the market value of assets such as mining computers and property. Additionally, a concern that is often touted by insurance companies is the potential for large loss exposure with a concentration of mining assets stored at a single location, such as a colocation environment. The cryptocurrency market is not unlike the cyber insurance market that developed in the late 1990s, when insurers had major concerns around data and exposure. It required the work of innovators willing to think outside the box to address the need.
Breaking through the cryptocurrency mining insurance bottleneck
While cryptocurrency miners need insurance, the perception of risk in the industry has prevented many insurers from aggressively pursuing this market. Milliman worked with Bitsure to help develop insurance coverages to address these gaps in the current marketplace. Bitsure was started by insurance specialist, Bitcoin miner, and cryptocurrency enthusiast Thomas Shewchuck. Thomas described how we worked closely together to create specialized coverage for the cryptocurrency industry.
“There’s isn’t a great deal of knowledge about Bitcoin or cryptocurrency in the insurance industry and even less so about cryptocurrency mining operations. Thus, we sought a measured approach to bring meaningful solutions to the cryptocurrency mining industry which has high demand for Property and Liability risk transfer products. This is a ‘crawl, walk, run’ strategy for us; providing necessary coverage for meaningful premium dollars, without creating excessive loss exposure. We hope this will allow us to expand product offerings and increase capacity with our carrier and reinsurance partners.”
When developing a new product without any historical loss experience or data, consider how the program can be designed and structured in a way similar to more traditional products currently on the market. The Bitsure product does not provide coverage for the value of cryptocurrency. Instead, the product is intended to help miners and colocation facilities ensure that their basic business requirements are met without being tied to the volatility of the Bitcoin market, while also not putting insurance companies at undue risk. Milliman and Bitsure developed a solution that includes coverage for:
- Property: The solution offers protection for mining computers and buildings, in addition to shipping containers and pods in a colocation facility. There is often a concentration of mining assets at a single location and therefore techniques used in property catastrophe rate-making were also used to develop this coverage.
- Income interruption: The solution provides protection from business income interruption to help miners pay expenses for a limited amount of time while their equipment has been damaged by a covered peril. For example, if cryptocurrency miners have their machines go down due to a covered loss, this coverage helps them stay operational for several months if necessary. While the business income interruption needs of cryptocurrency mining operations may be different from other commercial risks, this coverage is intentionally limited in order to reduce the insurer’s exposure to the volatility of the cryptocurrency.
- Liability: In an increasingly litigious world, cryptocurrency miners also need liability insurance because of their commercial risk. If a third party is hurt on a property, for instance, a mining operation could get sued and lose their business completely. Other commercial liability programs can provide a starting point for developing this coverage.
Developing a well-considered underwriting approach was key to striving for insurance profitability. Because this is still a new market, insurers entering early have the luxury of being selective about which customers they insure and going to market with the indicated rate level without competitive rate pressures.
Insurance will play a role in crypto’s future
As new technologies and risks begin to emerge, it’s important to realize the role insurance can play in alleviating those risks. Thomas Shewchuck notes, “The insurance solutions offered by Bitsure help reduce risk in the cryptocurrency industry more broadly, helping to support future applications of the technology. Working with Milliman, we were able to create viable products for an industry that really needed them. This should help drive further adoption and investment in the industry.”
In a larger sense, this project demonstrates that, when it comes to product design, many of the rate-making approaches and techniques used for more traditional insurance products can be applied to new and emerging markets such as cryptocurrency mining. This not only helps us conceptualize the product and what aspects of the risk are insurable, it also provides a baseline for product design that helps develop a solution that is financially viable for the long term while providing substantial value for the policyholders. The bottom line: cryptocurrency, like any industry, requires a foundation of stability to grow and develop. The right insurance can help make that possible.
1 Board of Governors of the Federal Reserve System (April 20, 2023). Central Bank Digital Currency (CBDC). Retrieved June 28, 2023, from https://www.federalreserve.gov/central-bank-digital-currency.htm.
2 Kharpal, A. (September 27, 2022). Bitcoin slides back under $19,000 as stocks fall deeper into bear market. CNBC. Retrieved June 28, 2023, from https://www.cnbc.com/2022/09/27/bitcoin-btc-price-surges-to-top-20000-even-as-stocks-hit-2022-lows.html.
3 Visit the following source for more information on blockchain technology: IBM (June 12, 2023). What is blockchain technology? Retrieved June 28, 2023, from https://www.ibm.com/topics/blockchain.