The surging popularity of cryptocurrency and digital assets has sparked increased demand for insurance, leading to the launch of several products to cover the related emerging risks.

Insurers initially were skeptical of covering cryptocurrency and digital assets because of negative publicity, but they have started offering novel products for the loss of digital assets while in the custody of private individuals rather than third-party custodians, smart contract insurance, and exchange default coverage, among others.

“The landscape of insurance products tailored for crypto exposures is rapidly evolving, which can benefit policyholders as insurers compete for business, but can also pose challenges to stay abreast of new risk transfer solutions,” said Geoffrey Fehling, a Boston-based partner at law firm Hunton Andrews Kurth LLP.

The appreciation of digital assets, greater market adoption of them, the increased proliferation of products such as exchange-traded funds and products for cryptocurrencies, and regulatory requirements have contributed to rising demand for coverage, said James Croome, head of cargo & specie and active underwriter for Lloyd’s of London syndicate 2012, operated by a unit of Arch Capital Group Ltd.

“The regulations governing digital asset transactions and custody have also become more sophisticated and expansive,” Mr. Croome said.

Capacity remains limited, he said. However, the crime and specie market in London offers products tailored to digital assets generated, traded and custodied on their respective blockchains, and the specie and property markets provide capacity to the blockchains’ physical infrastructure, such as computer hardware, he said.

Among the most significant concerns are defining the scope of coverage, such as what constitutes a covered peril, uncertainties over custody and ownership, and cyber threats, experts say.

“Determining who truly controls the private keys to digital wallets can be complex and is often not supported by legal precedent,” said Jonathan Zeigler, the Philadelphia-based managing principal of Baker Tilly’s financial services practice.

Insurers must establish procedures to verify ownership and control at the time of underwriting and throughout the policy period, because an unauthorized party could potentially access the assets at any time.

Cyber and ransomware attacks resulting in the loss of cryptocurrency and digital assets also are a significant concern.

Hot wallets — cryptocurrency storage facilities connected to the internet — exchanges and digital assets custodians are frequent targets, Mr. Zeigler said.

“As these threats evolve, especially with the use of artificial intelligence by bad actors, insurers will need strong internal or third-party cybersecurity and blockchain expertise to assess the insured’s cybersecurity maturity,” he said.

Valuation volatility also is an emerging issue, and clear contract language is essential for underwriting and risk assessment, Mr. Zeigler said.

“For example, if a policy covers a wallet holding 100 bitcoins that is currently valued at around $10 million, how will the loss be calculated and paid? Will it be reimbursed in U.S. dollars, and if so, at what value and on what date? Or will it be paid in bitcoin, introducing significant valuation risk for the insurer? These details must be clearly defined to avoid ambiguity and exposure,” he said.

The emergence of deepfakes, advanced AI tools and sophisticated criminal and nation-state adversaries has made the underwriting landscape more complex, Mr. Croome said.

Regulatory uncertainty in the past also added complexity to the cryptocurrency and digital asset sector, Mr. Zeigler said.

The recent scaling back of regulatory pressure by the U.S. Securities and Exchange Commission and the Commodity Futures Trading Commission, however, has changed the environment, said Glenn Morgan, the San Diego-based head of digital assets at Aon PLC.

“This is the first time in the history of crypto that the industry has actually had a tailwind instead of headwinds from a regulatory perspective,” he said.

The GENIUS Act, which the U.S. Senate recently passed, would be a great benefit for the industry, he said. It is designed to regulate some cryptocurrencies and establish rules for stablecoins, a type of cryptocurrency pegged to the value of a specific currency, often the U.S. dollar. The bill still must be approved by the House and go to the president.

“By having rules to the road, we will be in a drastically better place than where we were before,” Mr. Morgan said.

Insurers also should assess their technology risk capabilities, either by building internal expertise or collaborating with specialists in blockchain, smart contract auditing and cybersecurity and conduct thorough due diligence on custody and infrastructure, such as whether a policyholder uses cold or hot wallets, multi-signature setups and third-party custodians, Mr. Zeigler said.

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Liability disputes delayed by questions over how to classify digital assets

There are few coverage disputes involving cryptocurrency because of the newness of the industry and emergence of new insurance products, experts say.

The dearth of directors and officers liability insurance coverage litigation over cryptocurrency stems from the largely unanswered question over whether it is a commodity or a security subject to regulation by the U.S. Securities and Exchange Commission.

“There’s no ‘one-size-fits-all’ answer,” said Michael Savett, a Philadelphia-based insurance coverage partner at law firm Butler Weihmuller Katz Craig LLP.

If a cryptocurrency is considered a security, then D&O coverage could be triggered, Mr. Savett said.

“Liability policies for potential crypto-related lawsuits, on the other hand, run the gamut,” said Geoffrey Fehling, a Boston-based insurance recovery lawyer at Hunton Andrews Kurth LLP.

D&O, cyber, media liability, tech errors and omissions and professional liability policies all could potentially respond to lawsuits against crypto or digital asset companies, he said.

Those policies could be triggered by allegations from shareholders, customers or regulators that the company was mismanaged, made misrepresentations, failed to execute transactions correctly, ran afoul of regulations or had poor cybersecurity, Mr. Fehling said.

Policyholders in the crypto sector should avoid problematic exclusions such as those that expressly bar coverage for crypto-related losses, he said.