Author: Darren Sonderman and Sydney Sonderman, Financial Insurance Brokers at CAC Group
Digital assets, decentralized finance (DeFi), and asset tokenization are no longer fringe concepts; they are reshaping the global financial landscape. It is expected that in the next decade, the tokenization of real-world assets will reach $20 trillion, and countries around the world are accelerating the establishment of robust legal and regulatory frameworks.
The United States is catching up, with the Trump administration promoting legislation on stablecoins and the structure of the cryptocurrency market, as well as establishing key working groups.
Meanwhile, governments around the world are accelerating investments, innovations, and advancing legislation related to digital assets. Disruptive technologies are driving the global economy forward. As digital assets and decentralized technologies reshape the global financial system, traditional insurance is lagging, exposing innovative companies to risks and highlighting the need for more adaptive insurance coverage.
Digital assets are about to become mainstream in the global market.
Directors and officers liability insurance is a cornerstone of emerging industries, providing risk transfer and financial protection to attract capital, drive innovation, and build trust.
Whether for public companies or private enterprises, regardless of size, and whether involving traditional finance or disruptive technologies, almost every company needs directors and officers insurance. Without functional insurance, companies will struggle to attract high-quality boards. The capital that investors seek will be forced to cover operational risks and legal fees that could be addressed through appropriately tailored insurance.
While some envision the future of on-chain insurance, traditional financial insurance companies are slowly accepting digital assets. Insurance rewards certainty, so many insurers chose to wait and see in the early stages of the technological revolution. The risks associated with blockchain, cryptocurrencies, DeFi, and tokenization remain difficult to quantify, causing hesitation among insurers.
When they do intervene, insurance coverage is often riddled with gaps, filled with loopholes that allow for claim denials while providing affirmative coverage. Many companies in the digital asset industry struggle to find insurers willing to provide robust, predictable, and efficient management liability insurance.
Directors and officers liability insurance tailored for SPAC transactions or initial public offerings is hard to come by, often lacking the necessary details to address the unique risks of these pathways. Technical liability insurance to protect intellectual property, trade secrets, confidential information, tokenized assets, or the efficacy of new technologies is almost nonexistent.
Cyber insurance, typically the foundational layer of protection, is nearly incapable of providing adequate coverage for theft or misappropriation of digital assets, ransomware incidents, or attacks by nation-state actors. This lack of reliable insurance leaves companies in the digital asset economy exposed as they take on transformative risks.
However, despite the obstacles, negotiating, arranging, and continuously improving effective insurance policies is achievable.
Off-the-shelf insurance policies designed for traditional finance do not apply to the digital asset space.
Custom, adaptive policy language is needed to ensure seamless coverage regardless of regulatory, technological, or infrastructure changes. More than 30 key insurance contract modifications are required to make insurance effective and functional for companies directly or indirectly involved with digital assets/disruptive technologies.
These insurance policy modifications include eliminating common exclusion clauses, introducing affirmative digital asset coverage, and rewriting policy definitions to encompass confidential information, trade secrets, intellectual property, tokenized assets, cryptocurrencies, stablecoins, derivatives, quasi-currencies, securities, assets, private keys, and alternative units of value.
Purchasing the right (and necessary customized) insurance policy could be the difference between a complete insurance recovery and no recovery at all. Companies and leadership teams that take the time to customize insurance policies and invest energy and action to support their business relationships with insurers—rather than just treating it as a transaction—have benefited. They will continue to reap the rewards of consistent and predictable superior insurance recovery outcomes. The importance of insurance is often realized too late. Without proactive measures, effective products will not be the ones owned in the event of a claim.
Regulatory clarity is key to the global promotion of digital assets, but regulation can also bring unpredictable risks. Current regulators may become parties to lawsuits in the future—recent civil rights fraud actions by the U.S. Department of Justice are a prime example. Legal and operational initiatives strongly recommended by regulatory bodies such as the Department of Justice, the Securities and Exchange Commission, the New York State Department of Financial Services, the Commodity Futures Trading Commission, the Financial Crimes Enforcement Network, and the Office of the Comptroller of the Currency have become the basis for these agencies to initiate multi-billion dollar lawsuits under new leadership. As administrative systems change, related litigation follows.
Similar situations have occurred in the past. In the 2000s, banks were encouraged to issue housing loans supported by the Department of Housing and Urban Development (HUD), only to face massive subprime loan lawsuits from the very regulators that had previously promoted the related policies. Some insurance companies even refused to pay claims, leaving financial institutions in distress.
Thus, insurance policies must be capable of responding to regulatory changes. Carefully designed and battle-tested insurance policies have paid clients hundreds of millions in legal fees and settlements without incurring high litigation costs.
The traditional financial industry has billions of dollars in D&O liability insurance capacity, while the customized insurance capacity in the digital asset/disruptive technology space remains at hundreds of millions. As disruptive technologies move into the mainstream, insurance capacity will increase, and insurance costs will decrease.
For digital asset innovators, obtaining millions of dollars in efficient strategic directors and officers liability, professional liability, technical liability, cybersecurity, and crime insurance coverage remains crucial.
Author: Darren Sonderman and Sydney Sonderman, Financial Insurance Brokers at CAC Group.
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Original: “The Insurance Mechanism for Smart Contracts is Lagging, Dragging the Entire Industry Down”
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