Bitcoin and the Insurance Industry

Bitcoin and the Insurance Industry

Theme: This session will explore a number of the most developing issues underlying Bitcoins. Attendees will hear from experts within and around the Bitcoin industry regarding the nature of Bitcoins, emerging insurance issues and potential for development of manuscript coverages. The panel will discuss their view on the most effective ways of mitigating risk from Bitcoins and whether existing policies cover this emerging industry.

1. Introduction (5 Minutes)
2. Background on Bitcoin and Regulation (15 Minutes)

1. What is Bitcoin?

1. a software-based decentralized digital currency
2. created in early 2009 by a mysterious entity or individual known as Satoshi Nakamoto
3. transactions are irreversible and generally anonymous, although there are apparently some tracing capabilities
4. new Bitcoin are minted through “mining,” which requires significant computer processing power to solve complex algorithms and unlock new bitcoins
5. bitcoins can be bought on exchanges, which convert money between other currencies and bitcoin
6. bitcoins are stored in a “wallet,” which is essentially a software file

1. wallet holds both

(1)bitcoin addresses and

(2)a “private key,” or password that the holder of the bitcoins uses to access and control the bitcoins held at that address

(a)private keys may make bitcoinsdifficult for courts and creditors to access

(b)private keys also may make recovery by an estate impossible in some circumstances

(3)there are offline storage options for the longer term, which can keep bitcoins secure

1. wallets range from secure to less secure

(1)Coinbase, Circle and Xapoassume complete control for the addresses and keys

(2)Non-custodial wallets are less secure but also give more control to the user; these wallets are only used for transactions – the owner retains complete control over the bitcoins

(3)Software is assembled by the individual bitcoin user

1. Useful characteristics of Bitcoin

1. Purchases are generally anonymous, which is why Bitcoin has been popular with online black markets (such as the now defunct Silk Road) for drugs and other illegal purchases
2. Low overhead costs

(1)No transaction costs for merchants – merchants do not have to pay credit card fees because the risk of loss is entirely on the user (or the wallet company that the user pays to use)

(2)Some of this may just be because bitcoin is new and there aren’t regulations in place which would require insurance/other requirements that would increase the cost of bitcoin for merchants and users

1. Issues with Bitcoin

1. Price volatility; value has ranged from less than $2 per bitcoin to more than $1,200 per bitcoin, and can vary significantly intraday
2. Purchases are irreversible, so there is the potential for catastrophic loss if the bitcoins are lost or the wallet is compromised (Mt. Gox example – Japanese bitcoin exchange that crashed in 2013 -- )

1. Legally, what are bitcoins?

1. Money

(1)Financial Crimes Enforcement Network (FinCEN), a division of the US Department of the Treasury, issued guidance to mitigate money laundering concerns with bitcoin and other virtual currency. FinCEN’s guidance includes registration, record-keeping and reporting requirements.

(2)United States v. Ulbricht, No. 14-cr-68, 2014 U.S. Dist. LEXIS 93093, at*70 (S.D.N.Y. July 9, 2014) held that bitcoins are “funds” within the meaning of a federal money laundering statute because bitcoins “can be either used directly to pay for certain things or can act as a medium of exchange and be converted into a currency which can pay for things.”

(3)United States v. Faiella, No. 14-cr-243, 2014 U.S. Dist. LEXIS 116114, at*3 (S.D.N.Y. Aug. 19, 2014) held that bitcoin qualifies as “money” or “funds” within the meaning of a federal statute prohibiting the operation of an unlicensed money transmitting business because bitcoin “can be easily purchased in exchange for ordinary currency, acts as a denominator of value and is used to conduct financial transactions.”

(4)California’s Assembly Bill 129 “[s]pecifies that current [California] law which bans the issuance or circulation of anything but lawful money of the United State does not prohibit the issuance and use of alternative currency.”

(5)Texas Department of Banking’s Supervisory Memorandum – 1037 (April 3, 2014) stated that cryptocurrencies like Bitcoin are not currency under the Texas Money Services Act, which only recognizes money that is designated as the legal tender of the United States or another country (“sovereign currency”). However, when Bitcoin is transferred into or out of a sovereign currency, it is subject to regulation under Texas’ currency exchange laws.

(6)The New York Department of Financial Services, which supervises insurance companies, investment companies, banks, loan services, etc., issued proposed regulations for Bitcoin licensing in July 2014. The proposed regulationswere seen as an unacceptable level of regulation in the Bitcoin industry, and finalized rules and regulations have yet to be announced.

1. Securities

(1)IRS: Internal Revenue Bulletin 2014-16 states that “[f]or federal tax purposes, virtual currency is treated as property.” Therefore, “[g]eneral tax principles applicable to property transactions apply to transactions using virtual currency.”Taypayers calculate taxes due to Bitcoin transactions by looking to the fair market value of Bitcoin in U.S. dollars at the date of payment or receipt.

(2)Predominant use of Bitcoin right now is speculative; it is not being used as a currency by the vast majority of Bitcoin holders

1. Potential Implications Under Existing Bonds and Policies (30 Minutes)

1. Is Bitcoin “money”?

(1)Depending on the policy/bond’s definition of “money,” Bitcoin could covered, unwittingly, by a number of policies or bonds

(2)Whether Bitcoin is covered as “money” would depend on the state (Texas does not recognize Bitcoin as money, but it appears that California and likely New York will recognize Bitcoin as money). Thus, the substantive law that applies to a coverage dispute may be determinative of coverage.

1. Bitcoin has many characteristics of a security

(1)Price volatility

(2)IRS views as property

1. Coverage Implications for the Classification of Bitcoin

(1)Bitcoin being able to be either a security or money means that there are more potentially applicable insuring agreements to evaluate and litigate coverage under

(2)Whether Bitcoin is money or a security will have consequences for valuation of loss

(a)If money, seems that covered loss would be paid in Bitcoin at the time of judgment/settlement

(i)Due to the high price volatility of Bitcoin, the day/time of the judgment or settlement could therefore become very important

(b)If Bitcoin is a security, it seems that covered loss would be the value of Bitcoin in USD when it was lost/stolen

1. Recovery through subrogation may be much more difficult because

(1)Cryptocurrency can be stolen by anyone from anywhere in the world just as easily as it can be stolen by someone in the US. This is unlike typical theft coverage where the theft often involves a domestic employee or a domestic customer

(2)An individual or entity could resist enforcement of a judgment by refusing to divulge the private key information

(3)Bitcoin is easy to lose, misplace or destroy ( )

1. Opportunities for New Endorsements/Riders and Challenges for Underwriting Moving Forward (10 minutes),.

1. The increasing popularity of Bitcoin and state and federal entities’ increasing interest in regulating it means that there is potentially a great need for Bitcoin-specific policies or virtual currency policies
2. Bitcoin and virtual currency coverage is best dealt with through a specific policy endorsement underwritten to cover this unique risk and to require insureds to comply with best practices to help guard against risk of loss – this is why it is important to have someone who is watching the industry to write the endorsement and applicable exclusions/conditions
3. Moving forward, it is important to stay informed of potentially applicable state and federal regulations that may impact the interpretation and possible expansion of existing clauses beyond what is contemplated
4. Insurers also may want to consider adding virtual currency exclusions to policies to clarify coverage
5. The difficulty of recovery of lost or stolen Bitcoin should be considered when setting premium rates

What should the participant “take away” from this session?

• A fuller understanding of Bitcoins and their use in society.
• Current regulations of Bitcoins and their impact on the Bitcoin industry
• Greater knowledge as to whether current policies cover Bitcoin losses.

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