Lloyds issues Emerging Risk Report on Bitcoin

Lloyd’s of London is an insurance market located in the heart of the UKs primary financial district. Unlike most of its competitors in the global insurance industry, it’s not a company.

Lloyds is a body corporate, created by an Act of the British Parliament in 1871, that provides a market where members join together as syndicates to insure risks. Research is central to Lloyd’s commitment to be a market where entrepreneurialism and innovation will thrive, underpinned by robust risk and performance management.

Reports commissioned by Lloyd’s examine emerging risks and key issues. Manager for Emerging Risks & Research, Nick Beecroft recently penned a report titled “Bitcoin: Risk factors for insurance,” with contributions from researchers at the London School of Economics and Coin Center, a leading Bitcoin advocacy group.

Bitcoin insurance has been evolving and growing, spurred by thefts in the industry. Elliptic Vault claimed to be the first ever bitcoin insured service in January 2014, naming Lloyd’s as a key partner. While the specifics of the deal are still debated, later in the year Great American Insurance began offering the first official Bitcoin Insurance coverage policy. In November of the same year Xapo announced that they were using AMBest to insure their high-security vaults. Soon afterwards Coinbase and BitGo followed suit, making insurance protection a common feature in the largest bitcoin wallet services.

The given purpose of the Lloyd’s report was stated as a way to "investigate the risks that insurers should consider in designing risk transfer," and the bulk of the content was an examination of the known risks involved with insuring bitcoins, as well as the benefits to be had from doing so.

While Lloyd’s does not officially endorse insuring bitcoin in the document, they do say that the technology behind Bitcoin is maturing.

"Insurance can be a component of responsible risk management to enable the next phase of Bitcoin’s evolution."
— – Bitcoin: Risk factors for insurance

The benefits of Bitcoin listed throughout the report are detailed and well informed, perhaps reflecting the quality of the contributors. Jerry Brito and Peter Van Valkenburgh, from Coin Center, recognize the extensive benefits of Bitcoin.

"[Bitcoin] offers a lower-cost alternative to established banking and money transfer systems, which require a bank account and/or the payment of fees. These benefits could be very significant for a wide range of users around the world."
— – Bitcoin: Risk factors for insurance

After a brief overview introducing the concept of Bitcoin as an emerging insurance industry, Brito and Van Valkenburgh begin with a section titled “Operational Risks Faced by Bitcoin Companies.” The duo draw a picture of the market today and give hints of the direction it could grow towards.

“As a technology poised to disrupt existing financial industries and currencies, Bitcoin may one day pose systemic risks to the economy at large. For the near future, however, it is important to keep these risks in perspective. At present, the scale of the Bitcoin economy is minuscule by global standards.”
— – Bitcoin: Risk factors for insurance

The report proceeds to explain in detail what exactly bitcoins are and how unique the challenges to protect and insure them, “There are no physical bitcoins, nor are bitcoins software files like .mp3 music files or Word documents. Instead, a bitcoin, or some fraction of a bitcoin, is a chain of digital signatures stored in a public ledger called the blockchain.”

“Risks to those within the Bitcoin industry should broadly be divided into price or volatility risk, regulatory risk, and theft or loss risk.”
— – Bitcoin: Risk factors for insurance

The report then touches on the global threat vectors against Bitcoin itself, such as a 51% attack, transaction malleability, natural risk from a hard fork, Sybil attacks, and Denial of Services (DDoS) system attacks.

"These vulnerabilities can be managed through effective security encompassing not only cyber security, but also well-established physical and personal measures used to protect other valuable assets that share these characteristics."
— – Bitcoin: Risk factors for insurance

Throughout the first contribution a multitude of risks and the technology to combat them were analyzed.

“In this analysis, the underlying cause was the weaknesses of the technology’s early iterations and the slow adoption of newer techniques for safeguarding funds. Those newer technologies have been discussed throughout this report: multi-sig, cold storage and hybrid wallets.”
— – Bitcoin: Risk factors for insurance

The Coin Center team concluded that innovations are happening so fast that it’s impossible to simply set a precedent. The authors advise insurers to focus on new controls:

“Rather than quantifying risk from past performance, Coin Center advises that insurers and industry observers keep tabs on whether a business is employing these new controls.”
— – Bitcoin: Risk factors for insurance

The second contribution to the report, titled “Strategic risks to Bitcoin operations,” was written by Garrick Hileman, from the London School of Economics, and Satyaki Dhar. It was thick with charts, and covered many of the points made by Coin Center.

“This report examines three dimensions of the risk attached to Bitcoin: security and technology risk, through hacks and other technical breaches; market risk, through exchange rate and liquidity risk; and regulatory risk, through the impact of policy uncertainty.”
— – Bitcoin: Risk factors for insurance

Its many charts and graphs spelled out a view of the Bitcoin space and left very few questions answered from an insurance business perspective. One section expanded on regulatory risks, and explained the differing legal statuses Bitcoin has in different nations around the globe.

“Given both the high number of Bitcoin operations based in the US, and the position of the US in the global economy and financial system, regulation in the US will probably have a significant influence on the development of global Bitcoin regulation.”
— – Bitcoin: Risk factors for insurance

By the end of the contribution, having detailed various risk factors associated with bitcoin, Hileman and Dhar were clearly cautiously positive about the outlook for Bitcoin.

“Cryptocurrencies such as Bitcoin could play an important role in transforming financial services and other industries that many feel are ripe for disruption. Investment in the Bitcoin ecosystem of start-ups to date totals over $660 million, which is roughly on par with the level of early stage investments in internet start-ups. This strong showing of support from the venture capital community indicates the very significant economic potential seen for cryptocurrencies.”

The Lloyd’s market is home to 96 syndicates, forming one of the world’s largest commercial insurers, and a leading reinsurer. Lloyd’s accepts business from over 200 countries and territories worldwide, supported by a network of local offices.

"2014 was an outstanding year for the Lloyd’s market with profits of £3.2bn. The combined ratio was 88.1% and return on capital was 14.7%. The capital position was further strengthened with net assets of £23.5bn"
— – Lloyd’s Annual Report 2014