[co-author: Ryan Pau]
On June 12, global insurance giant Lloyd’s of London released a report titled Bitcoin: Risk Factors for Insurance. Lloyd’s knows a thing or two about risk—it has been underwriting for more than 300 years and has insured everything from the Titanic to Keith Richards’ hands—so what does Lloyd’s think about the risks of Bitcoin businesses?
According to the Lloyd’s report, businesses seeking to enter the virtual currency marketplace—whether by running an exchange, holding bitcoins in secure “wallets” for users, or simply accepting bitcoins as payment—must be aware that Bitcoin’s “security risk will never be reduced to zero.” Such businesses face the possibility of loss both through local attacks geared toward stealing a user’s private key and global attacks aimed at the Bitcoin network as a whole. Insurers want to see that companies are aware of these risks and working to mitigate them.
Lloyd’s identifies several specific mitigating steps businesses can take to avoid unnecessary risk, including: establishing robust server-side security; placing private keys in offline or “cold” storage; and linking a public address to multiple private keys stored in different locations. These steps can lessen overall exposure to potential threats and minimize expected losses.
On top of the security risks Bitcoin-related businesses face, Lloyd’s points to two more critical areas of risk: market risk created by exchange rate and liquidity risk; and regulatory risk created by enforcement in an area of legal uncertainty. The significant volatility of bitcoin’s value in its still young life makes it a risky venture for any business. Since November 2013, the currency has skyrocketed from less than $200 to over $1100, then falling to its current value of approximately $250.
And businesses cannot ignore the likelihood of increased regulation. As Bitcoin continues to expand its reach throughout the world, each country—and the international business community as a whole—will address difficult questions about how much (or how little) to regulate Bitcoin. Lloyd’s aptly notes that both market volatility and regulatory enforcement will have an impact on the “risk profile” of Bitcoin as the virtual currency industry develops and more Bitcoin-related businesses seek insurance.
Unlike security risks, volatility and regulatory enforcement cannot be mitigated at the individual level, but their impact on businesses taking part in the Bitcoin economy cannot be ignored. Volatility, Lloyd’s report notes, has the potential to decrease as the number of market participants increases, so businesses assessing these risks must maintain awareness of market depth. Similarly, businesses must pay attention to the United States’ regulatory stance on virtual currency; given the country’s strength in the global economy, U.S. regulatory changes will likely have a greater impact on Bitcoin’s future than those put in place by any other country.
At bottom, Lloyd’s report projects cautious optimism for the future of the Bitcoin industry, at least from an insurer’s point of view. It notes that “the challenges that are described in this report should be viewed as symptomatic of an emerging, innovative technology, rather than evidence of underlying critical flaws.” Bitcoin-related companies that wish to stay in business should get smart about insurance. Lloyd’s report is a good place to start.