Coinbase In Talks With Insurance Broker Aon To Launch Its Own Insurance Company
Coinbase is in talks with the world's largest insurance broker Aon to launch its own captive insurance company. Captive insurance subsidiaries are a way of reducing costs in case of any theft or hack attack. These form of insurances are quite common in traditional markets. Nearly all of the fortune 500 firms along with hundreds of mid-size firms maintain a form of the captive to help them cope up in case of an unfortunate event.
However, the same is not the case in the decentralized space, and many crypto exchanges like Kraken and Huboi only reserves a portion of the coins as an emergency measure to help them cope up with adverse situations like a hack. The problem with this kind of reserves is that the firm might get tempted to use it for any situation that falls upon them first. Take the recent case of Bitfinex, they used their tether reserves worth $800 million to manipulate their yearly losses.
Coinbase and Aon see this structure of regulated captive insurance firm for the crypto space as an answer to the shortage of insurance services available to crypto exchanges. With independent captive insurance, the funds are held in a regulated and audited system, which the firm can then use to attain more cover through reinsurance market.
This is not the first time that Aon and Coinbase would be working together, initially back in April this year, Aon helped Coinbase in arranging $255 million worth in coverage for its hot wallets. The exchange only keeps 2% of customer funds in their hot wallets.
Captive Insurance is the Need of the Hour for Crypto Exchanges
Looking at the number of increasing hack attacks and theft on crypto exchanges, the need for captive insurance for these firms have become a necessity, especially to ensure a sense of security among investors and customers. Aon revealed that a handful of crypto firms have shown interest in captive insurances. The insurance broker firm has already set a crypto captive earlier this year for an unnamed client in Caymans islands.
The Cayman island based captive would write crime policies for crypto firms, mostly focused towards hack of hot online wallets as well as cold storage wallets. The firm also confirmed that leading US onshore domiciles as well as Bermuda might follow on the path of Cayman island.
Jacqueline Quintal, a managing director and the financial institution's practice leader at Aon said,
“There is a lack of capacity and some are uncomfortable with what is available in the marketplace and are looking to alternative solutions. I think the path for most will be to buy some amount of traditional insurance first and then to explore alternative structures, potentially including a captive — and we are having more and more of these conversations.”
How Does Captive Works?
A captive is an insurance company which is not related to the parent company in any way or form, and this captive helps them in providing coverage in case of any mishaps. If the pricing for ensuring a firm becomes too high and no insurance company shows interest in ensuring that firm, then captive comes into the picture. However, these captives are not controlled by the main firm, as they are independently regulated and audited.
Quintal explained the advantages of captives over self-insurance and said,
“If a firm is self-insuring, they’ve accepted responsibility for funding 100% of any loss. Captives, in comparison, provide a means through which firms can access insurance or reinsurance, while also pre-funding self-insured loss amounts in a more formal way than simply setting aside capital.”
He added further,
“by having more control over a firm’s insurance program, captives can bring the price of risk financing down over time.”
Ward Ching, the managing director of Aon Captive Insurance Manager called for the inclusion of crypto in the Cayman captives investment activities. He said, “It’s all about doing the math and showing the domicile regulatory leadership how the inclusion of cryptocurrency as an asset class both satisfies the regulatory mandate and provides financial flexibility in a constructive and safe manner.
The Issues With Self-Insurances
Crypto exchanges in absence of any form of insurance rely on self-insurance to help them cope up in case of any unfortunate event of hack or theft. The problem with ensuring crypto exchanges comes at a hefty price, and this expensive nature prohibits many mainstream insurance firms to provide them with the necessary safety net to fall back upon in times of crisis.
So, these crypto exchanges just lock away a certain amount of funds in cold storages for the difficult times. Kraken a San Francisco based crypto exchange has been quite vocal about its self-insurance policy. The firm has put away almost $100 million worth of Bitcoin in cold storage as a security fund.
Similarly, Huobi put aside almost 20000 bitcoin as insurance fund which they call “the Huobi Security reserve”. Josh Goodbody, head of Europe and the Americas, Huobi global sales and institutional business said,
“If you add our protection fund up with our reserve fund we are talking well over $400m of protection there,”
Kraken CEO Jesse Powell is not a big fan of insurance provisions offered to crypto firms, as he notes that he has been offered several insurances but the prices were too ridiculous and a scene. He went onto explain,
‘There’s just not a good deal out there, I'm sure you can get someone to write you a deal for like 10% a year of the balance and actually have real meaningful coverage. But I don’t think people are going to pay that.”
Powell also explained that in lieu of self-insulating many of these crypto exchanges incur heavy losses in the process. He went onto explain,
“I think everybody basically has these funds on their balance sheet and they are investing them or dipping into them for operations. Nobody, as far as I know, has provided some sort of audit or an explicit statement about how these funds are segregated and kept in a different entity as if it were really like third party insurance provider.”
Powell is also not certain on what good this captive insurance can bring to the table, and questioned what value would it add setting up a separate captive firm.
“I just feel like it’s moving money between pockets of the same entity, and I don’t really see how this actually helps the consumer have more protection. It’s all the same basket of money anyway,” said Powell. “I don’t know why this would be able to get a better deal than we could get directly with an insurance broker.”
However, Huobi was more optimistic than the Kraken CEO and called the approach of Aon extremely interesting and positive for the market.
Some of the major players in the insurance space have also suggested that instead of forming individual captive insurance companies, space must look for pooling various disaster funds together and put them in a system of reinsurance. Powell seems to agree with the idea of pooling captive funds together and said
“You could conceivably do a group insurance deal among the exchanges, like a co-operative kind of thing. But then you have to have your competitors audit everything and I think everybody’s too smart for that – and too paranoid,”
Thus it would be interesting to see whether Aon goes on with the idea of creating an individual captive insurance firm for everyone looking for insurance security, or they move toward the idea of pooling these security funds of various exchanges and use it in reinsurance market to generate more capital. However, neither Coinbase nor Aon has confirmed or commented on the news doing the rounds.