Insuring the Digital Future: Coverage Issues for NFTs

Just a few years ago, Christie’s auction house sold a non-fungible token (NFT) representing a purely digital work of art for over $69 million.¹ A company called OpenSea, positioned as the Amazon of NFTs, is valued at over $13 billion² and in January 2022 recorded a monthly trading volume of over $5 billion.³ Multi-national retailers, including Coca-Cola, Nike, and Gucci, are selling NFTs of their products for avatars in virtual reality worlds like the Metaverse and Decentraland, where users are purchasing NFTs for virtual plots of land.⁴ Many experts believe NFTs are here to stay and will eventually become mainstream, even used to transfer ownership of real estate.⁵ This article provides an overview of the insurance landscape for these assets.

What are NFTs?

NFTs are essentially certificates of ownership for an item that may be strictly virtual or that may exist in the real world. Unlike cryptocurrency, which is fungible, NFTs are one of a kind and not interchangeable. They are purchased with cryptocurrency and a record of the purchase is documented on the blockchain (a public digital ledger which allows users to validate any given transaction). While the use of NFTs for digital artwork, video clips, and in-game purchases get the most headlines, NFTs can also convey ownership of physical objects like fine art and collectibles, while not necessarily transferring physical possession of the object. As well, NFTs can protect intellectual property rights related to the increasing use of “digital twins” – virtual versions of a physical product or asset that function in the same way and are useful in engineering and product development.

Who are the potential insureds and what are their risks?

Purchasers of NFTs are exposed to numerous risks, including buying a fraudulent NFT (i.e. one not sold by the creator or holder of the property rights) and theft from hackers or through phishing scams.⁶ NFTs have been reported to disappear due to a broken link. As well, physical assets conveyed through NFTs can be physically damaged.

Creators and intellectual property owners face risks from the unauthorized sale of their property through the use of NFTs. For example, Playboy Enterprises International was recently granted a preliminary injunction to stop the unauthorized sale of NFTs of fake Playboy Rabbitars through counterfeit websites created to look like the official Playboy website and utilizing their trademark.⁷

The online marketplaces where NFTs are bought and sold, like OpenSea, are exposed to risks similar to Amazon – multiple court rulings have found the e-commerce company responsible for defects in products sold by third-party merchants on Amazon’s website. Other potential insureds include third-party service providers in the NFT space, such as companies that purport to verify the authenticity of an NFT before purchase, or custodians of digital assets that offer protection from online threats, may also be exposed to liability if something goes wrong.

There is also a general risk for all interested parties arising out of the difficulty in valuing NFTs. Not only can the value of the digital asset itself fluctuate rapidly, the exchange rate between US dollars and the cryptocurrency used to purchase the NFT is subject to erratic fluctuations.

Coverage Issues Under Standard Policies

First-Party Property Policies

Coverage under these policies typically requires direct physical loss or damage to covered property. Covered property typically includes real and personal property and property of others. NFTs may be considered personal property or, for companies that operate as digital custodians, the property of others. However, NFTs themselves are 100% digital and cannot suffer physical damage. The servers or other electronic media that hold NFTs may suffer physical loss or damage, but typical policies exclude electronic data and/or the value of electronic data stored in such property. Insuring NFTs is also complicated by their fluctuating prices and lack of consensus over their value.

Commercial General Liability Policies

Coverage for liability because of “property damage” faces the same hurdle as first-party coverage, as the standard CGL policy requires either physical injury or loss of use to “tangible” property and excludes damage arising out of loss to electronic data. Hypothetically, an insured creator and/or seller of NFTs could submit a claim for a defense under Personal and Advertising Injury in the event they are accused of copyright or trade dress infringement in the insured’s advertisement. However, the coverage would only extend to infringement in the advertisement, not the sale of the NFT itself, and would have to overcome exclusions for knowing violations of the rights of another and for insureds whose business is an internet content or service provider.

Cyber Policies

Coverage under cyber policies varies widely, but they would generally only be useful to online marketplaces. It generally does not cover property damage, which includes computer and other technology equipment that is often damaged as part of the cyber attack. They can cover business interruption losses where network outages prevent an insured’s customers from making purchases. They typically do not compensate for stolen assets. However, cyber liability insurance may cover the cost to defend lawsuits for copyright infringement. It is unclear whether a digital media file linked to an NFT is insurable through a cyber policy that includes coverage for “digital asset restoration.”

Crime Policies

Traditional crime insurance policies were developed before emerging technological concepts and though they cover losses for theft, damage, or destruction of money, securities, and/or other property both on the insured’s premises or elsewhere (for example, while in transit), the covered property is mainly tangible and/or non-digital. However, the Insurance Services Office recently introduced an optional endorsement addressing loss involving digital tokens including NFTs.

New Products Developed to Address NFT Risk

Insurtech company Coincover (with the support of certain members of the Lloyd’s of London market) has developed a “disaster recovery” product to insure custodians who store digital assets for clients against hacking, phishing, and other malicious activity. They have also developed a product to protect consumer-owners of NFTs from theft and lost access.

Buyers and sellers of NFTs may also find coverage with decentralized and/or ‘mutual fund-style’ contracts, which have been developing to insure digital assets, including NFTs, against losses caused by hacks and halted exchanges on third-party marketplace sites. These funds are not insurance companies, so they are not regulated. One such provider is Nexus Mutual, a “discretionary mutual” entity that pools money together to pay claims and only pays claims if an internal consensus is reached.

Conclusion

While it is tempting to dismiss the multi-million dollar NFT industry in its entirety as hype, NFTs have value as tools to address authenticity and ownership of assets in the digital age. As the digital marketplace matures, insurers will increasingly be able to model and assess the associated risk to provide new insurance products protecting NFTs and their associated assets.