Bitcoin Backers Seek FDIC-Style Insurance

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WASHINGTON — A diverse group of entrepreneurs is trying to solve a riddle that may hold the key to Bitcoin and other digital currency moving into the mainstream: how to insure accounts.

For all of the energy and innovation behind the Bitcoin movement, perhaps the biggest factor separating digital money from bank accounts is the latter are backed by the Federal Deposit Insurance Corp. But Bitcoin wallet services — which operate in some ways like banks — and other startups are beginning to focus on how the private sector can offer FDIC-like backing to virtual currency users.

The biggest step so far has been by Elliptic, a London wallet service that on Jan. 9 offered Bitcoin accountholders insurance through Lloyd's of London.

A Boston-area company still in beta testing, called Inscrypto, plans to allow investors to insure bitcoins through derivatives trading. Separately, a New York insurance company called Founder Shield, which specializes in policies for startup firms, has developed a product specifically to protect Bitcoin service providers from loss.

Other concepts are unique to the technological world, such as miniature hardware devices allowing users to store and access their bitcoins offline. Some observers have discussed a model for insuring bitcoins the same way investment securities are protected.

"I get a call about every two weeks asking me about the feasibility of... running an FDIC for bitcoins," says Marco Santori, a counsel at Nesenoff & Miltenberg LLP who advises technology startups. "One of the big hurdles to bitcoin adoption is security — keeping your bitcoins safe. People are being hacked or claiming they were hacked and people are losing their bitcoins. These are precisely the kinds of losses that the FDIC is meant to guard against."

To be clear, the kind of support resembling what the FDIC provides bank customers may be many years away for Bitcoin. The technology is still young, while a lack of clarity by regulators on how they view online currencies is also an obstacle. Another factor is that banks, which have partnered with nonbanks to attach deposit insurance to relatively new retail products like prepaid cards, have been reluctant to enter the Bitcoin world.

"With stored-value and prepaid cards, there is an actual... regulation that gives them the path to insurance. We don't have anything like that on the virtual currency side," says Angela Angelovska Wilson, a partner at Reed Smith. "I don't think the regulators, especially the FDIC, are ready at this time to take action and classify how these virtual currencies should be treated for purposes of deposit insurance."

But some observers say that if Bitcoin catches on the way many hope it will, regulators in the future may view the issue quite differently.

"This is very much down the road, but one can imagine government consumer protection regulations someday that would require... services that hold bitcoins for consumers to insure them in some way," says Jerry Brito, a senior research fellow at the Mercatus Center at George Mason University.

Many Bitcoin-related companies are not waiting around for a public-sector solution. Top wallet service providers, such as Coinbase, already tout steps they take to guard customers' funds, including offline storage and using safe deposit boxes to keep hardware and paper records.

But the Elliptic "Vault" goes a step further. In addition to the "cold" storage methods practiced by other wallet services, Elliptic has added insurance backing from Lloyd's of London, which protects against a failure in the company's storage methods. Customers can choose a "liability limit" for how much of their bitcoins are insured.

James Smith, Elliptic's co-founder, says for now any insurance payouts for lost bitcoins will be in real currency. But he is hopeful that will change when Bitcoin's price stabilizes.

"The insurer might be able to pay out in Bitcoin," Smith says. "It's not a very big step from taking those pounds to using those pounds to buy Bitcoin again."

Other entrepreneurs hope a Bitcoin-related derivatives market can provide a model for protecting customers against loss. The service being developed by Inscrypto, which is complex, is in some respects more focused on protecting customers against price drops in what is still a highly volatile currency. Essentially, investors will use put and call options to insure the value of customers' Bitcoin holdings while benefiting from the upside of price gains.

"We've had quite a number of investors approach us with interest because this is kind of an unregulated market that a lot of people want access to, but for regulatory reasons are concerned about directly holding digital currency," says Ryan Selkis, Inscrypto's founder, who is also developing a platform for givers to make online charitable contributions with bitcoins.

"The fact that we can create this layer between the two different parties that have very different needs is a solution to a major pain point in the industry right now," he added.

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Comments (1)
Anyone familiar with private deposit insurance knows it is an oxymoron. It can work in a normal market but not in a downturn or industry crisis without government backing. Virtually all of the private deposit insurers in the US failed in the 1980s, often with tragic results for the depositors. The FDIC and FSLIC paid all of the claims of federally insured depositors in the 1980s only because they were backed by the US Government. That is why no reputable insurance company offers such coverage. Offering "insurance" for all bitcoins would be a massive fraud.
Posted by gsutton | Thursday, January 23 2014 at 6:46PM ET
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