Will Bitcoin's Libertarians Pay for Private Deposit Insurance?

As a journalist, Ryan Selkis had his big moment last week when he got his hands on a document purporting to show that Mt. Gox, once the world’s largest Bitcoin exchange, had lost about $400 million worth of the digital currency, leaving its customers with little chance of recovering their lost funds. Because he is an entrepreneur, Selkis’s focus has been on a product that would presumably have been very helpful in just this situation: insurance for Bitcoin accounts.

He is the founder of Inscrypto, which is still in a private testing period, and he declined an interview request because he didn’t want his reporting on Mt. Gox’s troubles to seem self-interested. Inscrypto’s website describes the company as “Bitcoin’s privately funded, decentralized version of the FDIC. We help you reduce or completely eliminate the risks of owning Bitcoin.”

That’s a tall order. The risks of the cybercurrency are legion, as this week has shown. Theft was a well-known problem even even before Mt. Gox acknowledged 744,000 of its customers’ Bitcoins seemed to have been stolen as it filed for bankruptcy Friday. Because Bitcoin is more like digital cash than a bank account, it can be accidentally deleted or thrown away by those forgetting they’ve stored some on an old laptop. Then there are the inherent financial risks, such as Bitcoin’s extreme price volatility and the uncertain regulatory environment that could limit Bitcoin’s use in the future.

The Federal Deposit Insurance Corporation metaphor is somewhat fitting, given how much Mt. Gox seems to have been run like a wobbly bank from the original Wild West. Then again, the idea of the government insuring deposits of an anarchistic cybercurrency is about as unattractive to Bitcoin holders as it would be to the federal government. A workable Bitcoin insurance will have to emerge from the free market, and if it did, it would be vindication for the Randian mindset that inspires many Bitcoin enthusiasts. There’s probably not a better time to test the idea.

“A guarantee would be a complete market differentiator,” says Angela Angelovska-Wilson, a partner at the law firm Reed Smith. “My hope would be that the Bitcoin industry would come up with something that is workable.”

The company furthest along this path is called Elliptic. Based in London, the startup offers cold storage—a technique of storing Bitcoins on servers that aren’t connected to the Internet and thus can’t be hacked. Elliptic isn’t selling insurance directly; instead, it says it has negotiated a policy with a large international insurance company and passes the cost along to its customers. When the company was launched earlier this year, it said it was insured through a Lloyds of London underwriter. But Lloyds says that was not true, and Elliptic has removed the mention of Lloyds from its website. Elliptic declined to name its insurer.

Tom Robinson, Elliptic’s co-founder, says its customers are rich folks and financial institutions who deal in Bitcoins but don’t want to worry about handling them. “They wouldn’t hold pounds or dollars, so why would they hold Bitcoin?” he says. Peace of mind doesn’t come cheap. Elliptic will guarantee that it won’t lose your Bitcoin at 2 percent of its value per year, although larger accounts can negotiate cheaper rates. One twist: You can’t actually insure Bitcoins, only a dollar amount. If you insure 100 Bitcoins at the going rate of $556 today, and they go missing next year when Bitcoin is worth (maybe) $1,000, you’re getting only 55.6 Bitcoins back.

Catherine Mann, a professor of global finance at Brandeis International Business School, is skeptical about the prospects of Bitcoin insurance. Bitcoin itself hasn’t been around long enough for startups to build serious reputations, which presents a challenge for an insurance model based on trust. And there’s some reluctance among traditional finance companies to be associated with it, if Lloyd’s exasperated response to a question about its alleged involvement with Elliptic is any guide.

Besides, people dealing in Bitcoin aren’t exactly risk adverse, and insurance would mean that people who hold Bitcoin would see their costs go up. Now that a few companies are building insured Bitcoin products, it will be interesting to see whether people come to use them in any numbers. “Talk is cheap,” says Mann. “Insurance is expensive.”

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