PERSONAL LINES

NFT INSURANCE: UNDERSTANDING THE CHALLENGES AND SOLUTIONS

Non-fungible tokens (NFTs) hit the mainstream in 2021, driven in large part by a $40 billion NFT art market that included a record sale of Beeple's “Everydays: The First 5000 Days" for $69.3 million. With so much money being invested in NFTs, owners are looking for ways to protect their investments.

If NFT art was like other fine art, obtaining insurance to protect against damage or theft would be an easy proposition with plenty of precedent. However, NFT art is not like other fine art. And the task of establishing a way to insure it in the traditional sense has proven to be insurmountable.

To understand the challenge of insuring NFTs, it is helpful to understand how they work. NFTs revolutionized the world of digital assets by allowing digital creations to be authenticated. Prior to NFTs, a copy of a digital file was identical to the original. Because NFTs are built on blockchain technology, they are connected to a decentralized historical record that allows for the provenance of a digital file to be established.

Ownership of an NFT is established and authenticated by immutable blocks of data on the blockchain. As a result, the original is nonfungible, or not interchangeable with any copies that might be made. By allowing for authentication and ownership of digital assets, NFTs also allow for digital assets to be valued and sold, which creates the need for NFT insurance.

The unique nature of NFTs becomes evident as one tries to apply normal insurance protocols. Standard homeowner policies focus on covering physical damage to assets. Normally, NFTs do not exist in the physical world. They are intangibles. They can be expressed physically, such as with a printout of a digital graphic, but the physical expression is not what is owned. In addition, NFTs exist on blockchain, which is public. Therefore, NFTs cannot be damaged or lost.

While NFTs are considered by some to fall under the umbrella of fine art, insurance policies covering fine art rely on determining a value for art that is based on an established market. The NFT market is brand new and highly volatile. Setting a value for an NFT is a risky proposition. In addition, fine art insurance also addresses the risk of something being physically damaged, which does not apply.

The task of insuring NFTs is further complicated by the fact that the NFT and the art that they represent are not one and the same. In essence, the NFT is a token that provides a unique digital signature of the digital asset and a link to the file, along with any other data associated with the ownership of the file.

The artwork that is associated with the NFT exists somewhere separate from the NFT.

Cyber insurance policies may provide a model for developing NFT policies, as they address a loss that occurs when digital networks fail. NFT marketplaces provide a place for NFTs to be bought and sold. In some cases, NFTs are stored on networks managed by marketplaces. When marketplace networks are compromised, NFTs can be stolen or lost.

For the most part, however, cyber insurance policies would address the marketplace's liability, rather than covering losses that might be experienced by individuals with marketplace accounts.

An insurance-like product known as a discretionary mutual fund is being explored by a growing number of companies as an alternative to traditional insurance that could apply to NFTs. This model allows for the creation of decentralized insurance pools that can cover losses experienced by those operating in the decentralized economy. However, the application is limited to a loss that happens as a result of failures or flaws in the smart contracts that are programmed into the NFT and that govern their exchange, rather than loss as a result of outside circumstances such as theft.

Progress toward the development of NFT insurance is being made but the timeline remains undefined. In the interim, the best advice for those seeking to secure their NFTs may be to rely on self-insurance and cyber safety. The NFT thefts that typically are reported result from the failure by owners to take the necessary precautions to secure them with available safeguards like offline storage and multi-factor authentication. If such precautions are not employed, NFT insurance, when it appears, may not provide coverage anyway.

This article was originally published on iamagazine.com in March.

> Nick Donarski,

Founder and Key Technical Expert, ORE System