How a captive can bring cryptocurrencies to the mainstream

Regulation is important to  Gemini Trust Company, the cryptocurrency exchange and custodian that launched a captive insurance company, Nakamoto, in January.

Nakamoto is thought to be the first captive to insure crypto custody. It allows Gemini Custody to increase its insurance capacity beyond the coverage currently available in the commercial insurance market. The captive was only possible because of Gemini’s commitment to strong regulation.

The captive addresses a problem that Cameron Winklevoss, president of Gemini, has argued is one of the main barriers to crypto mass adoption: the availability of insurance.

Gemini had originally launched in 2015 with a trust license and a mandate to provide a safe place to buy, sell and store digital assets, such as bitcoin and other cryptocurrencies. The business is regulated by the New York State Department of Financial Services, but operates in an industry in which trading on unregulated exchanges is rife – a fact with implications for everyone operating in the space.

For a number of years the insurance industry had been witnessing substantial losses in the cryptocurrency space, much of it on these unregulated exchanges. Insurers were therefore reluctant to provide any significant form of capacity, noted Yusuf Hussain, head of risk at Gemini. When they did, it came at a significant premium.

Hussain was determined to find a way to affordably insure crypto assets. “Security is of the utmost importance in our industry because if we don’t implement it correctly then it results in the direct loss of customer funds,” explained Hussain. “Compliance is important as well – making sure that we adhere to regulatory expectations.”

It was against this backdrop that, in 2018, Gemini was looking to obtain insurance for its hot wallet from the traditional insurance markets. Hussain believed that security needed to be set to the highest standard, to protect client information and digital assets in a relatively young asset class where many investors still feel some reticence. It was only by providing this comfort to investors that interest could really grow, and cryptocurrencies could come into the mainstream.

“We were able to demonstrate to Aon, our broker, and our underwriters, that we had appropriate governance in place to demonstrate our security in a fairly rigorous manner,” said Hussain. “We could demonstrate that we were undergoing an independent audit [SOC 2 Type 1] from Deloitte, which gives an independent opinion on the state of our security infrastructure.”

In 2018 Gemini obtained insurance for its online hot wallet. It has also secured insurance for its institutional-grade, cold storage system, which supports an expanded list of digital assets. That list includes bitcoin, etherium, litecoin, bitcoin cash and Zcash, among others.

The question of regulation was central to Gemini’s decision to base Nakamoto in Bermuda, said Hussain. “We decided on domiciling our captive in Bermuda because the Island is a leading domicile for captives that has a robust regulatory framework and takes a very serious stance towards regulations, security and compliance,” he said.

Hussain added: “Given our stance on embracing regulation, we thought that Bermuda was the right place for us. Our captive, Nakamoto Limited, is the world’s first captive insurance company to insure crypto custody. We’ve got a combined solution for insurance – it’s a captive and commercial insurance market solution, so a portion of the insurance solution is being provided by a captive and a portion of it is provided by commercial insurers.”

Gemini has $200 million in coverage, which is the largest coverage for any cryptocurrency custody solution. “Customers can also buy additional coverage if they want to secure additional insurance for their digital assets as well,” Hussain added.

While Nakamoto currently only writes custody risk coverage, it is already thinking about potentially expanding that to insure other risks for Gemini.