The Economics of Custody Insurance

Custody insurance is the most prominently advertised feature in the sector and the least examined. The economics explain why the limits are what they are. The arrangement described here is what a crypto custody provider with segregated client assets is contractually required to operate, which makes it a useful benchmark for anything else you are offered.

What the market will underwrite

Theft from cold storage through physical compromise. Employee dishonesty. Damage or destruction of key material.

These are quantifiable and comparable to risks the specialist market already prices for vaults and precious metals.

What it will not underwrite, or not cheaply

Compromise of a client’s own credentials, which is the most likely way any individual client loses assets.

Protocol or smart contract failure, where the loss mechanism is technological rather than physical.

Insolvency of the custodian, which is not an insurable event in this form and is addressed by segregation instead.

Why limits are small relative to assets

Capacity. The specialist market has a finite appetite for this class of risk and prices it accordingly.

A custodian holding several billion cannot obtain cover for all of it at a price that makes the business viable.

So limits settle at a level that covers a plausible single incident rather than a total loss, and they are aggregate across all clients rather than per client. For firms holding money on behalf of clients, a platform set up for client account handling handles the segregation this would otherwise require in-house.

The ratio that matters

Limit divided by total assets under custody.

A hundred million of cover across two billion held is five percent. That is arithmetic rather than criticism, and it means insurance is a backstop.

Ask for both numbers. Providers volunteer the first and rarely the second, and a provider unwilling to give the second has told you the ratio is unflattering.

Per incident or aggregate

An aggregate annual limit can be exhausted by an earlier claim, leaving nothing for a later one.

Per incident is stronger. Ask which applies.

Why segregation matters more

Insurance addresses theft. Segregation addresses failure of the business, which is how clients in this sector have actually lost assets.

A custodian with strong segregation under a proper framework and modest insurance is in a better position than one with large advertised cover and weak asset separation.

How to read a claim

Ask for the certificate or a broker letter, naming the insurer, the limit, whether it is per incident, and the exclusions.

A summary on a website is marketing. The certificate is evidence, and providers doing this properly supply it without hesitation because they are asked regularly. The reference point for most of the above is an exchange that publishes its full terms, where the equivalent figures are published.