If cryptocurrencies and blockchain technology were not already difficult enough to understand, an emerging feature of blockchain is the creation of non-fungible tokens, or NFTs. Blockchain is a database that stores digital information in groups known as blocks. When the storage capacity for a block is reached, the block closes and is linked to prior blocks of information, which form what we call the blockchain. Much like human history, as a block closes and becomes “chained” to blocks that came before it, the blockchain provides a distributable, unalterable evolutionary history of the data of which it is comprised. While most laypeople are perplexed by the form and function of a blockchain and the systems that utilize it, this technology is now mainstream and the insurance industry must evolve to address risks associated with the emerging asset classes utilizing the blockchain, including NFTs.
On the Block
The concept of blockchain technology first emerged in the 1990s, but it was not fully realized or implemented as a widespread application until 2009 when Bitcoin was created. A fundamental characteristic of the present-day commercial banking system requires a centralized, manually verifiable (but fallible) record of transactions. Art or antiques bought or sold require provenance to maintain their values, whereas blockchain forms a secure and decentralized record of transactions that does not require a centralized verification system. This technology enables the emergence of cryptocurrencies like Bitcoin and Ethereum, which have evolved from insiders-only use to availability on platforms like Venmo. Today, an insured can even pay insurance premiums via cryptocurrency.
NFTs, on the other hand, are unique blockchain-based tokens that represent an asset rather than a currency. Most of us envision images when considering NFTs, but it is important to consider that a .jpeg itself is not the NFT but what is represented by the NFT. While this may seem fantastical, it is no more fantastical than the series of zeroes and ones that make up the fiat currency in our bank accounts, which simply represent the value of what is in those accounts. Gone are the days of storing coins and paper currencies in a vault for personal use.
NFTs exploded onto the scene in 2021 and 2022, with sales in 2021 totaling roughly $25 billion. However, there is not yet a standard form for insurers to underwrite the risks associated with NFTs. Underwriters, claims professionals, and legal professionals face challenges trying to retrofit NFT-related risks into current coverage offerings. Even valuing the risk is difficult given the rapidly fluctuating price of an NFT.
Copying images from the internet is simple, as we can use non-trademarked images, purchase stock images, or even screenshot an image on our phones. However, the images that represent NFTs are created to prove the ownership, authenticity, and specific individuality of the asset. NFTs are generally stored within the Ethereum blockchain, which demonstrates possession and ownership based on the underlying principles of blockchain. Thus, while the provenance of an NFT is easy to prove, its underlying value is not as simple.
Cryptocurrency values fluctuate widely because they are non-fiat currencies. The price to acquire depends heavily on demand and availability of any given cryptocurrency. Remarkably, these assets compound and hold value simply because their owners believe they have worth. Valuing an NFT is similar. For example, Jack Dorsey’s first tweet sold as an NFT in March 2021 for $2.9 million. It is difficult to comprehend who would pay such an amount for an NFT and, more importantly, why the tweet has that ascribed value. When the same NFT was offered for sale roughly a year later, the highest bid was only $277, further demonstrating challenges with potential loss-related valuation. However, like cryptocurrencies, NFTs are a finite resource that require relatively specialized skills to source, create, and sell. By definition, they cannot be replicated or replaced, and purchase prices and values are driven by the market and consumer demand.
NFTs have been called the “baseball cards” of our time. In fact, Major League Baseball announced in 2021 that it would begin selling NFT baseball cards. Even the National Basketball Association sells “Top Shot” NFTs: for example, a video clip of LeBron James dunking during a game. These NFTs are, naturally, one-of-a-kind and, like their older, tactile predecessors, have value that is driven by their rarity and collectability.
Relevant Risks and Coverage Concerns
Art and collectibles are at risk for theft, forgery, and destruction. NFTs, as code on the blockchain, are not exposed to these risks. However, as with any other asset with attributed value, the creation, marketing, and sale of NFTs has created conflict. As mainstream companies sell more NFTs and the general public invests in them, these disagreements will become more frequent, costlier, and more contentious. Frequency and severity, as always, will be the impetus to developing insurance products for emerging risks. Accordingly, inquiries into the insurability of these disputes will grow.
In 2021, Miramax, the studio behind the 1994 film “Pulp Fiction,” sued the film’s director, Quentin Tarantino, over his plan to release NFTs based on the film, including deleted scenes from an early script and his hand-written notes on the film. Miramax alleges Tarantino’s NFT efforts infringe on its intellectual property rights relative to the film and that Miramax, not Tarantino, owns the right to develop, market, and sell NFTs associated with its film library, including “Pulp Fiction.” A similar lawsuit was initiated by Hermès, the luxury brand creator of the Birkin bag, against a digital artist who created MetaBirkin. MetaBirkins are images of fuzzy Birkin bags minted and sold as NFTs. Like Miramax, Hermès alleges MetaBirkin infringes on the Birkin trademark, dilutes its trademarked brand, and constitutes cybersquatting. The artist argues MetaBirkin is expressive art protected by the First Amendment, much like Andy Warhol’s famous “Campbell’s Soup Cans” artwork.
NFTs can either be stored “on-chain” or “off-chain,” but, either way, they are stored in digital wallets. Hackers are already using phishing and other fraudulent schemes to steal NFTs stored “on-chain.” The theft, destruction, or mysterious disappearance of a flash drive or computer could cause losses to “off-chain” NFTs. As demonstrated by the Miramax and MetaBirkin cases, the creation and sale of NFTs could also result in trademark infringement and other business-related claims. Regardless of whether your NFT is worth $1 million or $50, how is it insured? What sorts of perils can it be insured against? And do those perils potentially fall within current market offers?
Under a homeowners’ policy special form (ISO HO3), the term “personal property” is not defined, although Coverage C, Personal Property insures against direct physical loss for listed perils. While an “on-chain” theft of an NFT is unlikely to satisfy the physical loss component of the afforded coverage, if the NFT is stored “off-chain”—say, on a computer or flash drive—and it is destroyed by a covered peril, would the destruction of the computer or flash drive containing the NFT constitute a physical loss of the NFT? While the computer or flash drive would be physically damaged, can the same be said of the NFT, which is not tangible, but a digital representation of an asset stored on the computer or drive? Even if it could survive the initial coverage grant, could an exclusion preclude coverage?
While coverage for an NFT-related loss may be challenging under a homeowners’ policy, could Miramax’s and Hermès’ trademark infringement claims fall within a CGL policy’s personal-and-advertising-injury coverage? Personal and advertising injury is generally defined to include infringement of another’s copyright, trade dress, or slogan in the insured’s advertisement. For example, are MetaBirkin’s NFTs reflecting furry Birkin bags sufficient to constitute an infringement on Hermès’ trade dress? Are the names so closely related as to constitute infringement on its copyrighted material? Would the same be true for Tarantino’s advertisement of NFTs utilizing the “Pulp Fiction” name or other copyrighted material from the movie?
Cyberthreats and Crimes
As NFTs are digital representations of an asset protected by a key unique to the holder, like any other digital asset, they are also subject to various cyberthreats. Whether you are a business institution that has acquired an NFT or are the NFT’s creator, protection of the key, which evidences proof of ownership, is paramount. Phishing and other cyber-related schemes target NFT owners and trading platforms in an effort to steal keys associated with NFTs, or possibly hold the keys for ransom. Cyber insurance is an emerging commercial line, and a policyholder might assert that NFT-related risks could fall within this coverage.
One commercial example is digital asset loss coverage under a cyber liability policy, which insures the loss of a digital asset as a result of damage, alteration, corruption, distortion, theft, misuse, or destruction of the digital asset that is directly attributable to a covered cause of loss. If an NFT and its associated key constitute data within the meaning of a policy like this, then a policyholder might assert that coverage could be afforded for computer system risks and other nefarious cyber-related threats intended to steal or corrupt digital evidence of NFT ownership.
Insureds may also attempt to seek coverage for third-party, NFT-related claims resulting from cyberattacks under a policy’s security and privacy liability coverage. As we underwrite and handle cyber-related risks, we must ask our insureds about their appetites for and exposure to NFTs as well as their NFTs’ estimated values. Underinsuring this asset class could prove catastrophic in the event of a cyber incident.
NFT creators and sellers are also being investigated by the Securities and Exchange Commission (SEC) over potential violations of securities laws associated with the sale of NFTs. For example, Sand Vegas Casino Club offered NFTs in a fundraising effort to create a virtual casino whose NFT holders would share in profits generated from the endeavor. If the SEC determines this type of NFT offering constitutes a securities offering regulated by securities laws, could a commercial crime or similar policy provide coverage for the loss of an NFT? Although coverage for a security loss is usually limited under these policies, what the NFT represents may impact the type and amount of coverage an NFT holder may seek to obtain.
Today, cryptocurrencies have a wide variety of treatments by individuals, corporations, and governments. Even where they are prohibited from being mined or traded, these currencies are legitimized simply by existing. The same is true for NFTs and other digital assets. Just as businesses like Coinbase work to back cryptocurrencies, we will undoubtedly see a growing demand to protect and insure digital assets like NFTs. Coverage enthusiasts will undoubtedly have differing views as to the scope of coverage afforded for these risks and the proper policy to respond to a claim, but ambiguities associated with the NFT market, along with relatively non-existent coverage litigation concerning NFT-related losses, make predicting how a court would view the insurability of these risks difficult. Thus, the insurance industry and its partners in the legal community should work to anticipate the challenges and risks associated with this emerging asset class.