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FMG Law Blog Line

BITCOIN COMPANIES TEST THE WATERS IN PROVIDING DEPOSIT INSURANCE

Posted on: February 13th, 2014

By: Abby A. Vineyard

Bitcoin is a new peer-to-peer digital currency that replaces the need for traditional money and essentially acts as “cash for the Internet.”  Bitcoin users enjoy several benefits that users of traditional currency simply do not have available to them.  They can use bitcoins to purchase things anonymously, and international transactions are inexpensive and quick since bitcoins are not linked to any specific country or subject to regulation.  Bitcoins are also becoming increasingly popular with small businesses since there are no associated credit card fees.  However, one major benefit bitcoin users do not currently have is the assurance that their money will not completely vanish if their bitcoin wallet (the equivalent of a bank account) is hacked.

Retail banks in the United States are, of course, insured by the Federal Deposit Insurance Corporation, which is the primary reason people trust those banks to store their deposits.  Bitcoin transactions differ from traditional currency transfers in that they are made without any middle men—also known as banks.  This advantage is accompanied by the drawback that the FDIC does not provide coverage to users who lose their bitcoin wallets or have their computers hacked.

However, bitcoin wallet providers are developing solutions to fulfill users’ desire to have their currency protected.  For example, Elliptic, a bitcoin wallet provider based in London, recently began offering deposit insurance to its customers.  The company, which is backed by Lloyd’s of London, guarantees that insured users who lose their bitcoins (due to mismanagement) will be compensated with traditional currency.

Other bitcoin wallet providers are taking a different approach to protecting their users’ currency by storing the majority of the currency offline so that it is inaccessible to hackers.  Additionally, technology companies are developing “hardware wallets” that prevent other software from being installed, thus making it more difficult for hackers to access the bitcoins.

But technological solutions, while a step in the right direction, cannot offer the guarantees and reassurance that deposit insurance provides.  However, it remains to be seen how quickly other private insurers will venture into this new territory.  Bitcoin is relatively new and is not currently regulated or fully understood.  It has also been the subject of negative media attention.  For example, bitcoin prices recently fell dramatically due to the announcement that a bug is allowing third parties that receive a bitcoin transfer to make it appear as if the bitcoins were never actually transferred, thus allowing those third parties to receive multiple transfers.  These types of risks are part of what is causing private insurers to be cautious about their foray into this new technology.  What do you think it will take before more insurers are willing to take on the risks associated with the new currency?

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