NFTs are creating a buzz in the art world. Touted as an innovative way for digital artists to get paid for their work, non-fungible tokens, or NFTs, offer a proof of ownership for things that by definition are intangible. NFTs also represent a whole new world of risk, and with risk comes insurance.
In some ways, the risks introduced by NFTs are novel, but in other ways they are as old as the insurance industry. And, while there aren’t yet a slew of policies stepping into the breach to cover NFTs, a new class of policies is emerging to manage risk for this developing market.
Basics of NFTs
An NFT is a nonfungible token. Something that is fungible can be traded for something exactly comparable. A $20 bill is fungible. A Picasso isn’t.
NFTs are pieces of computer code. They are made up of URLs that point to something in the world – typically a piece of digital art hosted on a server somewhere, along with a metadata description of the thing the NFT represents.
If someone draws a character on an iPad and then hosts that character on a server, that artist can create an NFT linked to that digital art and then sell it, transferring ownership in a verifiable way. NFTs are tracked through a blockchain ledger, creating a publicly validated chain of ownership.
The owner of the NFT can store it in their digital crypto wallet and has the right to sell it to anyone else down the line.
A common confusion is that many people see NFTs as the art itself, but it is better thought of as a “digital deed of ownership.” Just like a deed represents ownership of your home, an NFT represents ownership of something else. While NFTs are often used for digital art, they can be associated with just about anything, even real-world art, baseball cards or real estate.
See also: The Opportunities in Blockchain
Insuring an NFT depends on what in particular you are looking to protect.
NFT policies can protect the digital asset itself, just like a homeowner’s insurance policy can protect an oil painting. If the art is destroyed, the policy could pay out.
But that is not the only place where NFT insurance comes into play. The digital NFT – the computer code – could also be insured in case the URL or the metadata is somehow corrupted.
When an NFT is minted, it comes with both a public key and a private key. The public key is what moves through the blockchain ledger. The private key is your proof of ownership, just like the private key to cryptocurrency, and is necessary to validate ownership or sell it to someone else.
If that private key is lost, ownership is essentially lost, so an insurance policy can cover this.
If a hacker gets that private key, they can transfer ownership, essentially stealing ownership of the art, and that possibility, too, can be insured.
Finally, the ability to transfer the NFT to an heir after death could be insured.
Most insurers aren’t offering NFT policies at this point. There is a policy offered by Coincover. Some auction houses may also be able to connect high-end buyers with other specialty lines, such as Lloyds.
NFT best practices
Because of its novelty, there are some unique challenges inherent to NFTs.
First, setting valuation is difficult. Because the art or property an NFT represents isn’t fungible, there is no market price to establish valuation the way a cryptocurrency can be valued.
There is also a challenge when it comes to copyright around NFTs. Because NFTs aren’t the art, but rather a proof of ownership of that art, if someone mints a fraudulent NFT it isn’t completely clear who is the crime victim. The artist wouldn’t necessarily have a copyright claim because the art itself wasn’t reproduced.
The person who bought the bogus NFT could have a fraud claim. It is akin to someone making a fraudulent deed to their neighbor’s house. They can sell that fraudulent deed, but that doesn’t transfer ownership, so the homeowner isn’t necessarily the victim — the person who bought the bad deed is the victim. Now, if someone with a bad deed tries to move in, then the homeowner has a claim, but it isn’t necessarily against the person who sold the deed, but instead against the person trying to move in and take ownership. Needless to say, things can get complicated fast.
Fraudulent NFTs have been a high-profile problem on some of the public art markets, with fraudsters and even bots minting bogus NFTs and then selling them on the exchanges, as recently reported in insuranceQuotes.com’s 2022 guide to protecting non-fungible tokens.
So, beyond the question of insurance, there is a large element of buyer beware where prospective buyers need to validate that they are buying something the other person has a right to sell in the first place.
NFT owners also must practice good crypto habits – protect their wallets, protect their private keys and use a custodian to ensure that, if the owner loses the private key, it can still be recovered.
It is also essential to back up the digital asset in as many ways as possible – on-site, on the cloud, or even through more complex solutions, such as a distributed file system, in case the original is damaged.
See also: The Defining Issue for Financial Markets
NFTs seem exotic, but protecting art and assets falls squarely within the constraints of typical insurance policies. Even protecting a deed could fall into the realm of title insurance. So, while NFTs themselves are new, the issues are all solvable.
As the NFT market matures, billions of dollars are expected to flow into this market, so more insurance policies will inevitably emerge.
But, while those factors fall into place, NFTs will remain an area of huge potential, and potential risk, that will inevitably shake out.