How Can You Protect Your NFTs?

In recent months several major collectors have suffered staggering losses after their NFTs fell victim to phishing schemes. Collector Larry Lawliet lost $2.7 M when hackers convinced him to sign bogus agreements giving them access to a digital wallet containing identifying information concerning his assets. New York art collector and gallerist ­­­­­­­­­­­­­­­­­­­­Todd Kramer suffered a similar loss.

In addition to the loss or theft of a password to a digital wallet or mobile phone on which it is installed, an NFT is vulnerable to a host of other risks, such as corruption or failure of the link to the underlying digital files, business failure of the company storing the asset, or the hacking or manipulation of smart contracts. Plain old human error provides another set of risks.

The logical risk prevention strategy is insurance, but while the minting and sale of NFTs has exploded, the market for insuring them has not. Conventional property policies (such as homeowners or renters insurance) won’t help since they are designed to protect against perils that cause physical loss. Fine arts policies are problematic because the value of the asset fluctuates, often rapidly and dramatically. Commercial crime policies typically exclude cryptocurrencies without specific endorsements. Some cyber policies held by galleries or auction houses may provide limited coverage for suits by third parties alleging negligence in safeguarding the assets.

There are also emerging products that may be promising. A U.K. company called Coincover, which has operated in the crypto space since 2018, now combines security technologies and insurance to offer a solution to protect NFTs.

In addition to problems of valuation, the reasons comprehensive NFT coverage is not generally available include lack of a critical mass of data that will allow insurers to underwrite risk and develop pricing; the volatility of the current market; and the regulations of reinsurance companies that do not allow for the sale of NFT policies. Insurers are working to develop policies that will cover fraud and intellectual property claims.

There is a growing trend towards decentralization. Certain crypto platforms offer their own insurance products. Meanwhile, a peer-to-peer network of risk management platforms is evolving; such insurance is offered by DAOs (Decentralized Autonomous Organizations) whose members (“governance token holders”), with some oversight, vote on coverage and claims issues. These policies are most likely to protect smart contracts against hacks and manipulations.

A recent court decision in the United Kingdom involving the theft of digital assets from an online wallet may have implications for legal protections for NFTs. The court found that the NFTs were “property,” thus making available to the plaintiffs a variety of legal remedies, including an injunction to freeze the assets and access to information. Whether the U.S. will extend the same legal protections to NFT holders is unknown.

Given the turbulence within the insurance market and the lack of comprehensive NFT policies, the best advice for NFT owners is to self-insure. First, do extensive due diligence during the acquisition process - use only trusted sites and double check metadata and URLs to be sure it is clear what being acquired. (In this connection, see the class action suit filed in May 2022 against a DAO by crypto-investors who allege that lax security practices led to the loss of $55 million to a phishing scheme.) Once the asset has been purchased, make a careful choice as to where to store the asset by comparing the security features of various wallets and platforms and take the usual critical precautions to secure passwords, keep software updated and be alert to offers from unverified sources. One expert advises

People selling, buying, or trading NFTs need to make sure they’re using a well-known and established custodian…They could even ask if that custodian actually has their own insurance, because, if they do, that means they’ve been vetted by underwriters from a crypto perspective and they meet certain standards. Insurers will likely only be comfortable providing coverage if galleries and auction houses are partnering with a custodian that’s known in the market and is already purchasing their own insurance program…

Lutzker & Lutzker will continue to follow developments in the high stakes NFT marketplace.