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The Unique Property Insurance Considerations For Bitcoin Mining Operations

ccLink by ccLink
April 19, 2022
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The Unique Property Insurance Considerations For Bitcoin Mining Operations
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It is crucial for Bitcoin mining operations to have adequate insurance coverage and understand their rights to recovery should their operations suffer losses. As far as traditional property-related risks, they are similar to those of any brick-and-mortar technology company, but also have additional, unique considerations.

Who Are The Miners And Who Owns The Mines? Structure Of The Operations

Properly distinguishing between who owns the mine and who owns the ASICs (mining machines, called application-specific integrated circuits) is a critical distinction for insurance purposes. In some instances, the owner of the facility housing the ASICs does not actually own the machines and only provides power, space, support and maintenance for the miners. Other types of Bitcoin mining operations own all of the equipment and retain all of the mining rewards, or have some other types of arrangements.

It is imperative that operations protect their physical assets while maximizing their insurance assets. Doing so requires understanding the insured operation and its interplay with insurance coverage principles.

Insurance Coverage For Bitcoin Mining Operations

ASICs are vulnerable to the elements and electrical interruptions. A mining operation will likely suffer losses if a fire breaks out on the premises, a storm damages ASICs or a power outage prevents access to the internet or turns off environmental controls. While not unique loss scenarios, the nature of the Bitcoin mining business and its structure poses unique challenges when seeking insurance coverage. Bitcoin mining operations must consider who is insured, the location of the operation, valuation and business interruption or contingent business interruption losses.

Given these complexities, insurance procurement and recovery are heavily dependent on the structure of the operation and the policy language, both of which must be carefully considered in light of one another. In both the procurement and recovery stage, the insurer will likely require detailed documentation of the operation’s structure in order to adequately price the risk, determine whether there is coverage for a particular loss and pay out any benefits. Detailed documentation will also make the operation’s claim preparation process smoother than it might otherwise be.

Named Insured And Additional Insureds

A mining operation must be clear about who is getting the insurance coverage it is procuring. Having the wrongly-named insureds listed or omitting necessary parties as named insureds or additional insureds can have severe consequences for coverage. For example, a policy insuring a hosting facility may not necessarily cover ASICs owned by third parties (or have limited coverage). Depending on a hosting facility’s agreements with miners, such coverage may be necessary and a loss may leave one or the other holding the bag. Either way, the hosting facility needs to know the extent of covered parties.

Mobile Mining Operations

Many mining operations are embracing agility and loading their ASICs into highly portable shipping containers and moving them to the cheapest sources of energy. Property policies often exclude coverage for personal property in transport or mobile equipment (or limit their coverage). If the policyholder did not disclose the mobile nature of the operation during the placement of the policy, they may be left without insurance in the event of loss or damage to the mobile units.

Property Damage

A Bitcoin mining operation contains a variety of valuable assets, many of which may be insurable under a property policy. And any loss at a mining facility can create complex valuation issues due to the variety of expensive property located at such a facility.

ASICs are expensive and fragile machines that are increasingly difficult to acquire due to high prices, chip shortages and other supply chain constraints. Bitcoin mining facilities can contain millions of dollars in hardware alone. Any loss of functionality or destruction of ASICs invariably cause losses to the Bitcoin mining operation. It is vital that the insured obtain appropriate insurance coverage to protect against the risk of damaging them.

Although it is clear that ASICs should be insured, it can be difficult to assess their value in the event of a loss. Property policies typically provide replacement cost coverage (cost to replace property) or actual cash value coverage (cost to restore the policyholder to their pre-loss position). Deciding which one is best is a complex decision for a Bitcoin miner. On one hand, ASICs may increase in value over time due to chip shortages and supply chain constraints. On the other hand, they may lose value over time due to advances in chip technology and overall ASIC design. Mining operations should also be cognizant of policy provisions limiting coverage for property of others, as third parties may be the owners of the ASICs. If not properly accounted for, an insurer could try to exclude losses or cap coverage for losses to third party miners the operation is hosting.

In addition to storing ASICs, a Bitcoin mining facility may keep wallets at the facility (whether this is advisable is an entirely different matter. OPSEC is outside the scope of this article). If a fire were to break out at a facility and destroy the wallets, the operation would lose access to all bitcoin for which those wallets controlled access. If the operation lacks redundancies (i.e., duplicates of the private keys or multisig wallets), there is no way to reacquire the keys and the bitcoin is gone. Unless a policyholder procures a bespoke policy covering loss of private keys, a traditional property insurance policy may not cover these kinds of losses without a specific endorsement.

One way to potentially mitigate some of these issues is to ensure the operation has adequate limits for its bitcoin and machinery. Another is to include an appraisal provision in a property policy tailored for a mining operation. These provisions allow people with expertise in Bitcoin and Bitcoin mining to attempt to value the losses without requiring the policyholder to commence litigation against the carrier. Ultimately, in order to make the claim process as smooth as possible, mining operations should keep detailed and accurate records of all of its property and the property in its custody so that it can provide a complete and thorough proof of loss to the insurer when it comes time to make a claim.

Business Interruption And Extra Expenses

Business interruption coverage covers the loss of income suffered by a business when damage to its premises by a covered cause of loss causes a slowdown or suspension of its operations. Extra expense coverage pays for additional costs in excess of normal operating expenses that an organization incurs to continue operations while its property is being repaired or replaced after having been damaged by a covered cause of loss. Any business interruption recovery might be offset by any reduction in operating costs or other income earned outside normal operations. For example, during the Great Texas Freeze in 2021, some bitcoin miners were able to power down their operations and could sell their excess electricity back to the grid or their neighborhoods for profit. Such income would potentially diminish or preclude any business interruption recovery.

Any downtime causes losses, but many business interruption and extra expense coverages contain “waiting periods,” i.e., the amount of time the operation needs to be suspended or hampered before it can claim losses recoverable under the policy. Such times can range from a few hours to a few days.

The structure of a mining operation can, once again, present unique insurance issues for business interruption coverage. If a mining operation merely acts as a host that rents out space for ASICs and derives its income from the services it provides to ASIC owners, the calculation of the hosting company’s business income may be more straightforward. However, if the miner-clients pay the hosting company out of the mining rewards the clients earn from their ASICs or if the hosting company is part of a mining pool, the mining facility’s loss calculation will increase in complexity.

A facility that owns its own ASICs (or operates a hybrid model) creates other complex issues. Insurers will contend that business income is speculative and challenge efforts to prove the likelihood of acquiring digital assets as rewards. Insurers may also point to the volatility of the assets, which can be even more volatile than other analogous assets. Agreeing to upfront bitcoin valuations may be the best way to avoid a headache, but could also cap upside gain if a loss occurs during a bull run. And, like any other business, mining operations will have to show past profits and losses to demonstrate their loss of income.

An example of Bitcoin mining losses that should be covered occurred during the 2021 Great Texas Freeze, when some mining facilities suffered extensive snow damage at their ASICs warehouses (see figure one).

Figure one. Source.

This type of loss would present the policyholder with both property loss and business interruption and extra expense loss. A property policy should reimburse the facilities for the costs to repair or replace the hardware, clean the facility and repair the building damage, as well as provide coverage for lost income and extra expense suffered while the business was recuperating. The amount of coverage provided for business interruption losses and extra expenses depends on how the facility operates and generates income, whether it incurs extra costs recovering, and whether it mitigates any of losses through other sources of income of non-continuing expenses. And, as always, any recovery is subject to a policy’s exclusions.

Contingent Business Interruption And Extra Expenses

Contingent business interruption insurance and contingent extra expense coverage is an extension to insurance that reimburses lost profits and extra expenses resulting from an interruption of business at the premises of a customer or supplier. A power outage at an internet service provider is one such event that a mining operation would want covered by its property policy. Contingent coverage may be triggered by an event at an internet service provider that affects the mining operation and ceases its ability to generate profits for a period of time.

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Recently, mining operations in Kazakhstan shut down when they lost connection to the internet due to the government’s decision to cut off access to the internet. The miner operations in Kazakhstan could not run at full capacity for several days and suffered slowdowns while attempting to restore their hash rates. Here, a contingent business interruption property insurance policy should have covered the income losses and extra expenses caused by the outages.

Exclusions And A Tight Insurance Market

As with any insurance policy, coverage is subject to the applicability of exclusions. Since most policyholders are not Bitcoin miners, many property policies contain exclusions for electronic data and/or bitcoin. Such exclusions may exclude Bitcoin mining operations losses in whole or in part, depending on the language of the exclusion. Further, standard property policies have language excluding losses resulting from the loss of keys, loss of bitcoin or other data-related losses. That said, Bitcoin mining insurance options are expanding.

Conclusion

In order for a Bitcoin mining operation to recover insurance proceeds under a property policy, it will have to navigate challenges presented by the structure and nature of its operation and the potential complexity of its losses, especially valuation. It is important for Bitcoin mining operations to have counsel on hand who understand their business with an expertise in the nitty-gritty of maximizing insurance recovery.

This is a guest post by Nick Pappas, Evan Zinaman and Ben Fliegel. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc or Bitcoin Magazine.

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