with co-author Brendan Hogan Blockchain, or distributed ledger technology (DLT), is widely heralded as the next cornerstone technological advancement of the digital age. Financial institutions are partnering with technology companies and startups to explore potential applications of this technology in all aspects of their business. The rush to implement DLT in the financial services sector is in full swing and institutions have been testing applications of DLT in equity swaps processing, the syndicated loans market, payment messaging, regulatory reporting, contracts and transaction management. Early adopters of this technology hope to achieve a competitive advantage by efficiently managing data, quickly processing transactions and increasing overall transaction security. As with any new technology, DLT applications create new and different risks, particularly in the earliest stages of development and application. Despite the increased security touted by innovators and early adopters, once any system accumulates enough value, hackers will find new ways to exploit vulnerabilities in that system – and DLT is no different. In addition to the specter of black-hat actors and insider threats, DLT adoption, by an institution or its third-party vendors, potentially exposes institutions to new regulatory compliance risks. Finally, though DLT itself is autonomous in many ways, the intersection of DLT, customers and business operations creates opportunities for human error. These risks pose potential liabilities that can and must be managed by effective compliance and security programs. Even the most robust systems, however, fail some percentage of the time, and in these instances, it is imperative that the proper insurance policies are already be in place to mitigate the impact of the resulting liabilities. Due to the potentially transformative implications of DLT, multiple types of insurance coverage could be implicated by a DLT-based liability. While there may be the availability of coverage, because these policies were likely procured prior to the adoption of DLT, there are likely gaps in an institution’s current coverage or situations where common definitions are ambiguous when applied in the context of DLT. Commercial computer crime policies for financial institutions generally provide coverage for losses due to computer fraud causing “property” to be transferred, paid or delivered. “Property” is defined to include certificated and uncertificated securities, money, electronic data, computer programs and items of tangible property. Even though this coverage grant appears to cover losses related to fraudulent modifications to a DLT system, consider a situation where an unauthorized person gains access to the ledger of equity swaps. Instead of transferring assets for his own benefit, however, the unauthorized user modifies the ledger to make future transactions of his appear legitimate, causing the institution to make payments it would not otherwise have made. In this situation, the subsequent payments might be excluded if the policy in question contains an “indirect or consequential damages” exclusion, which excludes losses that are proximately but not directly caused by a covered event. In this context, the institution might not be covered for the improper payments it erroneously approved based on the modified ledger, because the approval of subsequent payments was not itself fraudulent, but rather the approval was indirectly caused by a fraudulent transaction. Business interruption coverage forms generally only provide coverage for suspension of operations caused by a direct physical loss and often contain clauses limiting coverage for electronic data or computer operations. Even in cases where such losses are covered, the covered loss may be limited to reconstructing the lost electronic data and specifically exclude profits or income that would otherwise have been generated during the suspension period. Furthermore, unless specifically purchased, cyber liability and computer crime policies often provide very limited or no coverage for first-party liabilities, potentially leaving losses caused by a suspension of operations for a DLT system uncovered if the cause of the suspension is anything other than a “direct physical loss.” While this potential gap in coverage exists with other forms of electronic data, the widespread adoption of DLT only serves to further highlight the need to review applicable business interruption coverage. Professional services coverage, which traditionally provides for negligence or mistakes in the performance of services in exchange for a fee, often contains limiting definitions and exclusions that could bar coverage for a loss related to a mistake in the development or implementation of a DLT system. Directors and officers policies traditionally provide coverage for the company, board members and executives for claims relating to regulatory and governmental investigations and actions. These types of policies, however, often contain exclusions for professional services that may apply to activities related to the development or implementation of DLT. For example, if a financial institution developed an in-house DLT system for brokerage transactions that was subsequently compromised, leading to a government enforcement action, that action might not be covered if the policy in question contained a professional services exclusion.
Indirect damages , such as those caused by fraudulent manipulation of digital ledger systems , such as blockchain , by an external individual , may not be covered by commercial computer crime coverage for erroneously approved fraudulent payments . If any damages are sustained that are not a “ direct physical loss ” , business interruption , cyber liability and computer crime coverage may not cover any data loss . Should a mistake occur in a setup , professional services policies may not cover any loss , and claims stemming from regulatory investigation or action will not be covered by typical director and officers policies .