Cryptocurrency or Kryptonite? Analyzing a Cryptocurrency Claim Under a Standard Homeowners Policy
All comic book fans know that Kryptonite is the one weakness of the otherwise indestructible Superman. What they may not know, however, is that Kryptonite (KRYP) is also a form of virtual currency in the marketplace today. While not as widely recognized as the DC Comics version of Kryptonite, it is one of a growing list of cryptocurrencies, including Bitcoin, Litecoin, Ethereum and Ripple—just to name a few.
Now, some of you may gloss over this article and think you may never have to deal with cryptocurrency issues. I wish I could assure you that will be the case, but the fact remains that it’s 2020, and in the next decade cryptocurrency may just turn out to be your Kryptonite!
Merriam-Webster’s dictionary defines cryptocurrency as “any form of currency that only exists digitally, that usually has no central issuing or regulating authority but instead uses a decentralized system to record transactions and manage the issuance of new units, and that relies on cryptography to prevent counterfeiting and fraudulent transactions.” There is a lot more detail that goes into the explanation of how cryptocurrency operates, but, for purposes of this article, you need only a basic understanding to flag the issues that may arise with cryptocurrency claims under a standard homeowners policy.
I was recently involved in a coverage investigation where the insured claimed he suffered a cryptocurrency loss after a lightning strike. The insured’s computer system, including his backup hard drive, was fried as a result of the strike. He claimed that several hundred thousands of dollars of cryptocurrency vanished as a result. While the investigation of such a claim can generate a whole host of issues (establishing a loss, attempting to recover the claimed damages, retaining cryptocurrency experts, etc.), from a pure coverage perspective, my initial instinct was that the loss was subject to the currency sublimit in the policy. Surprisingly, I found precedent that disagreed with me.
In Kimmelman v. Wayne Ins. Grp., No. 18 CV 1041, (Ct. of Common Pleas, Franklin Cty. September 25, 2018), the court addressed whether Bitcoin was subject to the currency sublimit found under a traditional homeowners policy. In Kimmelman, the insured submitted a claim to Wayne Insurance Group, reporting stolen Bitcoin in the amount of $16,000. Wayne Insurance accepted the claim and paid the insured $200 because they determined the property was “money” and governed by the policy sublimit. The plaintiff sued Wayne Insurance for breach of contract and bad faith. Wayne moved for judgment on the pleadings, arguing that Bitcoin is widely recognized as money, citing articles from CNN, CNET and The New York Times in support of this position.
However, the only legal reference Wayne cited to was a document released by the IRS that describes Bitcoin and other electronic property as “virtual currency.” The plaintiff provided citations to federal courts in other jurisdictions, but the court found none of these arguments governed the issue. Rather, the court relied on the only authority presented before it, IRS Notice 2014-21, which states, “[f]or federal tax purposes, virtual currency is treated as property.” Accordingly, the court held that Bitcoin, because it is defined as virtual currency, is recognized as property by the IRS and, therefore, not subject to the monetary sublimit(!). All of a sudden, there was a homeowners policy—with no premium for such loss—providing coverage for losses involving virtual currency.
Interestingly, there may be grounds to disclaim coverage under a sublimit for securities. There is much debate about whether certain forms of cryptocurrency can be classified as a security—it all depends on the characteristics and use of the particular asset. U.S. Securities and Exchange Commission Chairman Jay Clayton has said that certain types of cryptocurrency, like Bitcoin, are not a security. (https://www.cnbc.com/amp/2018/06/06/sec-chairman-clayton-says-agency-wont-change-definition-of-a-security.html However, other virtual currencies, such as a “security token,” may be treated as a security. The distinction lies in the fact that a “security token” is a digital asset whereas money is exchanged for providing a return. (Determining whether an asset is a “security token” is another article for another day.) The longstanding rule to determine if an asset is a security is defined by the “Howey Test,” which classifies a security as an investment of money in a common enterprise, in which the investor expects profits from others’ efforts. SEC v. W. J. Howey Co., 328 U.S. 293 (1946).
So what is a cryptocurrency? Is it money, property or a security? While the answers to these questions remain to be seen, much will depend on the policy language and virtual currency at issue. There has been no other case law in this unique context to shed light on how courts might address such claims. For now, I would argue that the case law remains unsettled, but the IRS definition remains unchanged. As more and more Americans are investing in cryptocurrency, carriers must evolve and be prepared with potential defenses to such claims.
*Jennie is a shareholder in our Philadelphia, Pennsylvania office. She can reached at 215.575.2781 or email@example.com.
Defense Digest, Vol. 26, No. 1, Spring 2020 is prepared by Marshall Dennehey Warner Coleman & Goggin to provide information on recent legal developments of interest to our readers. This publication is not intended to provide legal advice for a specific situation or to create an attorney-client relationship. ATTORNEY ADVERTISING pursuant to New York RPC 7.1. © 2020 Marshall Dennehey Warner Coleman & Goggin. All Rights Reserved. This article may not be reprinted without the express written permission of our firm. For reprints, contact firstname.lastname@example.org.