California Holds Stolen Cryptocurrency Does Not Qualify as “Physical” Loss Under Homeowners’ Policy
From IRS rulings that “virtual currency” is taxed as “property” to an SEC lawsuit claiming that digital assets are “securities” under federal law, meteoric growth of the largely unregulated crypto industry has raised numerous questions about whether crypto-related risks are covered by insurance. In the latest example of the intersection of crypto and insurance, a California federal court recently held that cryptocurrency stolen from a Coinbase account did not constitute a covered loss under a homeowner’s insurance policy. The fundamental issue was whether the stolen crypto met the policy’s requirement for “direct physical loss to property” and, more specifically, whether the losses were “physical” in nature. The court ruled against coverage, reasoning that lost control of cryptocurrency is not a direct physical loss as a matter of California law.
The dispute arose when two siblings inherited various cryptocurrency (i.e., Bitcoin, Ethereum, Chainlink and Yearn Finance) that was held in a Coinbase account. Hackers took over the account and transferred the cryptocurrency into the criminals’ own electronic “wallet.” The siblings submitted a claim for the theft under their homeowners’ insurance policy, and after being denied coverage, brought suit for declaratory relief, breach of contract, breach of the implied covenant of good faith and fair dealing, and violations of California Unfair Competition Law.
At issue was the policy’s insuring agreement covering personal property, which required (1) “direct physical loss to,” (2) “personal property.” Specifically, the court analogized the stolen crypto to prior cases considering “data lost from a database crash,” concluding that cryptocurrency cannot constitute a direct physical loss because cryptocurrency does not have “a material existence, formed out of tangible matter, and is perceptible to the sense of touch.” The plaintiffs cited other court decisions holding that cryptocurrency is considered “property.” But the court found none of those cases to be “on point” because they did not address cryptocurrency in the context of “direct physical loss” under California law.
If this analysis sounds familiar, it’s because it has been at the heart of many disputes over whether the COVID-19 virus is covered under businesses’ commercial property or all-risk insurance policies, which typically require physical loss of or damage to property. If cryptocurrency truly is intangible, however, then decisions like this underscore why loss caused by the presence of a virus should be covered—a virus is tangible, has a physical presence, and has material existence on property and in the air.
In any event, the decision has other ramifications for businesses that hold cryptocurrency and expect to look to insurance as a way to protect their investment. The rise and interest in cryptocurrency makes crypto’s treatment in the insurance context increasingly relevant. This decision underscores the need to ensure the right insurance is in place to protect such a loss.
For example, there are commercial crime, cyber, and directors and officers (D&O) insurance policies that may respond to crypto-related losses. Endorsements can also be added to certain policies that are specific to cryptocurrency. Coverage under these types of policies will be fact-specific, such as whether the cryptocurrency has simply been stolen, whether a ransom demand has been made where a business is being extorted, or whether there is a lawsuit being instituted against an officer of the company which holds the cryptocurrency.
Additionally, though this California decision may be a sign against coverage under a homeowners’ policy for cryptocurrency stored electronically in a Coinbase account, there is an open question as to what a court might decide if the cryptocurrency is maintained in “cold” storage—where it is not stored online, but instead offline in a hard storage medium (i.e., in a hardware wallet), such as a flash drive. In this circumstance, the cryptocurrency is maintained in a hard format that is susceptible to physical loss or damage.
Given that cryptocurrency is still a relatively new method of monetary payment, the law will continue to be developed in this arena as new issues come up. It is vital for policyholders to consider how cryptocurrency is characterized moving forward may impact coverage under different policies, and the use of experienced coverage counsel can help lead the way and advise on potentially applicable coverage.
The full opinion in Burt v. Travelers Com. Insurance Co., No. 22-CV-03157-JSC, 2022 WL 3445941 (N.D. Cal. Aug. 16, 2022), can be found here.