Digital property is, well, not “physical” in the tangible sense. Though it is physical in that it is real and has real value, it cannot be held in your hand. As a result, some courts have elected to rigidly apply vintage caselaw about property insurance to conclude that digital property is not covered, simply because it does not have a corporeal form. Doing so fails to recognize that this caselaw was decided before property could be nonphysical.

Insurance coverage for losses related to nontraditional forms of property, such as cryptocurrency, is a developing area. Courts are determining how to apply existing caselaw to losses involving cryptocurrency.

While there is no conceptual distinction between cryptocurrency and other forms of insured property—such as gold coins or computer systems—courts have struggled to interpret standard form language in the relatively new context of nonphysical property. As detailed below, courts have reached conclusions that defy logic, as well the policyholder’s reasonable expectations, when rigidly applying case law to newer forms of property.

Property insurance arose out of the Great Fire of London, which destroyed thousands of houses and stripped their owners of nearly everything. It was designed to protect the assets of the average citizen from what was then the greatest risk to fiscal stability: fire. Around the same time, maritime property insurance was developed to protect sailors and merchants from financial ruination should their ships be lost to pirates, weather, or the Bermuda Triangle. As risks have evolved, so too has property insurance. Yet its core promise remains the same: property insurance shields the policyholder from financial harm from accidental losses to their property caused by covered risks.

Most standard form property policies used today were written decades ago, far before digital property became prevalent. To trigger coverage, most policies require that there be “physical loss” or “physical damage.” The use of the qualifier “physical” in the phrase was meant to exclude circumstances where property diminished in value but was not physically damaged or lost, such as stocks plummeting after a market crash.

In recent years, however, an increasing amount of property—for example, cryptocurrency, nonfungible tokens, central bank digital currencies and security tokens—is held digitally. Like traditional forms of property, digital assets risk accidental loss by various perils, threatening the policyholder with financial harm. The only thing that has changed is the medium in which the property is maintained. Since the type of property is traditionally covered by property insurance, it follows that most policyholders reasonably expect the property to be covered under their property policy.

But there can be a slight problem. Digital property is, well, not “physical” in the tangible sense. Though it is physical in that it is real and has real value, it cannot be held in your hand. As a result, some courts have elected to rigidly apply vintage caselaw about property insurance to conclude that digital property is not covered, simply because it does not have a corporeal form. Doing so fails to recognize that this caselaw was decided before property could be nonphysical. It also contradicts the purpose of property insurance and contravenes the policyholder’s reasonable expectations that their property will be covered regardless of its medium of existence.

The U.S. Court of Appeals for the Fourth Circuit had the chance to recognize the evolving nature of property in a recent case concerning insurance coverage for losses caused by a theft of digital property—there, cryptocurrency—under a homeowners’ insurance policy. See Sedaghatpour v. Lemonade Insurance, No. 23-1237, 2024 WL 4563855 (4th Cir. Oct. 24, 2024). The plaintiff, Ali Sedaghatpour, owned nearly $170,000 in cryptocurrency in a hot wallet before it was allegedly stolen by the company whose servers stored that wallet (APYHarvest). When he discovered the theft, Sedaghatpour filed a claim under his homeowners’ insurance policy, which was issued by Lemonade (a recently founded, AI-powered insurance company). Like many other property policies, the homeowners’ policy required that there be “direct physical loss” to the insured’s personal property “caused by,” among other things, “theft.” Lemonade declined Sedaghatpour’s claim and he sued, arguing that the theft was covered.

The U.S. District Court for the Eastern District of Virginia sided with Lemonade on the grounds that the theft of cryptocurrency was not a “direct physical loss” because cryptocurrency “exists only virtually.” See Sedaghatpour v. Lemonade Insurance, 654 F. Supp. 3d 525, 526 (noting that storage of cryptocurrency on a hot wallet is virtual only), 528, 530 (E.D. Va. 2023). The court followed Burt v. Travelers Commercial Insurance, 621 F. Supp. 3d 1049, 1052 (N.D. Cal. 2022), which held that theft of cryptocurrency was not a “direct physical loss” because cryptocurrency does not have a “material existence, formed out of tangible matter, [nor] is [it] perceptible to the sense of touch.” The court rejected NMS Services v. Hartford, 62 F. App’x 511 (4th Cir. 2003), where a hacker had deleted files necessary for the insured’s computer network to operate—which damaged the physical computer system—because the theft of cryptocurrency did not damage physical property.

The Eastern District of Virginia also rejected Sedaghatpour’s argument the phrase “direct physical loss” was ambiguous—meaning it could be understood in more than one way—and should be construed against Lemonade. According to the court, “there was only one way to understand how the ‘direct physical loss’ language” would apply to cryptocurrency because “cryptocurrency does not exist tangibly, but rather exists only virtually.” The court did not discuss the dictionary definition of “physical” or other potential meanings of the word.

On appeal, the Fourth Circuit upheld the Eastern District’s decision, but without blessing its reasoning. See Sedaghatpour, 2024 WL 4563855 at *1 (assuming trial court was incorrect). Rather than recognizing that requiring “direct physical loss” was a relic of an earlier era and not meant to preclude coverage for theft of personal property that happened to be digital, the Fourth Circuit applied the same standards applicable to traditional forms of property and found there had been no “direct physical loss” caused by the theft of cryptocurrency, citing Elegant Massage v. State Farm Auto Insurance, 95 F. 4th 181, 190 (4th Cir. 2024) (holding that “direct physical loss” required “present or impending material destruction or material harm”, i.e., that the property be “physically altered”). The Fourth Circuit did not explain its analysis beyond citing to Elegant Massage.

The lack of detailed analysis prevents policyholders and insurers from determining whether the Fourth Circuit considered all of the reasons that a more nuanced approach may have been appropriate. The citation to Elegant Massage provides a clue. In Elegant Massage, the Fourth Circuit considered whether a massage parlor that suspended its business during COVID-19 had done so because of “accidental direct physical loss.” There had been no harm to the business premises or damage to the property there. The Fourth Circuit concluded that “accidental direct physical loss” required that property be at risk of “present or impending material destruction or material harm” or otherwise be “physically altered” and that neither had occurred, thus there was no coverage. But Elegant Massage is materially different from Sedaghatpour. In Elegant Massage, no property had been lost or harmed by the COVID-19 virus, but in Sedaghatpour property was stolen—which is plainly a loss of property.

As noted at the beginning of this article, Sedaghatpour does not reflect the contemporary policyholder’s expectations of coverage. For now, though, decisions involving newer forms of property will likely continue to rely on dated cases involving “traditional” property. When litigating insurance coverage for contemporary forms of property, policyholders should be prepared to explain not only how the property at issue functions, but also how it is similar to and different from more familiar types of property. And investors with significant digital asset holdings should review their insurance policies to determine whether any potential theft or other loss would be covered, as any policy requiring “direct physical loss” may not provide coverage.