Let's Talk Cryptocurrencies and "Digital Assets": A Primer for Trust and Estate Lawyers
- By now, nearly everyone knows that cryptocurrency is digital money and cryptocurrency transactions are recorded in secure digital ledgers known as blockchains. But that doesn't even scratch the surface of this robust technology.
- Most cryptocurrencies have their own whitepapers, stories and lingo. That means, on top of being a disruptive technology, the crypto ecosystem presents a learning curve to even the most willing and engaged investors.
- Digital assets will soon become a common part of the client's portfolio. As a result, trust and estate lawyers must become at least generally familiar with the various types of digital assets in order to competently advise their clients.
By now, nearly everyone knows that cryptocurrency is digital money and cryptocurrency transactions are recorded in secure digital ledgers known as blockchains. But that doesn't even scratch the surface of this robust technology.
Since the bitcoin network came into existence in 2008, thousands of new digital assets have emerged. These include coins, tokens, tethered currency, non-fungible tokens (NFTs), as well as other cryptography-based mediums of currency. Most cryptocurrencies have their own whitepapers, stories and lingo. That means, on top of being a disruptive technology, the crypto ecosystem presents a learning curve to even the most willing and engaged investors. Typically, at an initial coin offering (ICO), the whitepaper is released by the developer for the purpose of providing technical information on the technology, purpose and marketplace considerations. The whitepapers contain the details that distinguish one crypto-project from another and define how each new digital asset is designed to solve a problem and/or fit into the marketplace.
Of course, just as you don't need a degree in finance to bank, you don't need to read the whitepapers to invest in digital assets. Digital asset owners range from tech-savvy miners to everyday investor.
Defining "Digital Assets": Executive Order on Ensuring Responsible Development of Digital Assets
On March 9, 2022, President Joe Biden issued his Executive Order on Ensuring Responsible Development of Digital Assets (the Order). It sets policy for advancing digital blockchain technology for financial services. The Order states: "The United States has an interest in responsible financial innovation, expanding access to safe and affordable financial service and reducing the cost of domestic and cross-border funds transfers and payments, including through the continued modernization of public payment systems." The Order includes useful definitions that will be applicable to trust and estate practitioners.
As set forth in the Order, the term "digital assets" is the umbrella term that refers to all cryptography-based assets – regardless of the technology used – that are issued in digital form through the use of blockchain technology.1 For example, digital assets include cryptocurrencies, stablecoins and CBDCs. What are those? The Order defines each of them.
- The term "cryptocurrencies" refers to a type of digital asset, which may be a medium of exchange, for which ownership is recorded with a blockchain or similar distributed ledger technology that relies on cryptography.2
- The term "stablecoins" refers to a category of cryptocurrencies with mechanisms aimed at maintaining a stable value.3 Stabilized value is accomplished, for example, by pegging the value of a coin to a specific currency/asset or by algorithmically controlling supply in response to changes in demand. Stablecoins are sometimes referred to as being tethered to a conventional fiat currency (i.e., the U.S. dollar) or other stablizing asset.
- The term "central bank digital currency" (CBDC) refers to the official digital money of a nation that is a direct liability of that nation's central bank.4
The Order directs multiple U.S. departments and agencies to act with the "highest urgency" to collaboratively conduct research and development on design and deployment options for a United States CBDC.5 The first round of reports are due to President Biden on Sept. 5, 2022, with further research and development efforts continuing for many months thereafter.6 By all accounts, the Order is a bold indication that the U.S. recognizes that blockchain technology, cryptocurrency and all digital assets are here to stay in both domestic and global financial systems.
Understanding Ownership of Digital Assets
At the inception of cryptocurrency, direct token ownership (i.e., via private key) and mining (i.e., participating in peer-to-peer validation of blockchain transactions in exchange for tokens) were the most common ways to own digital assets. However, these are no longer the primary means of acquiring digital assets. Now, anyone with access to a computer or smartphone can download a wallet and invest in digital assets. That means that trust and estate lawyers need to take conscious steps to confirm whether an individual owns any digital assets and to plan accordingly.
Traditional means of investing are also available for cryptocurrencies and becoming more widely available, including for retirement plans. All varieties of coins, tokens, tethered currency, NFTs and other digital assets are becoming more well-known, backed and regulated. While some are still highly volatile and represent a risky investment, others are almost colloquial and an accepted assets class among investors.
For these reasons, digital assets will soon become a common part of the client's portfolio. As a result, trust and estate lawyers must become at least generally familiar with these types of digital assets in order to competently advise their clients.
Understanding the Transfer of Digital Assets
The primary function of cryptography is security and is the backbone of blockchain. Transfer of encrypted assets, such as cryptocurrencies, without the owner's consent, is well obstructed. The robustness of blockchain security is memorialized in the phase "Not your keys, not your coins." In fact, blockchain is considered such a robust security technology that it is beginning to be utilized in many industries outside of finance.
Because of its highly secure nature, transfer of digital assets to heirs after the owner's death can be extremely complicated, if not well-planned for in advance. For example, identifying digital assets on an assets schedule attached to an estate plan can be insufficient, without more. While identification is a start, actual transfer of digital assets at death requires logistical considerations of cryptography and the owner's particular holding solution.
Different digital assets have different wallet solutions. If you hold digital assets and your estate planner does not know the difference between cold, warm and hot wallets, the likelihood of a successful transfer of these types of assets to your heirs is not very good. Stories about millions of dollars in lost or inaccessible cryptocurrency are now commonplace, often involving private keys held in cold wallets, without a backup plan or transfer of knowledge at the owner's death. While cold wallets represent excellent security during life, they also represent difficulty at death and require particularized planning.
Estate Planning for Digital Assets
Creative transfer solutions exist and may, in some cases, be required. Digital assets can be administered through a trust or estate if it is done in a manner that ensures that the private keys can be securely accessed at the right time by the right person. Unlike transfers from traditional bank accounts, where financial institutions are insured and provide additional oversight, a mistaken or unauthorized transfer of digital assets is nearly impossible to recover.
A sophisticated estate planner can ensure that a trust expressly empowers your trustee to access, retain and manage digital assets however they are held. Each is a separate power that needs to be expressly given to the trustee and some jurisdictions are more crypto-friendly than others. A savvy estate planner can advise on options such as cold storage, key custodians, special trustees and appropriate situs.
In addition, it is worth considering that not all "traditional" trustees, such as trust companies and private professional fiduciaries, will be willing to serve as trustee for digital assets, whether it be because of an unfamiliarity with the technology, or because of the volatility of the asset class. As such, special consideration needs to be paid to trustee selection, including confirming that the selected institution has the expertise and willingness to administer digital assets.
Hot wallets (also known as crypto exchanges) have different rules and regulations are in the infancy stages. Some exchanges allow trusts to own assets and some do not. Depending on the particular digital asset at issue, the owner may not be able to fund it into a trust by traditional means. In addition, for some of these digital assets, the asset class is so new that no consideration has been given to post-death transfer. As a result, determining the particular asset transfer process can be cumbersome. But, failing to plan for transfer to heirs can easily result in loss of wealth that would have otherwise passed on to beneficiaries.
While crypto communities bring some flair to finance, the endeavor is to build real, solid and secure financial tools. Ownership of complex assets calls for sophisticated and knowledgeable planning.
For more information on handling digital assists within your trusts, estates and portfolio, contact the author or another member of Holland & Knight's Private Wealth Services Digital Assets Team.
1 Executive Order, Sec. 9 (d)
2 Executive Order, Sec. 9 (c)
3 Executive Order, Sec. 9 (e)
4 Executive Order, Sec. 9 (b)
5 Executive Order, Sec. 4 (a) (i)
6 Executive Order, Sec. 4 (b) and (d), Sec. 5 (b), Sec. 6-7.
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.