Despite Bitcoin prices plummeting in 2018, ever higher numbers of individuals are investing in cryptocurrencies. There are now over 2,000 cryptocurrencies listed on the various cryptocurrency exchanges, such as Litecoin, Gemini Dollar, Tron, VeChain and Ethereum. However, there is still a dearth of guidance for clients and their advisers on how to hold and manage investments in cryptocurrencies and, significantly, how to incorporate them into their estate planning.
Legal status of cryptocurrency
The legal status of cryptocurrency and the extent to which you can ‘own’ an intangible digital asset is still relatively uncharted ground. Cryptocurrency is made up of a bundle of rights, but which, if any, are classified as ‘property’ and capable of ownership? According to most analyses, an intangible digital asset is mere ‘information’. Conversely, the IRS in the United States has confirmed cryptocurrencies are treated as ‘property’. In the UK, guidance published by HMRC on 19 December 2018 confirmed HMRC’s position that crypto assets are treated as ‘property’ for inheritance tax purposes.
To the extent Bitcoin is property and can be owned, traded, gifted and inherited, where is the asset located and which laws govern its succession? This can give rise to complex jurisdictional questions and disproportionately expensive advice for clients. Despite a multitude of unanswered questions, clients and their advisers need to understand the nature of crypto assets to come up with practical solutions to ensure the management, control and succession of cryptocurrencies in this digital age.
From blockchain to Bitcoin
Digital currency such as Bitcoin enables almost instantaneous transactions and borderless transfer of ownership using blockchain technology. An ever-growing list of records (called ‘blocks’) are linked and secured by way of a distributed ledger. Data is recorded, shared and transferred via multiple electronic ledgers, all cryptographically secure, non-modifiable, and all maintained independently. The data records are highly secure, although the threat of hackers cannot be underestimated. Most ledgers are public and transparent.
This contrasts with a traditional centralised ledger maintained by a centralised agency (the most obvious example being a bank) which records and regulates all financial transactions relatively privately. Unlike with blockchain, if something goes wrong you would have a claim against the central issuer.
What’s in your cryptowallet?
A secure virtual ‘wallet’ is required to store, send and receive cryptocurrency. Unlike traditional money, the cryptocurrency itself is not technically held in the wallet (it is stored and maintained in a ledger in the blockchain). The wallet holds the private ‘keys’ which the individual needs to access and spend their cryptocurrency. As with selecting a bank, the user needs to ensure their chosen wallet is secure enough to keep their cryptocurrency safe.
However, if someone loses their private key or dies unexpectedly, unlike in systems with a central authority, there is no mechanism to restore the private key and access the funds as arguably such a mechanism would undermine the security of cryptocurrencies.
So how can you pass your private key to your heirs? Without the key, a deceased person’s cryptocurrency will be lost forever. There are numerous examples of crypto pioneers who amassed a considerable fortune in Bitcoin, but who have either lost their private key or died unexpectedly leaving frustrated and bereft family members unable to access their inheritance stuck in the blockchain.
Different types of wallet
There is no consensus on the most secure type of virtual wallet:
Some users prefer ‘hot’ storage, where your private key is kept online. This allows for quick access to your cryptocurrency but opens up increased risk of hacking and theft.
Alternatively, you can have a ‘cold’ wallet (i.e. not connected to the internet) where your private key is stored in a USB, offline computer or even on a piece of paper.
A few banks offer the opportunity to invest in cryptocurrencies and can store wallets on behalf of clients. These are stored online so the risk of hacking cannot be completely excluded. However, the client may have a remedy against the bank if that happens.
A custodial or ‘hosted’ wallet, managed by a third-party service, can hold the private key for you. Crypto exchanges usually offer wallet services through a cloud account, such as CoinBase or Binance.
However, no option is free of risk. About $190 million in cryptocurrency has recently been lost following the death of the founder of QuadrigaCX, one of the largest cryptocurrency exchanges, who died unexpectedly without leaving any instructions to access the funds on the exchange, leaving its customers with no way to access their cryptocurrency held in QuadrigaCX’s cold storage facility.
If someone dies or loses mental capacity and has left instructions on how to access to their computer and their (hot or cold) wallet, their personal representative or attorney (acting under a Lasting Power of Attorney) would be able to log in and deal with the cryptocurrency after their death.
If someone dies or loses mental capacity without leaving instructions on how to access their virtual wallet, there is very little which can currently be done to retrieve their crypto assets. However, in Part 2 of ‘Bitcoin After Death’ we will be discussing some digital estate planning tips for practitioners and their clients to help ensure that valuable crypto assets are not lost after death.
If you enjoyed reading this, do take a look at these articles also published this month:
Taming the wild west: the future of crypto-asset regulation
Cryptoassets and tax: an alternative view?
If you require further information about anything covered in this briefing note, please contact Caroline Vollers, or your usual contact at the firm on +44 (0)20 3375 7000.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, February 2019