Cryptocurrency has become increasingly popular as a form of investment in recent years. More and more established financial institutions recognize cryptocurrency and allow its use. As cryptocurrency becomes mainstream, it’s important to consider estate planning implications for holding this digital asset.
As the world moves toward increased reliance on all things digital, it’s only natural that this has included digital currency, otherwise known as cryptocurrency (“crypto”). You can use crypto just like money, to buy goods and services, trade, or simply invest and collect. Many companies issue their own crypto, called tokens. Much like the tokens that you would receive at an arcade or casino, the tokens have no independent value until traded for actual currency. Although there are over 13,000 different publicly traded cryptocurrencies, Bitcoin remains the most well-known. Crypto bears a close resemblance to publicly traded stock: it has initial offerings called “initial coin offerings” and fluctuates based upon market indicators. Unlike the publicly traded stock on an exchange, crypto remains decentralized, meaning that there is no oversight or regulatory body governing this asset, although numerous exchanges exist for buying, trading, and selling crypto. Note that H.R. 3684 Infrastructure Investment and Jobs Act contains new reporting requirements for crypto brokers and includes as a broker anyone who, for consideration, makes a transfer of digital assets. Although not yet law, the bill has been presented to President Biden for signature. It remains to be seen how it will impact crypto; however, it’s clear that crypto warrants special consideration and presents unique issues for estate planning attorneys which will be explored in this article.
Crypto uses a decentralized technology called blockchain to manage and record transactions. Each block in the chain records information that cannot be changed. With every transaction that occurs, the chain adds another block to the individual investor’s ledger; however, the blockchain contains no personally-identifying information. Instead, the investor receives a seed phrase which is used to create a key. A series of letters and numbers comprise the key, known only to the owner. This allows the holder to access, transfer, and otherwise dispose of the crypto. This technology makes hacking or cheating the system difficult because each block contains numerous closed transactions and only the owner knows the key. Likewise, this makes the asset challenging for purposes of estate planning because crypto has no certificate of title, deed, or account statement that proves ownership. If the investor alone knows the key and becomes incapacitated, the crypto can be lost forever without a solid estate plan.
The investor stores the key in a wallet, but not the leather kind that holds your bank and credit cards. Crypto wallets come in two varieties, a hot wallet, or a cold wallet. Hot wallets include web-based wallets, mobile wallets, and desktop wallets that are connected to the internet and provide the fastest access to your crypto. While faster with easier to access your crypto, hot wallets are more vulnerable to online attacks. By contrast, cold wallets are offline storage devices like a USB drive, computer, telephone, or tablet not connected to the internet, making the cold wallet more secure. Investors trade easy access for increased security by using a cold wallet. A potential hacker needs physical possession of the cold wallet along with the key to access the crypto. Clearly, a mix of hot and cold wallets provides the greatest protection and ease of access for those wishing to maintain crypto themselves but also leaves the owner more vulnerable to loss of the crypto if the owner loses access to one of the parts and makes a transfer of the crypto upon the owner’s death more challenging.
Now that many of the major financial institutions allow crypto investments, investors who desire exposure to crypto, but prefer working with an established institution have options. Although most institutions do not allow for “spot” investing, they offer other solutions such as smart contracts, non-fungible tokens, stablecoins, trading shares in trusts holding large pools of crypto, and other innovations. These ever-expanding options make understanding and planning for digital assets even more important for a comprehensive estate plan. The Internal Revenue Service has long considered crypto an asset rather than the currency which means that the estate plan needs to consider tax implications, many of which are addressed in Notice 2014-21, 2014-16 I.R.B. 938. Planning for crypto, much like planning for any assets involves consideration of what occurs both during incapacity and at death. The constant evolution and volatile nature of crypto will require flexibility in planning.
To properly plan for crypto, someone other than the original investor needs to know that it exists, where to find it, and what to do with it. If someone happens upon the key but doesn’t know what it means, then it’s worthless. Perhaps letting the named fiduciary know where to find the key and how to access the crypto works for those with a modest amount of crypto. For those with significant amounts of crypto, perhaps that means sharing the seed phrase and private keys with a trusted family member or friend. If privacy concerns remain paramount, perhaps spreading the seed phrase and private keys among multiple individuals thereby preventing any one person from controlling the digital assets provides comfort. If none of the foregoing options works, then the investor could set up a dead man’s switch app that will trigger the transfer of the crypto if the investor fails to timely check-in. Regardless of the amount of crypto you have, working with an estate planning attorney to create a comprehensive estate plan that references the crypto and provides the fiduciary with the information and tools necessary to access the same has become necessary in this digital world.
Tereina Stidd, J.D., LL.M. (Tax)
Associate Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
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