In January 2009, Hal Finney received the very first crypto asset transaction from bitcoin’s mysterious creator, Satoshi Nakamoto. Finney was a master cryptographer and had been researching a way to create a new type of currency that was private and unbeholden to governments or institutions. A post on a cryptography mailing list about something called Bitcoin intrigued him. Bitcoin pioneered using cryptographic public keys and private key pairs as a way to create a digital currency. Using this method, Nakamoto sent ten bitcoins to Hal Finney as a test. Since then, cryptocurrency has exploded into a completely new type of asset class. Proponents believe that the decentralized finance model behind crypto assets will disrupt traditional finance.
There are many individuals and families who have invested in crypto. But as they prepare for the inevitable wealth transfer of trust and estate administration, it’s clear that the newness of this type of asset can create a host of horror stories. There are many potential issues with regards to crypto assets and estate planning, but the first area that should be of critical concern is how crypto assets are stored.
Normally, when a person wants to store their money, they’ll put it in their wallet or deposit it at a bank. Crypto assets are different. What’s stored in a wallet or crypto custodian is not actually the cryptocurrency (e.g. Bitcoin, Ethereum, etc.) or virtual asset (e.g.an NFT), but the public and private cryptographic key pairs required to send and receive the asset.
If a person is new to crypto and wants to buy a crypto asset, he must first create a wallet to generate a public/private key pair. The public keys are essentially like public addresses, almost like a Venmo username, that individuals can send assets to and can hold balances. Private keys, on the other hand, are like digital signatures used to sign transactions. A private key is required to digitally sign any valid transaction initiated by the owner, including buying, selling, or transferring the crypto asset.
In order to store a crypto asset, a person needs to create a new wallet which generates a public and private key pair. For a buy transaction, he’ll need to use his private key as a digital signature, and the crypto will be assigned to the wallet’s public key address.
This is why people worry about the security of crypto asset wallets. If a hacker gains access to the wallet, they gain access to the private key which will let them send the cryptocurrency anywhere.
When creating a crypto wallet, some people choose to create the wallet using software or apps. Some wallets can even be an extension to a computer web browser, like Google Chrome. These apps are connected to the Internet (hence the term “hot”) and allow the wallet owner to buy and sell crypto assets. Because these apps are created through software or app, there is no identifiable personal information associated with the hot wallet. What is associated with the wallet is a 12-word key phrase that is generated during the initial creation of the wallet. This key phrase can be used to recover the wallet in case a phone or computer gets wiped.
As crypto assets have risen in value, hot wallets have become more susceptible to hackers. As a result, after a wallet has been created, some people store the private and public key information in a format that is not connected to the internet. This applies especially to investors who like taking a buy and hold strategy, affectionately known as HODL (hold on for dear life) within the crypto community.
Sometimes what’s stored in the cold wallet is the private key itself, other times it’s the recovery key phrase for a specific wallet. In reality, a cold wallet can be almost anything as long as it can be used to store a string of letters and numbers. It might be a slip of paper, a hard drive, or a USB drive. There are crypto investors who even print their key information on a steel plate in order to protect against a fire or flood.
For some people, the process and technology behind all of this is a bit complicated. Crypto custodians were created to make it easier to transact with crypto assets without having to deal with some of crypto’s technology hurdles. This has helped make crypto assets more mainstream at the expense of privacy. This is because crypto custodians, in order to exist, are required to follow know your customer (KYC) rules created by the Department of Treasury. As a result, these institutions may provide 1099 tax documents or transaction statements.
Trustees and estate executors are used to providing institutions and banks their papers or letters from the court showing their legal right to act. Crypto assets, however, are built upon a decentralized structure; in many cases these papers or letters are worthless because the cryptocurrency key information is not held with a specific custodian but in a hot or cold wallet. Even when the assets are located at a custodian, not all custodians have straightforward decedent processes in place. The asset class is so new that many are still figuring things out.
For estate and trust administrators who will be handling a family’s assets, this can make locating and marshaling crypto assets difficult, even if the assets have been previously identified in a will or trust. It’s easy to create a new hot wallet that has no traceable account information, and there are no statements or tax forms for that wallet to provide a clue as to the location of the crypto assets.
For trustees or estate administrators that are trying to locate assets, it’s important to be familiar with the different types of hot wallets and custodians out there. Know the app icons and names of hot wallets that could be stored on your client’s phone, like Trust Wallet, Defi Wallet, and Metamask. Research who the custodians are – like Coinbase, Crypto.com, Binanace – and determine their decedent processes.
Because these institutions are not brick and mortar, they will not have the same level of customer service of a bank or financial advisor. In many cases, you, as the trustee, might be on your own in locating assets and determining value. Because of a lack of institutional control, trustees also need to be aware of the potential liabilities involved with administering these assets.
There are some custodians arriving on the scene that can provide a level of protection, but most of these custodians will only work once the value of the account is significant.
Whether the beneficiary has already invested in Bitcoin or may be looking to diversify their dollars in this new asset class, it’s ultra important to have full transparency into their crypto assets. Here are a few examples of conversation starters and topics to consider working into your estate planning dialogue.
The decentralized finance platform may have its advantages with privacy and ownership control, but it does not displace the importance of trustees, administrators, and executors who will be involved with the wealth transition of an estate’s crypto assets. Attorneys, successor trustees and families need to work together to make sure these assets are properly cataloged and documented before it’s too late.
With the newness of cryptocurrency and lack of regard for estate administration, it’s not unusual to have questions. Prudent Investors is experienced in the nuances of crypto assets and recently spoke at the Professional Fiduciaries Association of California (PFAC) conference on the trustee and administrator’s role in locating, marshaling, administering, and investing crypto assets. If you are a trustee or estate executor with questions about your client or family member’s crypto assets, we invite you to connect with our team.
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