The rise of the crypto-asset: practical advice for trustees
By David Cooney (pictured), Group Partner, Collas Crill – There are thousands of crypto-assets (or cryptocurrencies, as they are also known) in existence, the most established being bitcoin. There is no single definition of crypto-assets, but it can be broadly defined as a digital ticket which exists on a virtual ledger with decentralised control. Most forms of cryptocurrency use a private-public key. The public key is used to send cryptocurrency and the private key is used to access those funds.
Many remain sceptical of cryptocurrencies, and their long-term future, but they have been increasingly adopted by the mainstream over the past couple of years and it seems increasingly likely that they are here to stay. Cryptocurrencies, along with a variety of other digital assets, are already part of the estates of many of the world’s wealthiest families, and that trend is likely to increase. Many of those families will seek advice on the ownership and control of their crypto-assets from their professional advisors.
Some jurisdictions have embraced, or at least accepted, cryptocurrencies. The English High Court held that bitcoin was property in December 2019 and the Swiss Canton of Zug has accepted payment in bitcoin for any outstanding tax bills, since February 2021. Not all jurisdictions have not been so open to cryptocurrencies. This year, the Indian government is considering a bill banning trading or holding cryptocurrency, despite industry analysts estimating that there are 15 million crypto investors in India, holding more than USD1.37 billion. China has banned crypto exchanges and so-called Initial Coin Offerings (ICOs) but has not barred individuals from holding cryptocurrencies. China is also looking to crack down on the mining of cryptocurrencies.
Given this uncertainty as to the legal status of cryptocurrency in many jurisdictions, for trustees' global clients, using corporate vehicles and trusts – established in jurisdictions that appear to respect property rights in crypto-assets - is an attractive choice. Otherwise the drivers for holding crypto-assets in trusts and structures are largely the same as those for holding other assets: estate planning, succession planning, asset protection and, sometimes, tax mitigation.
The holding of cryptocurrencies within trusts and corporate structures presents two main challenges. The first is how to deal with the risks arising from the volatility displayed by many cryptocurrencies, and the second is how to safely store them as assets.
Cryptocurrencies are synonymous with volatility. Bitcoin surged to a record high of more than USD60,000 in mid April 2021, but was down 50% by mid May 2021. Investing in an asset class known for such dramatic fluctuations - which is therefore highly speculative in nature - is an uncomfortable prospect for the prudent trustee. Thankfully, trustees already have at their disposal a range of tools that they can use to address the problems presented by this new asset class. Reserved Powers Trusts transfer the investment decision making from trustees to others, leaving someone else (typically the settlor or the trust, or a protector appointed by the settlor) to make the decisions to buy and hold crypto-assets. So-called "Anti-Bartlett clauses" offer a trustee protection from liability where the crypto-assets are purchased within a company owned by the trust, rather than being purchased by the trustee itself. In other cases, crypto-assets might best be owned through a non-charitable Purpose Trust, the purposes of which can be tailored to permit – or even require – the acquisition and holding of crypt-assets. If all else fails, trustees should consider limiting any crypto-holdings to a small proportion of the trust fund’s value, or to getting their crypto-exposure through funds, or other investment vehicles, which are established specifically for that purpose.
The value of cryptocurrency hacks and thefts between 2019 and 2020 increased by 38.38% from USD370.7 million to USD513 million. Trustees, like all holders of crypto-assets, therefore need to take the risks of total loss very seriously. When trustees first started holding crypto-assets in structures they would often seek external advice on holding those assets within their own offline – cold storage – wallet. However, the significant recent developments in crypto-related infrastructure means that this approach is becoming less and less common. In most cases, the properly advised trustee would be better placed using a third party custodian to hold their crypto-assets – essentially outsourcing the holding of the crypto-assets and the associated security concerns.
Linked to this decision to use a third party nominee or custodian to hold crypto-assets, trustees will want to make sure that they are appropriately protected from liability if something goes wrong with this arrangement. Are they permitted to custody the assets with a third party? What are their obligations in selecting that third party? What are their ongoing monitoring obligations in respect of that third party? In some jurisdictions, there are statutory provisions dealing with lots of these issues but where crypto-assets are involved, a well-drafted set of clauses in the Trust Instrument is going to provide the best protection to the trustee.
Trustees will increasingly encounter crypto-assets and will be expected to hold them within structures, so need more than a passing awareness of the technology and processes involved in cryptocurrency management. They will require a level of understanding sufficient to apply trust and structuring principles to this new type of asset.
But beyond the technology, a trustee can apply fundamental principles to crypto-assets. Much of the emerging "best practice" in this space is not that different from how trustees get comfortable with owning family businesses within trust structures. If trustees go back to basic trust principles, many of the worst risks surrounding crypto-assets will be sidestepped and trustees will be able to continue to meet the needs of their 21st-century clients.
David Cooney, Group Partner, Collas Crill
David is a partner in Collas Crill's International Private Client and Trusts team. His private client practice involves a broad range of commercial and private trust matters, including in connection with the establishment and administration of investment funds structured as unit trusts, pension trusts and employee benefit trusts. David frequently advises family offices, charitable organisations, trustees and high net worth individuals on complex trust structures for wealth and estate planning, as well as the use of private trust companies, foundations (under both Cayman and Guernsey laws) and STAR and VISTA Trusts (under Cayman and BVI laws).
He is a member of the Society for Trust and Estate Practitioners (STEP) and is also currently a member of the STEP Zurich Council. He has previously served on the STEP Council in England and the Cayman Islands, as well as on the STEP Technical Sub-Committee, in the Cayman Islands.