The growth in popularity of cryptocurrencies gives rise to real world questions, not least of which, can digital assets be inherited?
Investment in cryptocurrencies has been growing apace and, despite a few noticeable dips in the market, including the fall in Bitcoin value during 2018, it shows no sign of slowing down. Even institutional investors have joined the race, with Bloomberg reporting large private buyers, such as hedge funds and endowment trusts, purchasing millions of dollars’ worth of digital coins in online transactions. This development confers a greater credibility and sense of legitimacy to crypto-exchanges and to currencies, such as VeChain, Ethereum and Bitcoin.
WHAT ARE CRYPTOCURRENCIES?
As a relatively new type of asset class, cryptocurrency has gained considerable attention and increased in popularity over recent years, especially amongst individual investors who hope their ‘tokens’ will appreciate over time, much like stocks and shares. It is no small task to keep informed about the various forms and uses of cryptocurrency, as it is constantly changing and evolving.
How are cryptocurrencies defined? It is generally accept that they are a virtual currency using cryptography for security, relying on blockchain technology to exist. In their simplest form, cryptocurrencies are digital representations, the values of which are determined by supply and demand. Due to their intangibility, cryptocurrencies are stored and traded electronically.
The attraction of these ‘currencies’ is their security. They are not issued by any central authority and, therefore, are theoretically immune to outside interference or interception. This feature explains their growing popularity and wider use. The term “cryptocurrency” quite literally means ‘a secret form of payment’ and privacy is one of the central benefits of this platform.
The covert nature of cryptocurrencies is a doubleedged sword and it is arguable that the lack of regulation brings with it certain difficulties. Investing in cryptocurrencies does not come without risk and the Bank of England identifies the primary danger to be the lack of central management, i.e., by a bank or government, to assist in the event of any trouble, such as fraud or theft. The cryptocurrency market has also proven itself quite volatile and unpredictable.
PITFALLS AND PRACTICALITIES
To keep up with the growing use of crypto assets (including cryptocurrencies), HM Revenue & Customs (HMRC) is striving to establish their position and recently issued guidance for individuals who possess crypto assets. It is clear that HMRC and the Cryptoassets Taskforce do not class crypto assets as ‘money’ or even as ‘currency’ and, as noted above, the buying and selling of such assets are likened to investments, as opposed to gambling. This means that, in general, Capital Gains Tax will be relevant on the disposal of a crypto asset and there may be Income Tax implications on the receipt of certain types of crypto assets.
If one does invest in crypto assets, and specifically cryptocurrency, consideration should be given to what will happen on death – who will have access to the virtual wallet and how will it be accessed? The intangible nature of these assets and the complexity, exchange and transfer of these assets within the digital space can make it extremely difficult to ascertain the true value of the asset on death, to access the assets in question and even to identify the owner. One example that crystallises the complications of inheriting cryptocurrency occurred in 2013, whereby Bitcoin miner Matthew Moody died in a plane crash in Chico, California. At the time of his death, Matthew had an unspecified number of bitcoins in his online wallet, which were each worth just under US$100. Today, the same coin is worth over US$8,000.
“Cryptocurrencies are digital representations Digital assets…liable for Inheritance Tax?”
Matthew’s relatives were unable to access his online wallet, lacking the “private key”, i.e., the identifying information required for access to the assets. Without this, the family were unable to recover any of the Bitcoins in question.
More recently, Gerald Cotton, the young founder of Canadian cryptocurrency exchange Quadriga CX, died suddenly whilst travelling abroad. As the only person with knowledge of the key unlocking the investments, it is estimated that approximately 115,000 individuals are owed between CA$180 million and CA$190 million in cryptocurrency, which may now be lost forever. To make matters worse, it is understood that Mr Cotton held the key securely on his laptop; however, attempts to recover the funds have shown the digital wallets to be empty, leaving Quadriga CX’s auditors Ernst & Young with the task of investigating the missing funds.
According to research by the Financial Times, between 2.3 million and 3.7 million bitcoins have been lost for a variety of reasons, including the death of the asset holder, which accounts for roughly 30% of the bitcoin market. The losses can be significant and ultimately claiming rights to cryptocurrency may prove to be a real issue.
How can we guard against this loss?
The best advice lies in the old adage, prevention is better than cure. It may be that a specific gift of the digital asset is contained within the Will itself or a Letter of Wishes is prepared, to sit alongside the Will, detailing instructions on how to access the funds or the private key itself.
Smart contracts or “blockchain contracts” may also offer an innovative solution to the problem. In contrast to traditional contracts, these are self-executing contracts with terms directly written into the blockchain code and are particularly suited to cryptocurrency because of their global enforceability and their protection of the contacting parties’ identities.
Various platforms have also made use of blockchain technology to help users set up systems through which keys to digital assets can be shared with beneficiaries after death, by distributing private keys or passphrases providing access.
Inactivity can be a significant indicator of a change in circumstance. Certain platforms have made use of Application Programming Interface (API) integrations, which measure activity signals. Users are able to predefine a period of inactivity, e.g., three years, which on elapsing will trigger the transfer of digital assets to select beneficiaries.
“Smart contracts or ‘blockchain contracts’ may also offer an innovative solution to the problem.”
Another possible solution lies in the token exchanges themselves. These exchanges, such as Coinbase and Kraken, are platforms that allow the purchase, sale and storage of virtual assets. Some of these exchanges have policies in place to allow the transfer of the deceased’s wallet to intended beneficiaries, after appropriate documents, such as a death certificate have been produced. This process may, however, prove just as cumbersome as attempting to access the wallet directly.
Naturally, once assets, including digital assets, have been inherited by a beneficiary, the next question is whether they will be liable for Inheritance Tax? Thankfully, the answer to this is clear. The recently published HMRC guidance, “Cryptoassets for Individuals”, states that “cryptoassets will be property for the purposes of Inheritance Tax” And therefore chargeable to Inheritance Tax.
Unquestionably, cryptocurrency, and crypto assets more broadly, remain a very novel and unchartered area, from both practical and legal perspectives. The law has always been slow to adapt to the changing digital landscape, in particular as regards the definitions of assets and property held virtually.
It is important to take precautionary steps to avoid one’s cryptocurrency being inaccessible at a time when it may be needed the most and including clauses relating to digital assets either within a Will itself or as part of an ancillary Letter of Wishes is becoming increasingly popular. Though digital currency exchanges are beginning to explore varying uses of the blockchain to prevent lost tokens and ensure greater certainty in matters of bequest, the best strategy is risk mitigation and for token owners to take action now to ensure their crypto assets are inherited by their intended beneficiaries.