A wealth management firm examines crypto-currency assets and how trusts and other structures can be used.

Transferring crypto-currency assets such as Bitcoin can present challenges, and what can be done via the tried and tested route of trusts? As this publication heard earlier this year at a conference in Switzerland, the trusts industry is still wrestling with how to address it. And this is an international issue: trust laws operate in those nations touched by English Common Law, or those which have chosen to recognize it. And that includes the US with its maze of different trust laws in certain states.

In this article, Tom Olchon, managing director and wealth, fiduciary advisor at Evercore Wealth Management and Evercore Trust Company, NA, considers some of the implications. This publication is pleased to share these views with readers and invites responses. Email the editor at tom.burroughes@wealthbriefing.com

(To see a previous article by Evercore, regarding wealth planning matters, see here.)

The risks of investing in intangible and often relatively illiquid crypto-currencies are well known. Less well known are the risks in managing and transferring these exciting but volatile assets.

Bitcoin, Ethereum and the like have no central or regulating authority. Instead issuance and transactions are managed by a decentralized system that relies on cryptography to prevent fraud. If that sounds like a circular – or cryptic – explanation, but it may be helpful to think of cryptography as a modern form of secret writing. Instead of invisible ink, information is encoded and decoded by computers. 

This security can work all too well. Matthew Mellon was a proponent and early investor in Ripple, a technology that acts as both a cryptocurrency and a digital payment network for financial transactions. At the time of his unexpected death in 2018 at age 54, his holding was reportedly worth about $500 million. But it isn’t worth a dime to his heirs, as no one seems to have the necessary passwords for his executor to access the assets. The passwords are held in a so-called cold wallet, a hardware device that is not connected to the internet. Without the passwords, the wallet can’t be opened.

The mysterious death of Gerald Cotton, also in 2018, caused more widespread trouble. As the co-founder of Quadriga CX, Canada’s major crypto-currency exchange, he appears to have had sole access to the exchange’s wallets and related keys. Quadriga CX has since been declared bankrupt and its assets remain inaccessible.

Most exposures are smaller, of course, but the custodial risks are broadly the same. Crypto-currency can also be stored online, in what are known as hot wallets. But once someone else has access to the key, that person can access the asset without the owner’s knowledge or permission. That risk has to be balanced against the risks of incapacity and the certainties of death in determining who has access to the assets, along with when and how. Anyone considering taking on fiduciary responsibility for these assets will need to be very careful, as discussed here.

In addition to security, storage and accessibility, investors in crypto-currencies need to consider taxation, price volatility, valuation and illiquidity.

The IRS views crypto-currencies as property, not currency. This is an important distinction, as it means the basis needs to be accurately tracked. The US dollar-denominated basis is established when the asset is acquired, and the gain or loss may be realized at the disposal of the asset. This could be on conversion back to US dollars, conversion to another crypto-currency, or when the crypto-currency is used to purchase a good or service. As with other property, crypto-currency assets receive a step-up in basis at the death of the owner.

Many early investors in crypto-currencies have substantial capital gains embedded in their holdings. This makes for an interesting planning opportunity for those who are philanthropically inclined. Funding a Charitable Remainder Trust with crypto-currency can be a very efficient way to diversify the position, minimize capital gains, and reduce income taxes. Not surprisingly, there has been a notable increase in charitable contributions made through Bitcoin over the past few years. Donors must be very careful to adhere to the IRS’ substantiation rules, appraisal requirements, and filing obligations (for both the donor and the charity).

When funding a Charitable Remainder Trust structure with crypto-currency, it is important to consider the potential volatility and illiquidity inherent in the underlying assets. It often makes sense to consider funding a more flexible NIMCRUT (Net Income with Makeup Charitable Remainder Unitrust) or NICRUT (Net Income with Charitable Remainder Unitrust), rather than more traditional structures. 

They allow more flexibility for the trustee/s, an important consideration with such volatile assets. Traditional Charitable Remainder Annuity Trusts, or CRATs, and Charitable Remainder Unitrusts, or CRUTs, are less attractive structures in this context. The potential fluctuations in asset valuations and/or the possibility of an illiquid market could inhibit distributions.

These are obviously complicated strategies that should only be considered in the context of broader wealth goals and in close consultation with experienced advisors. We expect this area of planning to develop rapidly as the market for these assets continues to evolve.

Crypto-currencies, in some form or another, are here to stay. But it appears that we can still lose our keys and wallets. Ensuring that these assets are properly managed and transferred will be an important focus for investors and their advisors.

Appendix

An Important Message for Fiduciaries by Darlene Marchesani. (Marchesani is trust counsel and the managing director of Delaware Trust Services at Evercore Trust Company, NA.)

Individuals considering accepting fiduciary responsibility as a co-trustee for a trust holding crypto-currency should first consider the potentially significant pitfalls.

Illiquidity and volatility issues of crypto-currency held in trust can cause problems for the trustee in satisfying its investment responsibilities. In addition, a lack of available funds could delay distributions, which may cause underpayment to the present beneficiary or underpayment to the charity or remainder beneficiary at the end of the term. Either or both events could result in litigation and negative tax consequences.

Delaware presents a unique opportunity for trusts looking to expand their investments into crypto-currency. A trustee is authorized to acquire every kind of property, with the investments to be considered as part of an overall investment strategy. Performance of an advisor is measured with a view toward the entire portfolio, rather than on an asset-by-asset basis.

In addition, the use of a Delaware directed trust can provide great flexibility. If a trust instrument requires a trustee to follow the direction of an advisor, and the trustee follows such directions (say, acquiring a legal/authorized investment such as Bitcoin as part of a portfolio), the trustee will not be liable for any loss resulting directly or indirectly from the investment.

An administrative trustee directed to hold crypto-currency in a trust account will, of course, require detailed current and regularly updated information regarding the assets, to protect all the parties involved. It is the trustee’s responsibility to ensure the safety and soundness – and the security, as discussed in the above article – of trust assets.