Cryptoassets for dummies and/or family lawyers

For some time now, ownership of cryptoassets has been on the rise and an inevitable consequence of this is that they are expected to become a typical asset class to be dealt with in financial remedy cases. The typical family lawyer may recoil in horror when faced with an asset schedule containing cryptoassets and so this article seeks to provide a basic introduction to cryptoassets, as well as considering how they might feature in financial remedy cases.

What exactly are cryptoassets?

Unfortunately for lawyers, who have a fondness for clear definitions, there is not one agreed definition of cryptoassets. According to the Financial Conduct Authority:

“Cryptoassets are cryptographically secured digital representations of value or contractual rights that use some type of distributed ledger technology (DLT) and can be transferred, stored or traded electronically.”

HMRC, which has a manual devoted solely to cryptoassets, states that they are “cryptographically secured digital representations of value or contractual rights that can be transferred, stored and traded electronically”. If, like us, you have no idea what that means, you may prefer to think of cryptoassets as any digital asset which has a value and can be traded or stored.

Definitions

Discussing crypto feels like learning a foreign language. So, a few basic definitions are helpful:

• Cryptocurrency: a bit of a misnomer; it is not a currency in the conventional sense, but a digital version held in an account or wallet. These digital versions are created through the process of mining.
• Bitcoin: not all cryptocurrencies are Bitcoin, but all Bitcoin are cryptocurrencies. Bitcoin is one “brand” of cryptocurrency, but there are others (Ethereum, USD, Tether, Dogecoin to name but a few).
• Mining: the process by which new digital “coins” are created. It is how those with cryptoassets grow the size of their holding without trading. They verify and process transactions on a machine/computer – “mine” – and are rewarded with a “coin” for doing so, thereby creating the cyptoasset. This is achieved using massive computers, using incredible amounts of electricity and there are concerns about the sustainability of mining and the impact it has on the environment.
• Blockchain: a secure database that records the transactions of cryptoassets in “blocks”, akin to a ledger, creating a reliable and secure record of the trade and investment of any cryptoasset, thereby enabling trust between buyer and seller.
• Crypto tokens: like cryptocurrency, crypto tokens are another form of digital asset that can be traded or stored. They are created as part of a platform built on existing blockchains and can come in different forms:

1. 1. Exchange tokens, these are intended to be used as a means of payment and are similar to cryptocurrencies.
   2. Security tokens, which provide the holder with rights or interests in a business, such as ownership, repayment of a specific sum of money, or entitlement to a share in future profits.
   3. Utility tokens, which provide the holder with access to goods or services on a platform. A business or group of businesses will normally issue the tokens and commit to accepting the tokens as payment for the goods or services in question.
   4. Non-fungible token or NFT. An NFT is effectively a one-of-a-kind trading card. NFTs can be anything digital: a piece of art, music, Jack Dorsey’s first tweet or even flowery toilet paper (yes that happened). Although this may seem like a somewhat ludicrous investment, $41bn was spent on NFTs in 2021.

• Crypto exchange: in return for money or other digital assets, people can now trade in crypto using an exchange of tokens or currency. An exchange is where you buy or sell cryptoassets and hold them in a wallet.
• Wallet: as the name suggests, this is where you put your cryptoassets once purchased, and where you manage them. There are two wallet types: custodial and non-custodial. Each has specific features.

1. 1. A custodial wallet is a type of software wallet used by a third party (crypto exchange) to store cryptoassets. The wallet provider retains custody of the private key, so is responsible for safeguarding a user’s funds
   2. A non-custodial wallet can be either a software or hardware wallet (think USB stick) controlled solely by the user (like keeping money under the mattress, although infinitely more mobile).

The user has full control over their private key and, with it, sole responsibility for protecting their funds.

• Keys: the electronic code used to secure cryptoassets. If lost, there is no way to recover or regenerate the key.

How do cryptocurrencies work?

Cryptocurrencies differ from ordinary, fiat currencies because they are not regulated by a central authority such as governments, central banks or financial institutions. Instead, they operate on a peer-to-peer network, with transactions being recorded on a public ledger using blockchain technology. The blockchain is a decentralised method of recording data in a structured way across a computer network, the data can be viewed by anyone at any time and cannot be hidden. The data is grouped into timestamped blocks which are mathematically linked or “chained” to the preceding block. This allows data to be shared globally, to verify transactions and prevent fraudulent double spending of cryptocurrencies.

The blockchain records all transactions, updated approximately every 10 minutes when a new block of transactions is created and added to the chain, it is effectively a ledger. The record-keeping process is known as mining. A new block can only be added to the chain once there is proof to establish the integrity of the transactions recorded: this is the process by which cryptocurrencies are entered into circulation. Those using the ledger are referred to as miners. As cryptocurrencies are digital, the blockchain ledger records where the currency exists as unspent transactions.

Cryptocurrencies are mostly held on a digital exchange such as Coinbase, Kraken, Bitstamp, or Binance. They can provide the holder with a platform to purchase, sell and transfer their cryptoassets. On these centralised exchanges, the cryptocurrency holder allows the exchange custody of the assets. It’s not essential to understand the underlying technology behind cryptocurrencies in order to hold or trade them. Many financial apps such as PayPal now allow you to trade cryptocurrencies with ease.

The legal status of cryptoassets

Cryptocurrencies are considered “property” in England & Wales (Bitcoin, AA v Persons Unknown [2019] EWHC 3556 (Comm)) as they meet the four criteria set out in the definition of property in National Provincial Bank v Ainsworth [1965] 2 All ER 472: definable, identifiable by third parties, capable in their nature of assumption by third parties, and having some degree of permanence.

As such, the Family Court can make both property adjustment orders and proprietary injunctions in respect of cryptoassets.

Disclosure

As with all other assets, cryptoassets must be disclosed in a Form E. While there isn’t currently a specific place for cryptoassets to be listed, the “Capital: Other assets” section appears the most appropriate.

One of the primary characteristics of cryptocurrencies is that they provide a level of privacy to investors, making it difficult to trace the details of some transactions. If a client suspects that their spouse may hold cryptoassets which are not disclosed within the Form E, the first sign would typically be within their bank statements, which might show deposits being transferred to an exchange such as coinbase. However, as mentioned above, these could simply be transfers to apps, which on the face of it may seem innocuous, such as PayPal. If a Form E (or its supporting documents) reveals that a party holds cryptoassets, or there is the suggestion of the existence of cryproassets by way of bank transfers to a monetary platform or app, it’s important to find out the following:

1. Where the assets are held (ie on what platform/digital exchange).
2. The name and amount of each token or any currency.
3. The public address key for each token or currency.
4. A dated statement of holdings for each platform on which the assets are held.

Whilst a lot of this information is publicly available because of the nature of the blockchain, it can be challenging to trace complex transactions and, in some cases, it may be necessary to instruct an expert for forensic analysis. If you are unsure, or if some money or transfers are not being accounted for, ask further questions or seek expert advice.

Valuation

Another issue that may arise in matters where parties hold cryptoassets is how to provide an accurate valuation. Cryptoassets and specifically cryptocurrencies exhibit extreme volatility with sharp drops in value but also high returns. The consequence of this volatility is that the value of crypto holdings may vary significantly throughout the course of proceedings. It is therefore crucial that up-to-date valuations are used in negotiations and at hearings. In some cases, the court may consider it necessary for valuations to be carried out several times throughout proceedings or for an average value to be used. As with disclosure, depending on the size and nature of the crypto holding, expert evidence may be essential and you may want to be cautious if considering offsetting cryptoassets against more secure, less volatile assets such as more traditional investments.

Tax implications

HMRC does not treat cryptoassets as currency or money, so a person’s investment in cryptoassets does not usually amount to a financial trade subject to income tax, but rather most disposals by individuals of cryptocurrencies are subject to capital gains tax (CGT).

The popularity of cryptoassets continues to grow, and ownership in the UK is surging, with 6.2% of the population owning cryptocurrency in some form. With ownership expected to continue rising, cryptoassets are likely to form a part of financial remedy cases more frequently, so how we deal with these assets through the financial disclosure process and within settlement negotiations is going to become increasingly important.