Cryptocurrencies, originally a way to conduct business outside the financial system, are increasingly seen as an asset akin to private equity or venture capital.
Cryptocurrencies have soared in value. In a decade, they’ve gone from a fringe obsession that allowed coin holders to conduct business outside the financial system to an alternative investment managed as if it were any other investment. It hasn’t hurt that the price of a single Bitcoin has gone from zero to over $30,000 in that time.
But if affluent investors are increasingly seeing cryptocurrencies the way they see other high-risk assets, like private equity shares and venture capital, that raises a new question for the people who manage their assets: How can a completely modern but volatile asset fit into legal structures that date back a century or more?
Estate lawyers, trust officers and financial planners are just beginning to consider the ramifications of including Bitcoin and other cryptocurrencies, like Ether and Ripple, in portfolios as well as trusts, which have more exacting rules and stringent penalties for mistakes.
The currencies still have a ways to go before they become mainstream investments. But giving some investors comfort are the custody and other back-office financial services that lower the risk of the currencies being lost or stolen.
“As Bitcoin gains more mainstream adoption, participants are now more sophisticated investors,” said Joel Revill, chief executive of Two Ocean Trust, a wealth management firm that offers investment, trust and estate planning services for traditional and digital assets. “They want to treat it like any other asset. They want transparency, and they want to be able to plan around it.”
In some ways, that runs contrary to the original intent of cryptocurrencies, which existed outside a traditional financial system that provides investment advice and trust services. With their keys, cryptocurrencies are, in some ways, more like old-time bearer bonds. Those bonds were issued by a company or government, but weren’t registered like regular bonds. Instead, whoever held the certificate could redeem the bond for its full value. This put an early premium on not losing that sheet of paper.
Today, the people who own some 20 percent of the 18.5 million Bitcoin in existence have apparently lost their keys, or passwords, to some $140 billion in those coins.
Both large financial service companies and boutique advisory firms are aiming to reduce the management risk while capitalizing on wider interest in investing in cryptocurrencies and the underlying blockchain technology.
John Willian, a retired Goldman Sachs partner, bought Bitcoin last summer after following it for several years. He said the tipping point was when he felt the marketplace for Bitcoin had grown beyond the earliest adopters and the currency was beginning to be seen as a store of value.
But he also said he was under no illusions that its volatility would subside. “I still look at it as a venture style of investing,” Mr. Willian said.
One thing that gave him comfort was the creation of a more traditional financial infrastructure around the basics of owning Bitcoin. “There had been some impediments,” Mr. Willian said. “The trading tools weren’t sophisticated. There wasn’t transparency on fees. It was hard to know how custody works. These are things we typically take for granted.”
There have been plenty of reasons for concern. Chief among them was the bankruptcy in 2014 of the Tokyo-based trading platform Mt. Gox, which left owners of cryptocurrency on that exchange trying to find passwords for hundreds of thousands of Bitcoin, worth millions then but billions now.
For wealthy investors, guarding the keys is just the start. They have to find a way to treat digital assets the same as other investments in their portfolio. That will allow them to pay whatever tax they owe but also to make plans for gifts and bequests to heirs through an estate plan.
“As the proliferation of the asset class grows, it is of huge importance to consider it within the estate planning context,” said Tom Olchon, a wealth and fiduciary adviser at Evercore Wealth Management. “You need to have a plan in place. There are several instances of people dying without anyone else having keys or access.”
One who comes to mind is the banking heir Matthew Mellon, who reportedly had $500 million in Ripple when he died in 2018.
That planning starts with storage. The initial ethos of cryptocurrencies rejected the banking system and promoted a system of self-reliance. Sometimes, that worked just fine. Other times, when passwords were forgotten, it did not.
Several firms provide secure key storage — or custody services, as they’re known with other financial assets. Two Ocean’s system, Mr. Revill said, combines humans and algorithms to securely move cryptocurrencies from “cold” storage, when the device holding the keys is not connected to the internet, to “hot” storage, where the Bitcoin is connected to the internet so a transaction can take place.
Tom Jessop, the head of Fidelity Digital Assets, a part of the financial services firm Fidelity Investments that acts as a custodian for cryptocurrencies and operates funds that invest in the currencies, said the firm’s strategy is to manage operations behind the currencies so they were no different from stocks or bonds.
“It approximates the utility of any other asset you own,” Mr. Jessop said. “There’s an account number, an ability to measure and monitor it, and your financial adviser knows about it and is aware of it in terms of an estate plan.”
Part of most estate plans is a series of trusts, which hold various assets for future generations. The trustees charged with carrying out the directives in trust agreements have a couple of major concerns about the currencies. One involves the liability that comes with a breach or loss of a key, said Frazer Rice, Northeast regional director at the trust company Pendleton Square Trust. But another is prudently managing the asset itself, given its volatility, in the context of other assets in the trust.
“We’re used to dealing with stocks and bonds and illiquid assets,” he said. “Now, crypto is intersecting with estate planning and legal tools that are hundreds of years old. People are really going to have to think through and ask what does it mean for someone else to be responsible for their crypto when they’re dead.”
For trust planning, investors who keep their keys on a thumb drive and lock it in a safe could find themselves in the same tax situation as people who put real property in trust. Jurisdiction over disputes rests with the location of the property, not where the trust was set up.
For years the State of New York has tracked where valuable art hangs. Someone may officially be a resident of Florida, which has no state estate tax, but if a $100 million painting hangs in that person’s apartment on Park Avenue, New York will tax it. The same could be true for where a thumb drive is stored, Mr. Rice said.
(Income tax is a different matter. Right after your address on the first page of the Internal Revenue Service Form 1040, filers are asked if they bought or sold any virtual currency that year.)
The regulatory environment will control a lot of what happens to cryptocurrencies as well as what protections the trustees have. “When I think about crypto, I think about who has the key, who protects the keys and how does it get passed down to heirs,” said Judith Pearson, family office and trustee group leader for Woodruff Sawyer, a law firm. “The trustee can get sued if the key gets lost or stolen. These trustees need to be protected by risk management protocols.”
In most places, that involves insurance, though the amount that could be at risk from one cryptocurrency mistake is substantial.
Some states have moved to clarify what happens if something goes wrong. Wyoming’s laws treat the handling of cryptocurrency much like other assets under the uniform commercial code. Mr. Revill, who also sits on the state legislative committee there that drafted the cryptocurrency laws, said: “In Wyoming you can hold cryptoassets like any other assets. And a court has jurisdiction if anything happens.”
There is optimism that cryptocurrencies, held at a reputable custodian, will soon be treated as if they were any other asset.
“If you’re a high-net-worth individual, you’re not holding your own keys today,” said Michael Novogratz, chief executive of Galaxy Digital, an investment fund focused on digital assets. “If you’re one of the original Bitcoin buyers and you bought it because you didn’t trust financial institutions, or you didn’t trust the government, then it’s more complicated.”
In general, though, the newest buyers have heard the horror stories and are more cautious. “If I gave you 10,000 Bitcoin and they were worth $27 each, you might lose your keys,” Mr. Novogratz said. “Now 10,000 Bitcoin is worth $300 million. You’re not going to lose it.”
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