With the recent rise in the price of virtual currencies such as Bitcoin and Ether, the public is becoming increasingly aware of and interested in virtual currencies. This article will explain what virtual currency is, where it is stored, and steps estate planning attorneys should take to help clients protect their virtual currency assets.
Background: Creation of Bitcoin
In October 2008, Satoshi Nakamoto published a white paper that described Bitcoin. Satoshi Nakamoto is a pseudonym for the creator of Bitcoin, and to this day, nobody knows who Satoshi is. Regardless, Satoshi created a very valuable technology akin to digital gold. This valuable technology is called Bitcoin. More recently, Vitalik Buterin launched the Ethereum Foundation, which built a blockchain platform called Ethereum. To use the Ethereum platform, users must pay in the Ethereum currency which is called Ether.
Virtual currencies such as Bitcoin and Ether have been rapidly increasing in value. On January 1, 2017, one Ether cost approximately $8.00. On December 4, 2017, one Ether was valued at $462.00. Thus, a client who purchased 100 Ether for $800.00 on January 1st would now have an asset worth $46,200.00. These valuable assets are certainly something that clients, heirs, beneficiaries, creditors, and the Internal Revenue Service will be very interested in.
What is a Virtual Currency?
A virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. See IRS Notice 2014-21. Bitcoin and Ether are examples virtual currencies. Virtual currencies are bought and sold on exchanges just like stocks. They can be exchanged for a variety of fiat currencies such as U.S. Dollars and Euros. Virtual currencies can be used to purchase goods. For example, Overstock.com, Expedia.com, and Subway all accept Bitcoin.
Where is Virtual Currency Stored?
Virtual currencies are stored in exchanges, website-based wallets, desktop wallets, and cold storage wallets. There are several different exchanges used to buy and sell virtual currencies. A few examples are GDAX.com, and the now defunct MtGox. For the story on the MtGox hack, search for, "The Inside Story of Mt. Gox, Bitcoin's $460 Million Disaster." Coinbase.com provides a web-based wallet similar to an online banking portal. A desktop wallet is a software application that is installed on the user’s computer that stores the user’s virtual currency and allows the user to send and receive virtual currency. Cold storage wallets involve storage of virtual currency in media disconnected from the internet.
Paper wallets are another option for storage of virtual currency. Paper wallets are the “low-tech” way to store virtual currency and only require the use of a pen and piece of paper to write down the private key. Click this link to learn more about private keys.
There are a number of companies that provide users with wallets. A few examples are Coinbase.com, Jaxx, Exodus, Ledger, Trezor, and Poloniex.com.
Intersection of Estate Planning and Virtual Currency
Estate planners need to be aware of the existence of virtual currency owned by a client to ensure the tax aspects of holding such assets are discussed with clients and a plan is agreed upon to ensure the virtual currencies are not lost but are transferred to the desired beneficiary. This is crucial because virtual currencies can quite literally be lost forever with no possibility of recovery. The Guardian published a story on a man who threw out a hard drive containing 7500 Bitcoin – worth approximately $19.5M USD. We have grown accustomed to being able to recover and reset our passwords with relative ease. Virtual currencies can be recovered, but only with the seed phrase. Without the password to access the wallet or the seed phrase, the virtual currency is lost forever and there is a high probability that no company can help you recover it.
Estate planning attorneys simply need to ask clients whether they have virtual currencies, and if so, whether they have adequately planned for their secure transmission in the event of their death.