Digital Assets in Transactions
By Lacey Shrum
Digital assets are illusive. They work here, they cause problems there. When working through a transaction like probate, divorce, financing, or bankruptcy – we can apply the law to these digital assets like we have in the past. Capital losses (2017 ICOs anyone?) are applicable, and so is step-up basis after a death. And securities law is a given.
However, it is also important to keep in mind that digital assets have different features and nuances that may not mix well with our traditional approaches. For example, an estate planning attorney needs to understand how digital assets are accessed to ensure the executor of an estate has the ability to access the assets when her client is gone, but not until then. A divorce attorney needs to understand what questions to ask to ensure that all assets (even those pesky digital assets!) are disclosed in a divorce proceeding. And, even more simply, professionals need to understand how to navigate a conversation and identify risk with a client.
Some things to remember when dealing with digital assets in transactions:
This is an asset
A digital asset has value and can be sold in exchange for another thing of value. And if not, capital losses, another asset, may apply.
At a very high level, ownership of digital assets is ownership of a key pair (a private and a public key) which allows the holder to access the asset. A continuously running ledger maintains a key pair’s access to that asset until the key pair is presented to transfer that asset. Whoever holds the key pair, owns the asset.
This asset can be held with or without a third party. No bank or custodian is required. A digital asset can be held by either hardware (i.e. a custodian) or software (i.e. an electronic wallet). In this case, “held by” means this entity or electronic wallet holds the key pair and provides access to the asset. Remember, whoever holds the key pair, owns the asset.
The asset is accessed through:
- A third party custodian (holder has traditional login),
- A key pair (letters and numbers in a string), or
- A seed phrase (a list of 24 randomized words).
If the asset is held at an exchange or custodian, that exchange or custodian holds the key pair and provides access to its user login. If the asset is held in an electronic wallet, only the wallet can present the key pair to access the asset. Similarly, the wallet itself may be accessible by a seed phrase. Remember, whoever holds access to the key pair, owns the asset.
Custody is not the simple solution
While the above may lead us to determine that simply custodying our assets with a third party is the best idea because it “looks” the safest, it may not be. Always remember the (now) old adage: whoever holds the key pair, owns the asset. Or – not your keys, not your bitcoin. Custodians are subject to hacks, simple MIA, restricted use, fees, and overleverage. The ability to self-custody your own wealth is one of the greatest features of digital assets. One has complete ownership of her assets, without fear of censorship, government currency controls, and any other impact one’s traditional banking account (see here, here, and here) can suffer.
This new asset class is extremely complicated and can have lasting consequences. Specifically in transactions, the characteristics of digital assets need to be identified and addressed to ensure clients are protected. Always make sure to hire an attorney and seek a specialized attorney when dealing with digital assets in transactions.