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/ 26 Oct 2021

Cryptocurrency in divorce

There are a growing number of people who invest in and use cryptocurrencies (crypto). Whilst crypto is still unregulated and in many cases misunderstood it is vital that family lawyers dealing in finance have at least a basic appreciation of this asset. Managing Partner Liz Francis considers what ‘crypto’ is, and the implications in divorce proceedings below.

Liz Francis

Managing Partner

Family & Divorce

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What exactly is Crypto?

Unlike mainstream ‘fiat’ currencies that are physical tokens, generally regulated and backed by governments, crypto is a digital (non-physical) token that operates via a decentralised exchange.

With crypto, the intermediary (the bank, in fiat currency terms) and its record keeping is replaced by any entirely different system called a blockchain.  The blockchain differs from a typical database in how it stores information; the block chain stores data in blocks that are then linked together. No one person or group has control as the crypto computers (known as nodes) are not held by one authority in one place, but by thousands of computers in lots of different locations, operated by separate people. So, it is a collective system of verifying data. It is accurate, secure and speedy so in some respects, a vast improvement on old style banking

Different governments treat crypto very differently. Whilst in many countries (including UK) it is perfectly legal to use it, in other countries it is outlawed and using crypto could lead to a serious criminal penalty, including jail. At the other extreme, El Salvador has very recently declared Bitcoin legal tender (the first country to do so) and encourages its citizens to use it, much to the astonishment of most commentators.

There are many types of crypto currencies- the most well-known being Bitcoin. Other examples are Ethereum, Litecoin and Dogecoin.

Crypto can be used to pay for things as well as to simply invest in the currency itself. Whilst it has a tarnished reputation for being used for nefarious reasons, many crypto holders will use it for entirely valid purposes (including investment).

 

What evidence can be produced to evidence a crypto holding?

One does not receive monthly statements as with standard bank accounts. Digital wallets are used to hold crypto and most vitally to store the private keys (like a password) needed to access them. The holder of crypto can view their ‘digital wallet’ anytime to see what they hold.

There are 2 types of wallet, a hot wallet or cold wallet. The difference between a hot wallet and a cold wallet is that hot wallets are connected to the internet, while cold wallets are not.

Hot wallets are therefore easier to use but they are less secure and could be exposed to hacking, although this is rare. On the other hand, a cold wallet is a physical offline device and less convenient. Holders could hold crypto in both hot and cold wallets.

Tax treatment

If you were to receive crypto from an employer or from mining (the process whereby people create new crypto to enter circulation), then you will need to pay income tax and national insurance contribution as you would on any other form of income. If you receive it via a limited company or other trading medium it would form part of the company’s income for accounting purposes.

If you buy crypto and then sell it, you need to report any gain which is liable to CGT.  Other countries will of course have varying tax treatments.

Crypto and divorce

Dividing the assets is all about first gathering the information to show what assets exist, ascertaining their value and then trying to negotiate a fair settlement. In most cases one has to work in that order.

Each party in a divorce has a duty of full and frank disclosure and all assets must be declared including crypto which is just another asset. The difficulty is what verification can be called for to ensure the number of tokens owned are as declared. There are no bank statements issued and one cannot write to the bank to ask for copies.

The private key allows the individual owner of the unit of cryptocurrency to spend or trade the units on the blockchain. If the private key is not known or is lost, it is impossible to access the cryptocurrency or trace it back to an individual.

Many crypto holders use a third-party service known as an exchange to hold the private key on their behalf.  In theory it is possible to subpoena an exchange for information. However, the crypto holding spouse could transfer the private keys from exchanges to a wallet that is not easily tracked.

The other way of trying to establish any crypto holding is to analyse standard bank statements to see what funds have been put into crypto or a crypto exchange. If there are transactions that you do not understand, then just include a request for an explanation in the questionnaire.  It may even be that the spouse has declared a gain on crypto in their tax return so questions on the transactions that gave rise to any reported gain (or loss) are worth asking.

Depending on the quantum of any likely crypto holding there are now forensic analysts working in this field. They will be expensive and may not be worth engaging unless the value they may uncover is very high.

Just a brief mention of digital artwork, which is a digital only piece of art embedded in the blockchain by way of a non-fungible token that can then be traded securely.  Some of these art works can be worth an incredible amount. Again, they are an asset and should be declared in financial remedies cases. Depending on the case it may just be worth broadening any question out to include any digital artwork.

Finally, it is also worth noting that Crypto is incredibly volatile. Whilst one would usually take the value at the time matters go to court or at the time of making a proposal this asset has enormous capacity to lose and gain vast value over a very short period of time. This makes it even harder to strike a fair deal as one or the other could suffer from a large gain or loss depending on the market thereafter. Whilst this could be mitigated by transferring some of the currency to the non-holding spouse in specie, this is not ideal and there are many that would be very uncomfortable and indeed find it very challenging to deal with crypto.

How can we help?

Our family team believe that family & divorce requires a rather different approach to many other areas of the law. We pride ourselves on our high level of client care and communication and will handle your case in a sensitive and professional manner. If you want to discuss any of the above in more detail or to find out more about how our team can help you, please contact one of the Family Law team on 02072280017.

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