With the rise in interest in digital assets and cryptocurrencies, particularly amongst younger generations, trust and estate practitioners must prepare well to counter succession planning challenges presented by this new asset class.
The world of money and finance has been disrupted since Bitcoin launched over 10 years ago, following on from the introduction of blockchain and distributed ledger technology (DLT).
While Bitcoin is currently sitting at around $34,000, excitement rose around Bitcoin when it surpassed $60,000 for the first time in March 2021. Despite the recent market dip, Bloomberg is still bullish on Bitcoin, forecasting that this popular cryptocurrency will likely head towards $100,000 rather than dive towards lows of $20,000. If current trends continue, it is high time for trust practitioners to understand how cryptocurrencies and other digital assets can form part of their clients’ wealth planning and succession strategies.
Digital assets grow in favour among the ultra-rich
Digital assets are essentially the next/newest asset class in the fast-expanding array of asset classes being actively considered by investors. Growing digital assets interest follows similar surges in other ‘alternative’ asset classes seen over the past couple of decades, including private equity, real estate and venture capital. Each was previously considered high risk, but with the evolution of the sectors and ecosystems that support them, they now form part of mainstream investment activity – at least for the more sophisticated ultra-high-net-worth (UHNW) investors and their family offices.
Wealthy families and their family offices had in the past been perceived as lower risk takers and certainly not trend setters. That has changed. Increased sophistication, complete with improved instituational-style investment approaches and wealth governance, has fueled UHNWs and their family offices’ firepower globally. Private deals and funds that were once the reserve of large investment banks and private equity firms are now increasingly being taken on directly by family offices, and this trend has extended to digital assets.
Further fueling interest in digital assets is the clear trend seen over the last decade or so of younger family members, armed with an invigorated and fresh perspective, becoming more actively involved in family wealth stewardship than ever before and holding increasing influence over investment direction.
A 2020 survey of institutional investors in the US and Europe, including high-net-worth individuals and family offices, showed that 80% of respondents find digital assets attractive and 36% already included them within their portfolio. This Fidelity Digital Assets study also revealed the three most compelling reasons for respondents’ interest in digital assets to be the lack of correlation with other asset classes (36%), the innovative technology play (34%) and the high potential upside (33%). Most notably perhaps, six out of 10 investors surveyed believe digital assets to have a place in their investment portfolios.
Digital assets as trust property
There has been some debate in the past about whether it’s possible for a trustee to hold digital assets as a part of a trust’s assets. A consensus seems to have been reached by experts in the fields of technology and trust law that digital assets are indeed identifiable and have the ability to be transferred, meaning a trustee does have the power to hold them.
Of course, the trustee will have to determine the precise nature of the digital asset as that has a knock-on effect on other administrative matters. For example, if the asset is a cryptocurrency, ownership is created and tracked through the use of a cryptocurrency ‘wallet’. Access is normally via private keys that enable the trustee to use or otherwise move the cryptocurrency. Safe custody of such private keys is therefore one important administrative matter for trustees, including taking appropriate steps to ensure that the private key is not shared (or stolen) by a third party.
Regulatory & insurance environment evolution
Trustees also have to consider the legal and regulatory environment in which they operate. Digital assets exist within borderless blockchains while regulatory bodies (created by governments) operate within a particular country/jurisdiction. This inherent tension is driving governments and their regulators around the world to try to find ways to strike a delicate balance between legislating for investor protection and creating an environment that encourages innovation and commercial activity. Although this situation is still evolving, we have started to see increased clarity in some jurisdictions, including for example in the US, UK, Hong Kong, Jersey, Switzerland and Singapore, including but not limited to legal recognition of digital currencies, security offerings and standards for digital asset managers.
Also relevant for trustees and other asset administrators is their insurance coverage as it pertains to dgitial assets held/administered such as cryptocurrency, which is also in it’s relative infancy. In fact, the cryptocurrency insurance market was recently described as “hesitant and uncertain,” according to experts in Marsh’s Digital Asset Risk Transfer (DART) team. In short, insurers remain very cautious, and indeed often reluctant, about allocating resources and capacity into this emerging digital assets space. No doubt this space will also continue to evolve.
Benefits (and challenges) of using trusts to hold digital assets
When a person owns an asset, they usually have legal title and the right to use and enjoy it. Whilst simple, this often results in the depletion of wealth over time due to a range of risk factors, including death, incapacity, creditor claims, family disputes, spendthrifts, misadministration, punitive or double taxation, and lack of privacy. Digital assets are also exposed to such risks. Trusts protect assets, including digital assets, by uniquely enabling the separation of legal ownership from the beneficial use or enjoyment of assets, and they offer families the ability to set out exactly how they would like their assets to be held and distributed in the long-term. Trusts significantly mitigate the risk of wealth depletion that is inherent when assets are simply held directly, or even via companies, and they allow for the much smoother passing of assets between current and future generations.
Depending on the country(ies) and related tax rules, trusts can also potentially assist with traditional gifting strategies to mitigate estate or inheritance taxation. If those predicting a significant increase of Bitcoin are correct, gifting such assets to a family trust now whilst the value is lower can defer or even potentially reduce related estate or inheritance tax exposure.
Another important but not often talked about benefit of a trust with a professional trustee relates to the relative lack of physical attributes of digital assets. A trust provides comfort to heirs that such intangible assets are held properly and securely over time. This is important because digital assets are not as easily discoverable as other investments and leave little to no paper trail.
At the same time, it cannot be denied that many digital assets, such as cryptocurrencies, tend to be viewed as high-risk assets relative to most other potential trust investments. Values can be volatile, the market is currently mostly un- or under-regulated and susceptible to risk from fraud, and assets may be under-insured or not insurable. Such risks must be considered and mitigated, for example in the terms of the trust, how the asset is administered and what proportion of the trust fund it represents. Having said that, these same considerations were also prevalent in the early days of the now-mainstream alternative asset classes noted above and no doubt will similarly relax as the supporting ecosystem for digital assets continues to evolve.
Finally, a major discussion point around Bitcoin these days is the enormous amount of energy consumed by the ‘mining’ of Bitcoins and other cryptocurrencies; more specifically the computing power and energy needed to run the process by which a Bitcoin is awarded to a computer that solves a complex series of algorithms. This focus on energy use (or waste) is gaining pace in the cyptocurrency space, particularly with environmental, societal and governance (ESG) considerations on the rise for many UHNW and institutional investors – especially amongst those same younger generations exhibiting an increased appetite for digital assets. This focus will, in turn, extend to trustees.
How trustees can come to terms with digital assets
Ultimately, it is vitally important for trustees to thoroughly scrutinise any digital assets that they wish to invest in or hold on the terms of the trust, to ensure that they're acting in the best interests of the beneficiaries and of the trust as a whole, and that they're discharging their fiduciary duties effectively.
This means that institutional and individual trustees are constantly being encouraged to familiarise themselves with a range of topics, including how digital assets function, how they are acquired, how they must be managed and how they can eventually be distributed to a trust’s beneficiaries.
From this, it is clear that although cryptocurrency and digital assets may have made certain transactions simpler, they have also added a further layer of complexity to the succession planning process. That being said, with the fast ascendancy and growing institutional acceptance of digital assets, advisors will inevitably begin to interface more and more with this asset class. As such, as with other alternative assets in the past, it is only a matter of time before they develop a natural comfort and entrenched expertise in applying the broad spectrum of solutions that can be used to address the succession planning challenges related to this new and exciting asset class.
Where IQ-EQ comes in
From the above, it is clear that, for this new and innovative asset class, UNHW individuals, executives, entreprenuers and/or their family offices need a trustee that not only understands digital currencies and the DLT sector but also keeps pace as it evolves at speed.
At IQ-EQ, our growing digital assets administration team supports our trust and fiduciary businesses worldwide and is conversant with all relevant aspects of digital currencies, blockchains and DLT. Our specialists have experience of the innovative financial channels, instruments and systems that are transforming the sector.
Most crucially, our team also works directly with leading financial centres and their regulators to support the development and regulation of this emerging asset class, which is especially important as the sector gains more recognition and support from investors, governments, central banks and wider industry globally.