The digital assets topic is increasingly visible in mainstream media and day-to-day life, whether through the ever-changing value of crypto coins, retailers seeking to accept payment from a digital wallet, or large companies taking and divesting significant positions in one or more crypto coins. Some countries have even started to move their title registries for public land into blockchain-based registers, moving ownership of physical assets into the digital domain.

Through this increased exposure, investors are increasingly considering whether to hold these assets – and whether to hold them in either wealth planning or succession structures. The increased exposure to digital assets, therefore, prompts the inevitable question: Can digital assets be held in a structure such as a trust, and if so, what needs to be considered?

What are the different types of digital assets?

We distinguish between three main types of digital assets:

Payment token: Digital tokens or coins represent a value stored on a blockchain. In broad terms, these assets are generally valued based on supply and demand considerations.

Security/Asset tokens: Rights to either complete or fractional interests or rights in/rights to hold these assets are represented by a token on a blockchain. Whilst the token represents ownership, the value lies elsewhere. Tokens of this nature can be fungible. However, there are non-fungible tokens (NFTs) as well, which are attached to a specific right to an asset and may be coded to behave in a certain way when transferred.

Utility tokens: These generally have a special purpose, such as providing access to social media accounts, purchased digital music, photos, etc. Careful planning is required to ensure that the value and services for which they provide access are not lost upon one’s death, as is highlighted by an awareness campaign of the Society of Trust and Estate Practitioners, which recommends that users establish legacy settings in these accounts.

Next, we take a look at the four most important considerations before holding digital assets in structures such as trusts.

1. What are common ownership issues when it comes to digital assets?

Practical ownership issues

Tokens are commonly ‘held’ and accessed through a digital wallet, which is personal to the owner. The wallet address is shared publicly (like a bank account number) and used to transfer tokens to it. The tokens themselves are actually stored on the respective blockchain, and the wallet contains the private key (think of this as a password), which allows the user to see the content and transfer assets to another wallet.

There are two main ways in which value can be lost from a wallet: (1) by accidentally disclosing a private key or (2) by losing the private key.

These risks could be addressed by using a regulated and insured custodian. Initially, this might appear to be somewhat counter-intuitive, as the approach seems to contradict one of the key founding principles of blockchains: a decentralised system. However, the involvement of a centralised, accountable institution, which has an incentive to protect its own reputation, gives investors a greater sense of comfort when dealing with such an unfamiliar technology. Therefore, investors must weigh up these factors to determine the most suitable way to hold digital assets based on their own priorities.

Special ownership issues for trustees

Trustees are under an obligation to safeguard trust assets under their control. Therefore, they need to ensure that (1) they can trace and prove the ownership of any crypto assets in the trust fund and (2) no one else has access to them. This leads to the question of whether and with which safeguards a trust company (and its staff) should have access to wallets.

Furthermore, a trust company must determine how the private keys can be safeguarded and whether they can reduce the risk of internal or external fraud by using a custodial institution that is accountable for security, safekeeping, reporting, and loss. This will likely mean, for example, that a trustee will not agree to take over an existing wallet controlled by the settlor, as it will not wish to share control (in case the settlor later makes unauthorised transactions). Rather, the trustee would instead wish to ensure that the digital assets are transferred to a ‘clean’ segregated wallet or to a custodian.

Ultimately, each trustee will need to determine a holding strategy that balances its risk appetite with legal and regulatory requirements.

2. What investment liability issues can occur?

When it comes to trustee investments, there are generally two main operating models through which the trust investments are made, which we refer to here as the traditional approach and the alternative approach.

Some digital assets are volatile in nature, meaning they can fluctuate in value, which may cause difficulties for any trustees who are liable for any investment losses caused by imprudent investing. Likewise, many NFTs may only have sentimental or speculative value. Therefore, if trustees are willing to invest in such assets, it will likely only be a very small share of the trust fund. Those who would like their trustees to invest in such assets will therefore need to consider reserving investment powers for themselves or their choice of investment advisor to ensure that the trustees are able to retain any digital assets transferred to their trust.

A further structuring consideration may involve the use of ‘nominated’ or ‘designated companies’ as part of the trust fund, perhaps controlled by the settlor or another third party, which would allow the trustees to take a less hands-on approach for the day-to-day management or trading of these assets. This strategy needs to be considered against the background of any regulatory requirements on the trustees to monitor transactions and safeguard the assets.

3. What about regulations and digital assets trustees?

Trustee regulation in the area of digital assets is still relatively immature in most jurisdictions. Any trustee will, however, need to take account of any guidance issued by its own regulator, whether generic or specific to an asset type. Trustees operating in jurisdictions where no guidance has been issued will need to be especially cautious. An absence of guidance is more likely to make a trustee operate more conservatively for fear that existing regulations will be interpreted in a way that the trustee did not anticipate.

Furthermore, if new regulations are introduced that hinder the way the trustee had been managing digital assets to date, this may require a rethink of the strategy agreed with the settlor.

4. What about tax and digital assets trustees?

The way in which trustees hold or segregate digital assets may also be influenced by the tax rules applicable to the trustee, settlor, or beneficiaries of a trust. Various countries have established formal (or informal, but likely binding) positions on the tax treatment of digital assets, which may affect the way a trustee holds or manages digital assets, for example, by pooling all assets within the same wallet for capital-gains tax purposes, or keeping assets segregated, as the case may be.

Furthermore, the location in which digital assets are deemed as being held may also play a role. For example, some countries treat crypto assets as a currency, while others treat them as ‘property’, resulting in different tax outcomes if sold at a gain or a loss. Trustees must take advice and monitor the position to avoid making costly mistakes.

Please note: the information provided is for educational purposes only.