LEVATUS Perspective | Crypto Currency, Digital Assets and Divorce – New Tool Kit Required
Six ways crypto assets differ from traditional assets in divorce
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As crypto currency and digital assets have gained visibility and acceptance, they have become a growing percentage of retail investors’ portfolios. With this, they have also become an increasingly frequent and significant component of assets handled in divorce. Proceed with caution, the rules of the road are unique and their impact on outcomes can be large.
According to an August 2021 CNBC survey, 1 out of 10 Americans are investing in crypto assets. The rapid growth of this asset class is causing many professionals to reevaluate and refine their processes to accommodate the unique nature of crypto assets. Divorce takes these adjustments to the next level. Understanding where and how the proceeding can differ from a divorce with more traditional assets, can help everybody avoid potentially stressful and costly situations. The following highlights a few important differences.
Crypto Vocabulary
It is completely reasonable to feel confused or even slightly overwhelmed by cryptocurrency, especially if you are new to the space and trying to figure it out while going through divorce.
One of the main reasons why it can be hard to grasp is that there is practically a whole new dictionary of terms that are used. Having a basic grasp of this new crypto-specific vocabulary can be a huge step forward in your comprehension and overall confidence when dealing with these assets. A great way to start gaining control is to understand the following terms:
o Altcoin: A term used to describe any crypto currency that is not Bitcoin. Ether (ETH), the transactional token on the Ethereum network, is currently the world’s largest altcoin.
o Bitcoin: A decentralized digital currency that relies on peer-to-peer software and cryptography. Bitcoin was the first crypto currency and is currently the largest.
o Blockchain: A digital ledger that records all the transactions ever made in a particular cryptocurrency.
o Gas: Gas is a fee that is paid to make a transaction on the blockchain.
o Mining: The process of verifying new transactions on a blockchain.
o Wallet: A crypto wallet keeps your coins or tokens safe by storing your private keys, which provide the ability to prove ownership or spend the funds associated with your public address. You can send, receive, and spend from your wallet. A software wallet (also called a “hot” wallet) is directly connected to the internet, which makes accessing your wallet and trading crypto convenient. Some popular ones are Coinbase, Kraken, Metamask or Gemini which generally have user-friendly interfaces and have some form of customer support in case you lose your password. The downside of an online wallet is that it is less secure than a hard wallet (also called a “cold” wallet). A cold wallet is secure as it is a physical storage unit (some look like a USB drive) that is kept offline in a spot that only you can access. The drawbacks of a hard wallet are that it can be lost and there is no way to retrieve a lost password.
2. Well-defined list of marital assets to include all digital assets and crypto wallets
While having a clear list of marital assets is required with any divorce, it is uniquely important with crypto currency to have the details, such as the name of each holding, the exact number of coins and where they are held, nailed down.
Currently, there are thousands of coins, tokens, and crypto currency funds with each differing in the types of wallets they can be held, the manner in which they can be transferred, their ability to be sold (liquidity) and the amounts of fees associated. For example, the larger coins (bigger market cap) such as Bitcoin or Ether can be held on almost all wallets such as the ones mentioned above or even more traditional players like PayPal and Venmo.
Bitcoin and Ether are extremely liquid and can be sold at any time, 24/7. However, a number of smaller altcoins are unable to be held on the most popular digital wallets and can be challenging to sell for U.S. Dollars. Once you have received the list of crypto assets, it is helpful for you to review and plan for each currency with the help of your advisors. It is important that the list is updated frequently as the value of crypto currencies is extremely volatile and can swing drastically from day to day or even hour to hour.
3. Cost Basis
One area that is not unique to crypto assets is that if there is a gain on the sale of the asset you are expected to pay taxes just as you would with other assets.
However, tracking down the cost basis, the price paid and date of acquisition, for crypto is trickier than with more traditional investments. It is relatively easy to find the cost basis information on a stock by looking at your account statement and when a stock transfers from account to account, the cost basis generally moves with it.
The purchase price of the crypto asset isn’t as easy to find and track so it is important to have a solid understanding of the cost basis for each coin. Cost Basis information can be found through some wallets or by utilizing tax software like Cointracker.
It is important to have a solid understanding of the future tax consequences for the sale of the assets for planning purposes as well as making sure each party has a clear understanding of their individual tax liability. Also, when the assets are divided, make sure there is a plan for splitting the tax lots fairly so that one party doesn’t incur an outsized tax bill.
4. Mechanics of transfer
The mechanics of actually moving your crypto is perhaps the biggest and most stress-inducing differentiator of all. When crypto assets are transferred, they need to go from one individual’s wallet to another’s. In order to initiate, the sender will need the coin-specific address of the receiver’s wallet.
Meaning that within your Coinbase account, you have a unique address for each coin. For instance, if you are set to receive both Bitcoin (BTC) and Ether (ETH), you will need to provide the sender with two addresses. Making sure the asset is sent to the correct address is of the utmost importance because if there is a mistake, there is no way to reclaim the lost asset. It is best practice to do a “test” transfer for a negligible amount of money to ensure receipt before sending a large amount. Please keep in mind that some wallets have limits as to how much crypto can be sent daily which could stretch the process out over the course of a few days and require more coordination between parties.
5. Asset Allocation decision making
This is important for all portfolios; crypto currency is unique because it is an extremely volatile and early-stage investment. A few things to consider when deciding if you want to hold digital currency as part of your investment portfolio:
o What are my current cash flow needs? If you are counting on the crypto assets to fund you day to day expenses, then it could make sense for you to liquidate out of this highly volatile asset class. It can be very stressful if you are counting on these assets to pay your bills as it can easily swing up to 20% per day.
o How much crypto exposure do I want? If you don’t necessarily have to sell the crypto portion of your settlement, you should actively decide how much to hold. There are a number of factors you should consider such as your risk tolerance, long term goals, income, and current portfolio allocation. Levatus recently wrote an article, Who’s Afraid of the Big Bad Crypto Currency Wolf’? Is It Portfolio Managers?, that addresses this decision.
o What are the tax consequences of selling? As mentioned in the Cost Basis section above, when the crypto is sold at a gain, you should expect to pay capital gains taxes. By accepting crypto currency into your portfolio, you may need to sell a larger percent of it to bring the overall risk of your portfolio down to a more acceptable level. Once the sale is made it is helpful to consider how much of it you will owe and set that amount aside in a separate account.
6. How to sell crypto
Once you have decided to sell your crypto assets, you can process the trades on an exchange. Many digital crypto wallets have exchanges built in that make buying and selling painless by having a clear and easily navigable user interface. However, these sites typically have higher fees.
There are other exchanges that may look a little more intimidating, such as Coinbase Pro, but have drastically lower fees. By spending a little time researching different exchanges, you can potentially save hundreds and thousands of dollars.
Once you have sold the assets for U.S. dollars, most exchanges make it relatively quick and easy to transfer the proceeds to your bank account. Generally, there will be an option for a wire transfer (same day processing, but there can be a nominal fee) or and ACH transfer which is free but can take 3-5 business days to settle in your bank account.
Going through a divorce is stressful enough, but when faced with a complicated emerging asset class like crypto it can feel overwhelming. The digital asset space is extremely volatile, not only concerning the value of the assets, but also as it relates to the rules governing these assets. Having team members, your attorney, accountant, and financial advisor, with crypto experience and knowledge can be an immense relief in this ever-changing landscape.
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