Over the past decade, we have seen an increase in crypto-currency trading. Crypto-currencies are commonly known as ‘digital’ or ‘virtual’ currencies that are based on decentralised technology, such as blockchain. Unlike a conventional currency, it is not underwritten by the government. You may be familiar with bitcoin – a type of crypto-currency. Although generally held as investments, crypto-currency users can exchange their digital currency for goods and services or can trade them for a profit. 

According to a Cambridge University study, the number of crypto-currency users has surged to 101 million investors. Despite the popularity of crypto-currencies, the Financial Conduct Authority (FCA) has placed a ban on crypto-derivates for retail investors – which came into force on 6 January 2021, owing to the potential for consumer harm that stems from crypto-currency's volatility. Below are some legal issues that may arise in crypto-currency trading. 

Crypto-divorce

Crypto-assets are inevitably going to present major problems in divorce proceedings. The non-disclosure of crypto-assets creates growing concerns over fraudulent misrepresentations. It is the duty of each party to provide an accurate account of their financial position – but how likely is each party to disclose the full extent of their financial position? After all, feuding partners attempting to withhold their assets has become relatively commonplace.

If you happen to own crypto-currencies, you will be aware that the ownership of crypto-assets will typically be of those who have access to both crypto-graphic keys – a public key and a private key. Further disputes will arise as to the ownership of the crypto-assets. Given the volatility of the crypto market, valuing crypto-currencies and deciding on the best way to divide the assets will be a challenge as the price is likely to fluctuate during divorce proceedings. A freezing injunction to secure crypto-assets is an option under section 37 of the Matrimonial Cause Act 1973 to prevent the disposal of crypto-assets until a decree absolute is produced. With limited regulation, it will be difficult to secure crypto-assets – resulting in delays to financial settlements.

Crypto-currency estate and inheritance planning

Another key question is who does this ownership get passed to when someone dies or loses capacity?

HMRC have confirmed that crypto-currencies are to be treated as ‘property’ for inheritance purposes. This will have implications on estate administration such as the payment of inheritance tax as it will become increasingly difficult to convert crypto-currency into pound sterling. As many investors are unprepared for crypto-currency inheritance, individuals will need to leave instructions on how to access their digital wallet. This may be by way of storing an inventory with the client's lawyer. Without this, such assets are gone forever.

Often buyers forget that crypto-assets are a taxable economic activity such as capital gains tax. Efforts are being made by HMRC to tackle tax evaders. As of 10 January 2021, it is a criminal offence to operate in the sale of crypto-asset activity without registration with the FCA. This highlights the importance to disclose any profits made on crypto-currency investments to HMRC, or risk being reported by such organisations due to the tightening of regulations. It  is likely that HMRC will be reaching agreements with further organisations to obtain information on users. All of this has practical implications for lawyers who are involved in the inheritance planning or administration of estates involving crypto-assets.

Crypto-cyber-threats

Arguably the greatest weakness of crypto-currency is data breaching. Cyber issues are present in any transaction but protecting assets intertwines with cybersecurity. In the virtual world, your funds are not protected so they can be subject to hackers. Increasingly, victims of data breaches may seek to claim against the organisation such as crypto-currency wallet services or crypto-currency trading platforms for failing to maintain effective security processes. Mitigating the damage of cyber-attacks is an option through the analysis of standardised data and code, tightening of regulations, and the monitoring of crypto-currency platforms. Claiming compensation against these platforms is possible, but not through the usual protection channels such as the Financial Services Compensation Scheme (FSCS). Taking cue from AA v Persons Unknown & Bitfinex [2019] EWHC 3556, the courts will need to use blockchain analysis companies to trace the origins of the assets and the point at which interception was made. Lawyers must keep up with the capabilities of modern technology to combat crypto-cyber-threats.

Crypto-crime

Moreover, crypto-currencies have become the favoured currency to facilitate money laundering and tax evasion. Crypto-currencies present further issues across the globe, giving rise to cross-border disputes. Let's consider the dark web. Following a cyber-attack, hackers can sell encryption codes on the dark web. The ease of accessibility and transfer means that the perpetrators and victims may reside in different jurisdictions. Anonymous trading makes it difficult to trace back to an individual, but not impossible. With the advances of modern technology, it is becoming increasingly possible to follow the trace and track down suspected criminals. However, the question arises as to which legal jurisdiction governs the rights of those involved and should a caveat emptor be applied to transactions? 

Preventing the trading of crypto-derivatives may not be such a bad thing considering this may indirectly reduce volatility as fewer people will retain their money in exchange. Ironically, if more people are spot trading (ie, buying the actual crypto-currency and not the derivatives) they will have full control of their funds. Finally, this may stabilise the institutions providing crypto-currencies with greater regulation to drive robust systems. The EU Directive 2018/843 on the Prevention of Money Laundering and Terrorist financing enacted in the Money Laundering and Terrorist Finance Regulations 2019, is an example of the regulatory advances of the crypto-market. This makes it compulsory for crypto-currency organisations to apply due diligence procedures and to report suspicious activities. For certain, this is an area that will bring in more work for practitioners.

Along with the recent announcement of Tesla’s investment in Bitcoin, the reality is cryptos are here to stay. It will be interesting to see how the legal sector tackles the challenges in locating and distributing crypto-assets.