Cryptocurrency in Divorce Proceedings

Is Cryptocurrency the New Swiss Bank Account?

Imagine you have a coin that is worth thousands of U.S. Dollars. Except unlike the traditional coin that you can hold in your hand, this coin only exists digitally. This is the concept behind Bitcoin, the first and most well-established class of cryptocurrency. Cryptocurrency is a new class of asset that is becoming increasingly popular, not only in the United States but across the world. Cryptocurrency defies the traditional notions of “currency”, in the sense that there is no central issuing authority or governmental regulatory body. Exchanges and transfers of cryptocurrency are encrypted so that each exchange or transfer is anonymous, the data is decentralized, and no third party can control the currency.

How Do Bitcoin Transfers Work?

In order to help clients or spouses of bitcoin holders, it is helpful for divorce lawyers to have a basic understanding of how bitcoin is exchanged. Bitcoins are exchanged over a worldwide peer-to-peer network. Every time a bitcoin is exchanged or transferred, there is an “entry” on a global, decentralized ledger known as the “blockchain.” A helpful analogy to explain the blockchain is thinking about it like a giant, worldwide poker game where the players left their chips and cash at home. In order to keep track of all the transactions, multiple players keep their own ledger on their own notebooks and compare their lists of transactions to catch any discrepancies. You can think of each “page” as a “block” of transactions “chained together” on a ledger, hence the name “blockchain.” Therefore, for each proposed bitcoin transaction, the bitcoin holder will need to announce to the network their account number, the account number of the person they are sending bitcoins to, and how many bitcoins they want to send. This ensures the blockchain is updated with all bitcoin transactions.

Tax Consequences of Bitcoin Transfers

An often-overlooked issue when dealing with bitcoin and divorce are the potential tax consequences of bitcoin transfers. The IRS considers bitcoins as capital assets subject to capital gain or loss treatment on all sales and exchanges. In fact, earlier this year, the IRS specifically issued a statement warning that “taxpayers could be subject to criminal prosecution for failing to properly report the income tax consequences of virtual currency transactions.” There are two recommended approaches for tax reporting for bitcoin transfers/exchanges: (1) Convert Bitcoin to U.S. Dollars for each purchase and sale transaction using the Bitcoin market price that day in U.S. Dollars, or (2) Use Bitcoin as a functional currency, using an average Bitcoin vs. U.S. dollar conversion rate for the tax year. Regardless of the approach a bitcoin holder utilizes, the potential capital gains are substantial and should be contemplated in a couple’s marital settlement agreement or final judgment.

Cryptocurrency in Divorce Proceedings

Divorce is difficult and you often times have trust issues between the spouses when one believes the other is hiding money or property to gain an advantage during the divorce proceedings. The difficulty is seeing another layer in this day and age of virtual currencies, such as Bitcoin, that are easy to hide and have values that extremely volatile and difficult or impossible to determine.

Bitcoins: Treated Like Cash but Mined Like Gold

There is also the potential to “mine” cryptocurrency. Mining is the terms used to describe the creation of new units. This needs some explanation:

How to “Find” and Transfer Cryptocurrency

To give you an idea of how the value of bitcoin has grown over time, the first retail purchase using bitcoin was on May 22, 2010, when a guy in Florida paid 10,000 bitcoins for two pizzas worth $25. At the time, bitcoin had an exchange rate of a few cents. Today one bitcoin is worth $11,390. Those pizzas in today’s value are $113,900.00.

Discovery Requests and Seeking Evidence of “Virtual Currency”

It is important to formally request documentation concerning cryptocurrency as you would any other financial account. Initially, you would take a look at all of the financial statements for signs of cryptocurrency transactions. Look for large, unexplained cash withdrawals and entries showing “localbitcoins.com” or other peer-to-peer sites on a bank statement and outgoing wire transfers could be a clue.

  • All documents showing public IDs or public keys you have used to transact in Virtual Currency
  • All documents relating to the person or entities you have transacted in Virtual Currency
  • All documents related to your purchase of Virtual Currency including the source of funds used to purchase, the person or entity from whom purchased, and the time, date and manner of the purchase
  • All documents and communications related to the purchase of equipment or software used to mine Virtual Currency (again you will need to define “mine”)
  • All documents and communications related to the amount of Virtual Currency you acquired, owned or held at any time through mining

Web-based Wallet Address, Hardware Wallet and Private Keys

Keeping in mind there may not being any document trail if the cryptocurrency is being kept in a web-based wallet or moved to a hardware wallet which is a USB memory stick that stores your private bitcoin key and requires you to use that USB to transact without exposing your “key” to the internet where it could be vulnerable to hackers. A private key is a secret, alphanumeric password/number used to spend/send bitcoins to another Bitcoin address. It is a 256-bit long randomly selected number which is generated as soon as you make a wallet. This is how the Bitcoin private key looks (it always starts with 5):

  • Have you ever owned any form of cryptocurrency?
  • Does anyone hold any cryptocurrency for you?
  • Do you or have you ever had any form of an e-wallet?
  • If you have cryptocurrency account, what exchange(s) do you use?
  • What are your wallet address, private key, and public key?
  • Have your reported capital gains on any virtual currency exchanges?

Be Aware of Cryptocurrency Issues in Divorce

Many attorneys and people generally stray away from addressing cryptocurrency holdings because they are new and foreign concepts to them. However, at the end of the day, cryptocurrency holdings are conceptually very similar to stock or stock options, which family law attorneys deal with regularly. The question at the end of the day becomes if a spouse wants to ride out the risk of taking a coin “in kind”, or if they want to just take a cash buyout/offset against other assets up front. The most important takeaways are to become knowledgeable about this new type of currency including its associated tax consequences, adjust your discovery requests accordingly, and understand how to transfer it or calculate a buyout in a final divorce settlement.

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