The crypto succession conundrum

The benefits of decentralisation, cryptographical security and anonymity, which make crypto-assets so appealing to many, are also the things causing real issues when such assets form part of a person’s estate on death.

Although nearly all ‘traditional assets’ leave a breadcrumb trail to be followed by personal representatives (PRs) on death, the decentralised nature of crypto-assets makes them less easily identifiable. Even if found, the cryptographical security that encapsulates such assets could leave them inaccessible on death if private keys and seed phrases are not made available to PRs.

Even if access information is made available to PRs, the apps on laptops and mobile phones, as well as hardware wallets and external hard drives that are used to hold wallets and ultimately access crypto-assets, may all be unknown to PRs.

How such apps and devices (as well as the crypto-assets themselves) are made known to PRs therefore poses an equal challenge to the need to leave access details on death.

This practical difficulty in dealing with digital assets is compounded further by how such assets can devolve on death, as ‘digital wills’ are not enforceable in England and Wales (nor in many other jurisdictions). It is therefore necessary to have a validly executed physical will to ensure the correct devolution of such digital assets. When coupled with the challenges of leaving a breadcrumb trail, be it physical or otherwise, this creates a complex crypto succession conundrum.

Current solutions

The current answers to this problem vary, from very basic planning whereby people write down private keys and seed phrases and leave them ‘somewhere safe’ in the hope they are discovered on death (and, arguably more importantly, remain safe during their lifetime), to online solutions involving, in essence, custodial services of data, which are made available on death.

Pen and paper

There seems to be a general reluctance from holders of crypto-assets to write down private keys and seed phrases, in fear that if such information were discovered during their lifetime it might result in fraud. Although this is understandable, it does not help to unpick the crypto succession conundrum.

One point to note is that if clients do not intend to make access information known on death they would be well advised to leave a letter of wishes explaining why their crypto-assets will not be accessible on death. This will then ensure that PRs and/or beneficiaries avoid the additional time and cost of trying to recover crypto-assets, which will invariably be inaccessible until technology enables the decryption of private keys and seed phrases.

Online custodial services

A more natural solution for many clients is found online through custodial services enabling the secure storage of private key and seed phrase data during lifetime, only to be released on death. Such services often include an element of cryptographical security and some are fully decentralised to provide peace of mind and reassurance to account holders. They enable the account holder to nominate guardians to, in essence, provide multi-factor authentication of the account details once notified of the death of the account holder. Many services go one step further and enable the account holder, during their lifetime, to nominate a beneficiary to receive the private keys or seed phrases to take the crypto-assets therein beneficially.

In solving one problem regarding passing on access details, however, such data custody services arguably create another due to a lack of distinction between legal and beneficial ownership. When nominating someone to have access to private keys and seed phrases, will they hold the crypto-assets on death as nominees for the benefit of others, or is the intention for the beneficial interest to pass to them?

If the former, will the nominee ensure the assets are distributed in line with the deceased’s will, particularly if the nominee is not a PR? If the latter, unless the wishes are effectively incorporated into a validly executed will, the beneficial interest will not pass in line with the nomination but will instead form part of the residuary estate. If the nominee and residuary beneficiaries are different, then this could lead to costly litigation to ascertain who should benefit from the crypto-assets. There is also the practical point that the nominee will not experience the delays encountered by traditional assets where a grant of representation is required and may well have moved the assets out of the deceased’s wallet and be long gone before PRs can try to take any action to recover the assets.

A final point to note is that the data custodial services often involve a third party, which can be counterintuitive to those who favour crypto-assets due to their decentralised nature. Therefore, the current solutions may have limited benefits and appeal.

The smart wallet solution

A smart wallet is also known as account abstraction. This, in essence, allows one’s wallet to be governed by a smart contract. The smart contract can be programmed to enable private keys to be rewritten through social recovery, to avoid the account holder being permanently locked out of the wallet.

Social recovery

Social recovery allows the account holder to retain the private key used for accessing the wallet and effecting transactions, but it enables ‘guardians’ to be named who can then, by majority, rewrite and create a new private key if the original is inaccessible. The guardians can be friends, family or trusted advisors.

Although similar to the data custodial services mentioned above, social recovery arguably takes this one step further as the private key does not need to be disclosed to anyone, and the social recovery process can be implemented by the guardians directly once they are notified of the death of the account holder. This also moves towards distinguishing between legal and beneficial ownership because, through social recovery, the guardian’s primary purpose is to verify the creation of a new private key rather than have access to and use of the private key, which could be construed as giving them beneficial ownership.

Multi-signatory authorisation

Smart wallets also allow for multiple signatories to authorise transactions relating to the wallet. This could therefore lend itself to the creation of legacy wallets, whereby crypto-assets are placed in a smart wallet and programmed for all transactions to be authorised by the testator and the intended beneficiary. It would be assumed that no transactions would occur during the testator’s lifetime but, on death, the beneficiary would be aware of the wallet, inform the executor and obtain access through the executor completing the multi-signatory process, so authorising a transfer to the beneficiary. This would still give the executor control if any crypto-assets in the wallet were required to settle an inheritance tax (IHT) liability while ensuring the breadcrumb trail
for the wallet was evident but also secure during lifetime.

One potentially ambiguous point to note with this approach, however, is whether such a wallet would be viewed in the same way as a joint account (and therefore treated as such on death). If so, it would mean that the doctrine of survivorship would apply to the wallet and pass to the surviving signatory outside the terms of the will. Half of the balance of the wallet could also be viewed as a gift for IHT purposes and could raise questions as to whether it would be a failed potentially exempt transfer for IHT purposes if the account holder died within seven years of creating the wallet, or whether it would be a gift with a reservation of benefit given the possibility that the deceased could have accessed all of the funds, albeit subject to the approval of the other signatory.

Despite the benefits that smart wallets offer, they do not fully resolve the crypto succession conundrum. The above ambiguity highlights the need for clients to continue to engage with ‘traditional’ succession planning. Including a specific legacy of a wallet in a validly executed will, or acknowledging that it forms part of the residuary estate and passes accordingly, is still key to the devolution of crypto-assets on death. Although this analogue approach to digital assets may not be appealing to some clients, it is clear that it is essential to ensure their wishes are fulfilled on death.