Business LawTax & Estate Planning

Not your traditional asset

By July 6, 2021 July 7th, 2021 No Comments
Business Law

Not your traditional asset

Lawyers need to get up to speed on the risks associated with handling digital assets for their clients.

Click here to view this article as originally posted in the CBA National.

Love it or hate it, Bitcoin ownership continues to gain steam in Canada and around the world. A 2021 study estimates that 1.2 million Canadians (3.2%) hold Bitcoin. This year also saw the release of several Canadian Exchange Traded Funds (ETFs), allowing Canadians to invest in Bitcoin without the technical difficulty of storing it. Significant price volatility since its inception have not lessened demand for Bitcoin and the new approach to value that they offer.

Bitcoin is just one of an emerging class of digital assets — among them Ethereum, ERC-20 tokens, Non-Fungible Tokens (NFTs), stablecoins, and a host of other emerging protocols where transactions are permanently recorded in a blockchain across a network.

As adoption grows, individuals, families, and businesses who hold digital assets will inevitably end up as clients in all types of legal practices. Litigators, family lawyers, wills and estate practitioners, tax experts, business advisors and insolvency lawyers are, in one way or another, going to stumble across issues related to digital assets.

It is crucial for lawyers to understand that digital assets don’t operate like traditional assets that they deal with on a daily basis. In simplified terms, transactions are grouped together into a block, which is then attached to block immediately preceding it. In Bitcoin’s case, a new block is created every 10 minutes and each block can contain upwards of 3000 transactions (whatever can fit within 1MB of data). Just by way of example, here is a link to Block 688,618 which was processed on June 23, and contains 3,314 transactions transacting 29,285 bitcoins ($1.2 billion Canadian).

That design creates a permanent ledger of every transaction ever completed on the network. Each bitcoin in existence can be traced back through all its owners to an origination point where that bitcoin was created (through mining). It’s why transactions cannot be reversed, cancelled, or altered once they are placed into a block and added to the chain, even if too much of a digital asset has been transacted or sent to an incorrect address.

Because of their design, of digital assets require a digital signature to complete a transaction. Digital assets are held in addresses and each address has a corresponding private key which allows that address to authorize a transaction on the chain. In a real sense, the private key is the representation of the digital assets in the real world.

Accordingly, proper security methods, planning, and protocols around private keys are an essential component of legal practice involving digital assets, which involve a number of questions. Does an appointed executor have sole access to the private keys so that they can implement a documented estate plan? How does a business offering digital assets up as security technically provide such a guarantee? These are all difficult questions that are addressable through technical solutions, and not necessarily legal ones.

Improper key management by either losing it or allowing a nefarious actor to access it can result in a complete and irreversible loss of the digital assets held in the wallet. Just recently, the crypto-services provider Fireblocks failed to properly back up a set of keys. The original key was lost and with it, $75 million of Ethereum became forever inaccessible. A lawyer who is responsible for safekeeping a private key without proper training could make similar errors and face significant professional liability.

Particularly in wills and estate practices, lawyers often assist their clients in storing documents, passwords, and account information that will assist the executors in administering the estate after a testator passes. To do that with digital asset private keys, a lawyer must have significant technical experience.

There are technical solutions that can assist in reducing risk and exposure for both lawyers and their clients. Multi-signature addresses can be set up requiring multiple private keys be used to authorize a transaction. A typical multi-signature setup could rely on three of five private keyholders authorizing a transaction. This sort of arrangement would allow a lawyer to assist in a corporate or estate plan by holding a private key without being a single point of failure. Again, these are not legal solutions but technical ones that the advising lawyer must be competent in creating and managing.

Opinion on the long-term viability of Bitcoin and digital assets vary and I have had many lively discussions with their detractors. However, even skeptical lawyers must take their clients as they find them. A lawyer’s skill in navigating this new technology doesn’t lie in case law or a robust precedent. If they are to protect their client’s interests, they need to take time to truly understand the underlying technology so that they can give proper legal advice, while being aware of their limitations. Treating digital assets in the same way we treat other asset classes is a recipe for disaster.

Invitation for Discussion:

If you would like to discuss this blog in greater detail, please do not hesitate to contact Geoff Costeloe.

Disclaimer:

Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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